Ch 01 introduction to economics micor and macro

introduction to economics

1. Introduction to Economics Ch 01

2. Introduction Economics is the way people make their living or is the study of how society copes with the problem of scarcity in human life. All societies, primitive or modern, and all individuals, young or old, male or female, white or black, speaking any language and living anywhere on the globe have to take part in some activity to fulfill their material needs. All have to work hard and make efforts to provide for food, shelter and other basic human wants. Study of all such efforts is economics.

3. What Economics All About? The origin of economics lies in our desires to have maximum quantity of material things. But we know that resources available for mankind are not unlimited. No society can produce goods in as much quantity as people desire, so difficulty arises in satisfying everyone’s demands. Individuals want to have food, houses, clothes, books, furniture, TV sets, telephones, medicines, movies and picnics etc. The government wants to construct roads, schools, hospitals, dams, airports and promote trade, industry or agriculture . All these things require money. But how to get money? Individuals can work and earn money. The government can do so by collecting taxes as well as printing of new money notes. Viewing in this sense, economics comprises the study of markets, supply and demand of goods, prices, industrial production, agricultural output, transport facilities, banking, exports and imports, taxes, government budgets, wages, rent, profits, employment and personal as well as national income. Because of scarcity of resources people have to make choices. Economics attempts to increase and facilitate people’s choice.

4. What Economics All About ? Cont’d Economics is a social science . It seeks to explain something about society , just like other social sciences, such as psychology, sociology, and political science. BUT Economics differs from other social sciences , in the following way: “Economics is the study of choice under conditions of scarcity”. This definition may appear strange to you. Where are the familiar words we ordinarily associate with economics: “money,” “stocks and bonds,” “prices,” “budgets,” . . . ? As you will soon see, economics deals with all of these things and more. But first, let’s take a closer look at two important ideas in this definition: individual choice and scarcity.

5. Individual Choice: The Core of Economics “Individual choice —decisions by individuals about what to do and what not to do”. Individual choice —for economics is, first of all , about the choices that individuals make . Do you choose to work during the summer or take a backpacking trip ? Do you buy a new CD or go to a movie? Human beings have unlimited needs and wants . Needs are the essential goods and services required for human survival. These include nutritional food, clean water, shelter, protection, clothing and access to health care and education. All individuals have a right to have these needs met. Wants are goods and services that are not necessary for survival. An individual's wants , or desires, tend to be unlimited as most people are rarely satisfied with what they have and are always striving for more. Wants are a matter of personal choice and human nature. Some of these are satisfied by physical objects (goods) and others by non-physical activities(services). Goods : All the physical objects people need and want are called goods (food, clothing, houses, books, computers, cars, televisions, refrigerators, and so on); Economic goods are those that use up scarce economic resources in their production. These include most consumer goods. Free goods are unlimited in their supply and availability, such as sunlight or air, and thus the opportunity cost of consuming them is zero. Services : the non-physical activities are called services (education, health care, entertainment, travel, banking, insurance and many more). These decisions involve making a choice from among a limited number of alternatives — limited because no one can have everything that he or she wants. Every question in economics at its most basic level involves individuals making choices .

6. Scarcity And Individual Choice Defining scarcity : Scarcity is the situation in which available resources, or factors of production, are finite ( limited), whereas wants are infinite(unlimited). There are not enough resources to produce everything that human beings need and want.

7. Scarcity And Individual Choice (cont’d) Why do individuals have to make choices? The ultimate reason is that resources are scarce . Scarcity is a very important concept in economics. The study of economics arises because people’s needs and wants are unlimited, or infinite. Yet it is NOT possible for societies and the people within them to produce or buy all the things they want. They would like to have more and better computers, cars, educational services, transport services, housing, recreation, travel, and so on; the list is endless. Why is this so? It is because there are not enough resources . Resources are the inputs used to produce goods and services wanted by people, and for this reason are also known as factors of production . They include things like human labour, machines and factories, and ‘gifts of nature’ like agricultural land and metals inside the earth. Resources/Factors of production do not exist in unlimited abundance: they are scarce , or limited and insufficient .

8. Scarcity And Individual Choice (cont’d) The conflict between unlimited wants and scarce resources has an important consequence. Since people cannot have everything they want, they must make choices . The classic example of a choice forced on society by resource scarcity is that of ‘ guns or butter’, or more realistically the choice between producing defense goods (guns, weapons, tanks ) or food: more defense goods mean less food, while more food means fewer defense goods. Societies must choose how much of each they want to have. Note that if there were no resource scarcity, a choice would not be necessary, since society could produce as much of each as was desired. But resource scarcity forces the society to make a choice between available alternatives. Economics is therefore a study of choices .

9. Resources/Factors of Production Production of any good or service requires resources. Definition of Resources: “Resources are the inputs used to produce goods and services wanted by people, and for this reason are also known as factors of production” . These are divided into four categories: Land Labour Capital Entrepreneurship

10. Resources/Factors of Production cont’d 1. Land : the physical space on which production takes place, as well as useful materials— natural resources —found under it or on it (such as crude oil, iron , coal , water, wood, metal ores, agricultural products or fertile soil—comes from nature, that’s why called natural resources. Natural resources are also called ‘gifts of nature ’.). 2. Labor includes the physical and mental effort that people contribute to the production of goods and services. The efforts of a teacher, a construction worker, an economist, a doctor, a taxi driver or a plumber all contribute to producing goods and services, and are all examples of labour. ( such as skilled and unskilled labour) 3. Capital also known as physical capital , is a man-made factor of production (it is itself produced ) used to produce goods and services. Examples of physical capital include machinery, tools, factories , buildings , road systems, airports, harbours , electricity generators and telephone supply lines. Physical capital is also referred to as a capital good or investment good .(physical capital helps us to produce other goods and services) Entrepreneurship (management) is a special human skill possessed by some people---that is, The ability and willingness to combine the other resources—labor , capital, and land — into a productive enterprise . ( risk taking, innovation, and the organization of resources for production ). An entrepreneur may be an innovator who comes up with an original idea for a business or a risk taker who provides her own funds or time to nurture a project with uncertain rewards . It could be argued that the entrepreneur is a human resource and therefore part of labour, but the argument for including the entrepreneur as a separate category is because of his/her organisational skills.

11. Think about the last lecture you attended at your college. Some resources were used directly : Your instructor’s labor and human capital (his or her knowledge of economics); physical capital (the classroom building, a blackboard or projector); and land (the property on which your classroom building sits). Somebody played the role of entrepreneur , bringing these resources together to create your college in the first place. (If you attend a public institution, the entrepreneurial role was played by your state government.)

12. Resources and Resource Payments/incomes Since resources are limited they command a payment. The payment for each type of resource has it's own term . The factors of production will earn incomes as follows: Land Land is rewarded with rent . 2 . Capital Capital is rewarded with interest . 3 . Labor Labour is rewarded with wages (including salaries ) 4 . Entrepreneurial ability The entrepreneur creates new business ventures and the reward for the risk associated with this is profit . (profits or losses)

13. Other meanings of the term ‘capital’ The term ‘capital’, in a most general sense, refers to resources that can produce a future stream of benefits . Thinking of capital along these lines, we can understand why this term has a variety of different uses , which although are seemingly unrelated, in fact all stem from this basic meaning. Physical capital , defined above, is one of the four factors of production consisting of man-made inputs---which is used to produce more goods and services in the future. Human capital refers to the skills, abilities and knowledge acquired by people, as well as good levels of health, all of which make them more productive . Natural capital , also known as environmental capital . It includes everything that is included in land, plus additional natural resources that occur naturally in the environment such as the air, biodiversity, soil quality, the ozone layer, and the global climate. Natural capital provides a stream of future benefits because it is necessary to humankind’s ability to live, survive and produce in the future. Financial capital refers to investments in financial instruments, like stocks and bonds, or the funds (money) that are used to buy financial instruments like stocks and bonds.

14. Definition of Economics “Economics is the study of choices leading to the best possible use of scarce resources in order to best satisfy unlimited human needs and wants”. “Economics is the study of choice under conditions of scarcity”. Economics is the study of how resources are allocated to satisfy the unlimited needs and wants of individuals, governments and firms in an economy. The three main economic agents or decision-makers in an economy are: individuals or households firms (businesses that operate in the private sector of the economy) the government. Each of us has limited resources. We have neither the time nor the money to do everything we might want to do. So we must choose: Out of all the possible options , on what will we spend our money and time? Economics is the study of how people make these decisions. It asks how individuals , families, businesses, and governments decide-- how to allocate their limited (i.e., scarce) resources. In other words, economics is the study of how people deal with scarcity.

15. Comprehensive Definition of Economics E conomics is the science that studies how people and societies make decisions that allow them to get the most out of their limited resources. And because every country, every business, and every person has to deal with constraints, economics is literally everywhere . “ Economics is the study of how we the people engage ourselves in production, distribution and consumption of goods and services in a society .” Economics studies the ways in which society decides what to produce, how to produce it, who to produce it for and how to apportion it .

16. Opportunity Cost Opportunity cost is defined as “the value of the next best alternative that must be given up or sacrificed in order to obtain something else”. Economists call the value of what you must give up when you make a particular choice an opportunity cost. Since resources are limited, every time you make a choice about how to use them, you are also choosing to forego other options. Economists use the term  opportunity cost  to indicate what must be given up to obtain something that’s desired. A fundamental principle of economics is that every choice has an opportunity cost. If you sleep through your economics class (not recommended, by the way), the opportunity cost is the learning you miss. If you spend your income on video games, you cannot spend it on movies. In short, opportunity cost is all around us. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else; in short, opportunity cost is the value of the next best alternative. Since people must choose, they certainly face trade-offs in which they have to give up things they desire to get other things they desire more.

17. Opportunity Cost and Individual Decisions As individuals—and as a society—we have unlimited desires for goods and services. Unfortunately, our ability to satisfy those desires is limited, so we must usually sacrifice something for any choice we make. The correct measure of the cost of a choice is not just the money price we pay, but the opportunity cost : what we must give up when we make a choice. Opportunity Cost and Individual Decisions : At the individual level , opportunity cost arises from the scarcity of time or money. Imagine , for example, that you spend $8 on lunch every day at work. You may know perfectly well that bringing a lunch from home would cost only $3 a day, so the opportunity cost of buying lunch at the restaurant is $5 each day (that is, the $8 that buying lunch costs minus the $3 your lunch from home would cost). Five dollars each day does not seem to be that much. However, if you project what that adds up to in a year—250 workdays a year × $5 per day equals $1,250—it’s the cost, perhaps, of a decent vacation. If the opportunity cost were described as “a nice vacation” instead of “$5 a day,” you might make different choices.

18. Opportunity Cost and Societal Decisions Opportunity Cost and Societal Decisions : For society as a whole , it arises from the scarcity of resources: land, labor, capital, and entrepreneurship. To produce and enjoy more of one thing, society must shift resources away from producing something else. Therefore, we must choose which desires to satisfy. Now let’s think about scarcity and choice from society ’s point of view. What are the goals of our society? We want a high standard of living for our citizens, clean air, safe streets, good schools, and more. What is holding us back from accomplishing all of these goals in a way that would satisfy everyone? You already know the answer: scarcity. In society’s case, the problem is a scarcity of resources —the things we use to make goods and services that help us achieve our goals. Opportunity cost also comes into play with societal decisions. Universal health care would be nice, but the opportunity cost of such a decision would be less housing, environmental protection, or national defense. These trade-offs also arise with government policies. For example, we’d all like better health for our citizens . What would be needed to achieve this goal? Perhaps more frequent medical checkups for more people and greater access to top-flight medicine when necessary. These, in turn, would require more and better-trained doctors, more hospital buildings and laboratories, and more high-tech medical equipment. In order for us to produce these goods and services, we would have to pull resources—land, labor, capital, and entrepreneurship—out of producing other things that we also enjoy. The opportunity cost of improved health care, then, consists of those other goods and services we would have to do without.

19. Case study: Opportunity Cost

20. Additional information Some examples of opportunity cost are as follows: When a consumer chooses to use her $100 to buy a pair of shoes, she is also choosing not to use this money to buy books, or CDs, or anything else; if CDs are her favourite alternative to shoes, the CDs she sacrificed (did not buy) are the opportunity cost of the shoes. When a business chooses to use its resources to produce hamburgers, it is also choosing not to produce hotdogs or pizzas, or anything else; if hotdogs are the preferred alternative, the hotdogs sacrificed (not produced) are the opportunity cost of the hamburgers. Note that if the consumer had endless amounts of money, she could buy everything she wanted and the shoes would have no opportunity cost. Similarly, if the business had endless resources, it could produce hotdogs, pizzas and a lot of other things in addition to hamburgers, and the hamburgers would have no opportunity cost. If resources were limitless, no sacrifices would be necessary, and the opportunity cost of producing anything would be zero. The opportunity cost of visiting the cinema on Saturday night is the sum of money you could have earned from babysitting for your neighbour instead of going to the cinema . The opportunity cost of building an additional airport terminal is the public housing for low-income families that the same government funds could have been used for. The opportunity cost of a school purchasing 100 laptops for use in the classroom might be the science equipment that cannot be bought as a result . Opportunity cost is the cost measured in terms of the next best choice given up when making a decision. Every choice made has an opportunity cost because in most cases there is an alternative.

21. Microeconomics vs. Macroeconomics Microeconomics focuses on choices made by individuals , households , or firms —the smaller parts that make up the economy as a whole . Microeconomics is concerned with the behavior of individual actors on the economic scene— households , business firms , and governments . It looks at the choices they make and how they interact with each other when they come together to trade specific goods and services. What will happen to the cost of movie tickets over the next five years? How many management-trainee jobs will open up for college graduates? These are microeconomic questions because they analyze individual parts of an economy rather than the whole . Macroeconomics focuses on the bigger picture—the overall ups and downs of the economy. Macroeconomics analyzes entire industries and economies rather than individual or specific companies. Macroeconomics focuses on economic aggregates —economic measures such as the unemployment rate, the inflation rate, and gross domestic product—that summarize data across many different markets. Instead of focusing on the production of carrots or computers , macroeconomics lumps all goods and services together and looks at the economy’s total output . Instead of focusing on employment of management trainees or manufacturing workers , it considers total employment in the economy.