01 Chapter - Lecture Notes
July 03, 2007
I. What is economics? A. Economics is the study of how individuals, firms, and the government make choices and how those choices determine the allocation of scare resources II. Five core concepts in economics A. Trade-offs 1. Every choice involves trade-offs Ex. Allocation of a weekly budget: a. What should one buy: pizza, beer, CDs, movies,... b. More of one means less of another c. There is no such thing as a free lunch 2. Trade-offs arise from scarcity a. One has limited resources which therefore effect one's choices. In the previous example scarcity of money affected weekly spending habits b. Society has limited resources B. Incentives 1. Incentives are the rewards and costs associated with making choices a. Prices affect incentives, as they show the rewards and costs in an exchange b. All decision makers (consumers, firms, and governments) respond to incentives C. Exchange 1. Exchange is the trade of goods and services 2. Voluntary exchange in markets determines what goods and services to produce a. Voluntary exchange means both parties get something they want Ex. Workers want a wage and employers want a certain job done, exchange in the labor market b. A market is any situation in which an exchange takes place i. A market need not be a physical place (Ex. Ebay) ii. Competition in a market means consumers have a choice of alternatives
iii. Most modern economies, such as the United States, are mixed economies which means that most exchanges take place in the market but the government plays a critical role Ex. The government may interfere with the market when pollution is a concern D. Information 1. Making informed choices requires information 2. Information may be viewed as any good or service a. Firms exist that specialize in the purchase and sale of information (Ex. Carfax) b. The difference with information compared to other goods and services is that the seller cannot let the buyer see the product prior to the purchase, unlike test driving a used car 3. In certain markets information is extremely a. critical Used car market b. Stock market c. Insurance E. Distribution 1. The market not only determines what goods and services are produced but also who gets those goods and services Ex. In the labor market higher skilled workers are more scarce than lower skilled workers and therefore a lawyer or a doctor earns a higher wage than a janitor 2. Some segments of society are uneasy about the uneven distribution of wealth 3. Government programs attempt to even out the distribution of wealth a. However, attempts to soften the distributional impact of markets disrupt economic incentives Ex. A welfare program attempts to change the distribution of wealth, but since the program is funded by taxation one is lowering the incentives for people to work III. Positive vs. normative economics A. Positive economics describes how the economy operates, that is what are the particular economic consequences of an action B. Normative economics is evaluation of the consequences from the action Ex. Consider a policy that increased the tariff on Chinese produced furniture 1. Positive economics tells us that as a result of this policy sale of domestically produced furniture increases, production of furniture in the U.S. increases, leading to increas...