Principles of macroeconomics Quiz
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spptchap001.pptxCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Introduction:
Thinking Like an Economist
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Economics and Economic Reasoning
In my vacations, I visited the poorest quarters of several
cities and walked through one street after another, looking
at the faces of the poorest people. Next I resolved to make
as thorough a study as I could of Political Economy .
— Alfred Marshall
CHAPTER 1
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Chapter Goals
Define economics
Discuss ways in which economists use economic reasoning
Explain real-world events in terms of:
Economic forces
Social forces
Political forces
Explain how economic insights are developed and used
Distinguish among:
Positive economics
Normative economics
The art of economics
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What Economics Is
Economics is the study of how human beings coordinate their wants and desires, given the decision-making mechanism, social customs, and political realities of the society
The three central coordination problems any economy must solve:
What, and how much, to produce
How to produce it
For whom to produce it
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Scarcity
Scarcity exists because individuals want more than can be produced
The degree of scarcity is constantly changing
The quantity of goods, services and usable resources depends on technology and human action
Scarcity means the goods available are too few to satisfy individuals’ desires
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Microeconomics and Macroeconomics
Economic theory is divided into two parts:
Microeconomics is the study of individual choice, and how that choice is influenced by economic forces
Macroeconomics is the study of the economy as a whole
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A Guide to Economic Reasoning
Steve Levitt’s bestseller, Freakonomics, contains many examples of “thinking like an economist”
Levitt uses economic reasoning to explain why people become drug dealers
The potential financial benefit of selling drugs is much higher than the cost of giving up a minimum wage job
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Marginal Costs and Marginal Benefits
Using economic reasoning, decisions are often made by comparing marginal costs and marginal benefits
Marginal cost is the additional cost over and above costs already incurred
Marginal benefit is the additional benefit above and beyond what has already accrued
The economic decision rule:
If the marginal benefits of doing something exceed the marginal costs, do it.
If the marginal costs of doing something exceed the marginal benefits, don’t do it.
MC > MB Don’t do it!
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Opportunity Cost
Opportunity cost is the basis of cost/benefit economic reasoning
Opportunity cost should always be less than the benefit of what you have chosen
Opportunity cost is the benefit forgone of the next-best alternative to the activity you have chosen
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Economic, Social, and Political Forces
The invisible hand is the price mechanism that guides our actions in a market. The invisible hand is an example of a market force.
A market force is an economic force that is given relatively free rein by society to work through the market
Economic forces are mechanisms that ration scarce goods
If there is a shortage, prices rise
If there is a surplus, prices fall
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Using Economic Insights
Theories are too abstract to apply in specific cases and are often embodied in economic models and principles
Theories tie together economists’ terminology and knowledge about economic institutions
An economic principle is a commonly held insight stated as a law or general assumption
An economic model is a framework that places the generalized insights of the theory in a more specific contextual setting
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Using Economic Insights
Models lead to…
theorems (propositions that are logically true based on the assumptions of the model)…
to arrive at policy precepts (policy rules that conclude that a particular course of action is preferable)
Theories, models, and principles are continually tested to see of the predictions of the model match the data
These theorems must be combined with knowledge of real-world economic institutions and value judgments to determine economic goals for society
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The Invisible Hand Theory
Prices fall when quantity supplied is greater than quantity demanded
Prices rise when the quantity demanded is greater than the quantity supplied
According to the invisible hand theory, a market economy, through the price mechanism, will allocate resources efficiently
Efficiency means achieving a goal as cheaply as possible
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Economic Institutions
Economic institutions are laws, common practices, and organizations in a society that affect the economy
Economic institutions differ significantly among nations
They sometimes seem to operate differently than economic theory predicts
To apply economic theory to reality, you've got to have a sense of economic institutions
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Economic Policy Options
Economic policies are actions (or inaction) taken by the government to influence economic actions
Objective policy analysis keeps value judgments separate from the analysis
Subjective policy analysis reflects the analyst’s views of how things should be
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Economic Policy Options
To distinguish between objective and subjective analysis, economics is divided into three categories
Positive economics is the study of what is
Normative economics is the study of what should be
Art of economics is using the knowledge of positive economics to achieve the goals determined in normative economics
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Chapter Summary
Three coordination problems are what to produce, how to produce it, and for whom to produce it
Economic reasoning structures all questions in a cost/benefit framework
Scarcity exists
Economics is divided into micro and macroeconomics
Opportunity costs exist
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Chapter Summary
Under certain conditions, the market, through its price mechanism, will allocate scarce resources efficiently
Economics can be subdivided into positive economics, normative economics, and the art of economics
Precepts are the guides for policies based on theorems
Unlike market forces, economic forces and the forces of scarcity are always at work
Economic reality is controlled by economic, political, and social forces
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