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Chapter 1

Introduction

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Text Objectives

• Tools of Economics

• Role of Market Economy

• Changing Nature of Economy

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Tools of Economics

• View the world from the perspective of an economist

• To accomplish this, need to understand the key tools of analysis

• Some of these tools include: – supply and demand – elasticity – production function – the multiplier

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Role of Market Economy

• In a market, buyers and sellers come together to voluntarily exchange goods and services for money.

• Market transactions are activities that produce and exchange goods and services for which other people are willing to pay.

• In this course we will study how markets work and prices are set.

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Changing Nature of Economy

• Individuals, businesses, and even countries are subject to limits and constraints.

• But these limits and constraints are constantly changing. – Goods once expensive are now

commonplace. – Countries once poor are rapidly growing.

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Key Forces Impacting Economy

• Need to understand forces driving change

• Three main forces at work: – Technological change – Globalization – Financial markets

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Key Forces Impacting Economy

• Technological change is an improvement in knowledge that increases the range of products and services the economy can deliver. – Examples: electricity, cars and the internet.

• Technology creates new ways of producing goods and services.

• Technology is the critical factor in raising living standards. – Technology is also a possible solution to the

energy crisis and global climate change. 1-7

Key Forces Impacting Economy

• Globalization is the exchange of goods, services, ideas, and people among countries. – The world economy is becoming more global. – Does this trend benefit the US economy? – Many aspects to Globalization, including:

• Trade in Goods and Food Stuffs • Trade in Services • Flow of Information • Movement in Money

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Key Forces Impacting Economy

• Financial markets encompass all those parts of the economy that have to do with borrowing, investing, or transferring money. – Includes stock market, mortgages, banks,

brokerage firms and credit cards.

• Financial markets are constantly evolving. – Fuel economic growth by enabling

companies, individuals, and government markets to raise money.

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Key Forces Impacting Economy

• Interest rates are defined as the cost of money and are determined in the financial markets. – The central bank plays a key role in determining

interest rates.

• Subprime loans given to people who did not have enough income to qualify for ordinary mortgages are currently a major problem in the financial markets.

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Policy Debate

• Who should guide the economy: government, or businesses and individuals? – At one extreme is a centrally-planned

economy, in which all economic activities are controlled from the top.

– At the other extreme is a laissez-faire economy, where no government regulations or laws exist at all.

• Role of competition in guiding the economy

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Policy Debate

• Competition is the most consistent force for growth and progress.

• The US economy is the most competitive in the world.

• There are some concerns over excessive competition. – Impact on job security, poverty, etc.

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Government Intervention

• Government plays a large role in the US economy. – Makes laws, regulates businesses.

• Macroeconomic policy: making sure that the economy doesn’t fall into deep slumps where a lot of people lose their jobs, or overheat to the point where prices soar out of control. – Key role played in the economy by Federal

Reserve. 1-13

Government Intervention

• Role played by the government and by private businesses differs across countries.

• There is a global trend toward deregulation. – Deregulation is the process of reducing

government control over industries.

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Economics Defined

• Economics is the study of how individuals, businesses, and governments make decisions and make trade-offs in the face of scarce resources.

• Role of Scarcity and Choice – Limited resources – Need to make trade-offs – Opportunity costs

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Economics Defined

• Two main area of focus: – Macroeconomics

• Studies the overall aggregate economy, focusing on issues such as growth, inflation, trade, and interest rates.

– Microeconomics • Studies the behavior of individual units in the

economy, such as households and businesses.

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Measures of Prosperity

• Improving individual prosperity is key goal for economy.

• Measure prosperity by using various indicators – One key measure is GDP.

• GDP is the dollar value of all the goods and services produced by the economy.

– Other indicators of prosperity include wages, income and consumption.

• Use GDP to compare the level of prosperity among countries.

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World’s Largest Economies

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Safety Net

• Provides a measure of security for poor, sick and vulnerable. – Consists of a wide array of government

programs, including Social Security, Medicare, etc.

– Objective is to improve the lives of low- income households.

• Debate among economists as to whether enough is being done.

• Safety net programs in Europe more comprehensive than in US.

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Economics Not an Exact Science

• Considerable policy disagreement among economists. – The role that government plays in economy is

one of the main debates. • Some key questions include:

– How to fund Social Security and Medicare? – How to solve the health care problem? – How to improve the educational system? – What is an appropriate tax policy?

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Why The Disagreement?

• Reasons for the policy disagreement are due to: – Political Agenda – Lack of Data – Winners and Losers

• The objective of this textbook is to present both sides of the discussion.

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