Econ 201- Erica Birk: Week 1, Chapter 1 Mon 9/26/16
Economists study decision making and the effect(s) of those decisions • What are the costs of the decision?
• What are the benefits of it?
Policy-makers ask questions that economists try to answer
Economics: the study of how people allocate scare resources to satisfy unlimited wants
Scarcity: the limited nature of society’s resources, given unlimited wants/needs
MICROeconomics: the study of individual units that make up an economy
MACROeconomics: the study of the overall aspects and workings of an economy. Macroeconomics involves foundations found in microeconomics
Prices: the ratio at which two goods are exchanged in a market. Measured in:
We also discuss several other topics like What is a paradigm? how does is shape research?
• Costs beyond money:
You cannot change one price without changing the price of a related outcome
The Five Foundations of Economics
1. Incentives: factors that motivate a person to or to not act Positive Incentives: Encourage actions that bring about good outcomes
Negative Incentives: Encourage actions to avoid bad outcomes Direct Incentives: The obvious incentives of a policy
Indirect Incentives: The more difficult-to-recognize incentives of a policy
2. Trade-Offs: In order to achieve one goal, you must give up another. What will bring about the best outcome?
Is the trade-off worthwhile?
3. Opportunity Cost: the highest-valued alternative that must be sacrificed in order to get something else.
How much will that opportunity cost me?
Choosing the option that gives the largest benefit minimizes opportunity cost
4. Marginal Thinking: Evaluating whether the benefit of one more unit of a given thing is greater than its costs.
About deciding to do MORE or LESS of something you are already doing
NOT about deciding whether or not to do something at all
Diminishing marginal returns: All else held constant, increasing one input will eventually lead to negative returns If you want to learn more check out How should these goods be distributed?
5. Trade: Voluntary exchange of goods/services between two+ parties. Markets: Unite buyers/sellers to exchange goods/services
Comparative advantage: When an individual, business, or country can produce something at a lower opportunity cost than a competitor can Comparative advantage leads to specialties, where one party focuses all resources on one good/service
The bottom line: Which policy do you make, and why?
Econ 201- Erica Birk: Week 1, Chapter 1 Wed 9/28/16
Model Building and Gains from Trade
The entire world’s economy is too complicated to completely analyze for every economic question. We also discuss several other topics like What is universal instantiation?
• Economists use simplified models to study very specific questions
Economists use the scientific method to answer questions 1. Ask a question
2. Do background research
3. Construct a model to test hypothesis
4. Perform experiments
5. Analyze data- verify, revise, or refute hypothesis
Economists find explanations for the phenomena they observe using hypotheses
Phenomena are found and hypotheses are tested in the real world because most economic observations cannot be put into a lab setting
Nothing can be PROVEN. You can only show that, with given information, tests, etc., it cannot be refuted
NON-BIAS: Separate what IS true and what you WANT to be true • Not always the same thing Don't forget about the age old question of Who is the king of crete?
• Must be impartial
Use positive statements, avoid normative statements
Positive Statement: Observable phenomena- can be tested and validated. Describes “what is”
Normative Statement: Not (presently) observable phenomena- cannot be tasted and validated. Describes “what should be”
• Economists use positive statements
• Policy-Makers use normative statements We also discuss several other topics like What are some of the reasons we first use assessment tools when first meeting a patient?
• Simplified versions of reality designed to analyze specific components of the world
• Good models are easy to understand, have flexible designs, and make useful predictions
• Economists alter only one component of a model to test how that factor impacts the overall result
Important Econ Vocab: If you want to learn more check out Which is the better sentence when writing for the mass media?
Ceteris Paribus: holding all else constant
In a model, what can and what cannot be held constant?
• Endogenous Factors: Variables that can be determined within the model and are contained/controlled within it
• Exogenous Factors: Variables that we take as given. They exist outside the model and are not controlled within it
Production Possibility Frontier (PPF): A model that illustrates the combinations of outputs that a society can produce if all of its resources are being used efficiently
Example: An economy produces two goods, ceteris paribus PPF curves show the trade-offs between producing two goods • Goods can be made at the same rate
• Produce less of one good to create more of another
• Trade-offs are rarely constant
Law of Increasing Relative Cost: The opportunity cost of producing a good rises as a society produces more of it. Producers may be forced to manufacture other goods
Gains from Trade
Absolute Advantage: The ability of one producer to make more than another given the same resources
Ex.: Russia vs. U.S. producing fur hats and vodka
Table represents labor hours to produce each good
Russia has the absolute advantage
How many bottles of vodka must Russia give up to produce one fur hat? Russia’s Relative Price:
• To produce 1 hat, Russia spends 5 hours
• To produce 1 bottle of vodka, Russia gives up 2 hats
• To produce 1 hat, Russia gives up ½ bottle of vodka
United States’ Relative Price:
• To produce 1 hat, U.S. spends 6 hours
• To produce 1 bottle of vodka, U.S. gives up 2.5 hats
• To produce 1 hat, U.S. gives up 2/5 (6/15) bottle of vodka
Comparative Advantage: When a producer can make a good at a lower opportunity cost than a competitor can
U.S. has the comparative advantage
• Producers aim to exploit their comparative advantage
• Trade creates value, explains why countries with the absolute advantage would want to trade
Trade less now to have more later?
Not always, but sometimes useful
Consumer Goods: Products for present consumption
Capital Goods: Products that help produce other goods/services in the future
Investment: Using resources to buy/create new capital