S. Introduction
Keith Evans
Iowa State University
January 13, 2009
Keith S. Evans (Iowa State University)
Introduction
January 13, 2009
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Questions to ask
There are a few questions to address before beginning the class.
1
What is Economics?
2
What is the dierence between Economics and Business?
3
Why should we study Macroeconomics?
4
How do we study the Economy?
Keith S. Evans (Iowa State University)
Introduction
January 13, 2009
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What is Economics?
Denition
The study of how individuals and society choose to allocate limited or
scarce resources among alternative uses to satisfy their unlimited wants.
Alternative: Economics is the social science that studies the choices that
individuals, businesses, governments, and entire societies make as they
cope with scarcity and the incentives that inuence and reconcile those
choices - Parkin 2008
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What is Economics?
Three key points:
1
Choices:
2
Scarcity: a situation where we are unable to satisfy all out wants.
3
Incentives: a reward that encourages an action or a penalty that
discourages one.
Example: Do I drive to campus or take CyRide?
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The Division of Economics
Economics is separated into two distinct categories:
Microeconomics focuses on individual and business decision making.
Furthermore, it analyzes how these choices interact, and the inuence
that governments exert on these choices.
Macroeconomics is the study of the eects on the national economy
of choices made by individuals, businesses, and governments. It
focuses on the aggregate outcome.
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The Division of Economics
Example:
Microeconomics: What will happen to the price of pizza over the
next ve years?
Macroeconomics: What makes the interest rate, in general, rise and
fall?
Microeconomics focuses on the ne details while macroeconomics looks at
the big picture (often ignoring the details).
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What is the dierence between Economics and Business?
Business is focused on the question:
What is good for the rm?
Economics is focused on the question:
What is good for the society?
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Why do we study Macroeconomics?
1
2
3
Macroeconomic issues aect society.
Macroeconomic issues aect YOU.
Thinking economically allows you to realize unintended
consequences
Examples:
Exxon Valdez Oil Spill
British Railroads
U.S. Steel
The Invisible Hand
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How do we study the Economy?
Economics is a social science:
Positive statements: statements about what is. These are relatively
scientic and focus on value-free descriptions and predictions of economic
relationships.
A poor coee harvest will raise prices and people will drink more
tea.
Normative statements: statements about what ought to be. Often
based on social norms and make some value judgement (opinion).
We should end world poverty.
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How do we study the Economy?
These statements can often be mixed together:
Cy earns $500 less than the national average for mascots. His salary
should be more than it is now.
The rst sentence is a positive statement while the second is normative.
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How we do study the Economy?
In order to study the complex interaction between consumers, rms, and
government, we use simplied versions of reality: Models. These models
are used to:
1
Represent relationships between variables, e.g. interest rates and
investment, or disposable income and consumption.
2
Analyze the behavior of the economy.
3
Serve as a guidance for policy making.
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How do we study the Economy?
All models begin with assumptions. There are two types of assumptions:
1
2
Simplifying assumption: any assumption that makes the model
simpler without aecting any of the important conclusions.
Critical assumption: any assumption that aects the conclusions of
the model in an important way.
Example: A road map.
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3 Important Questions
Macroeconomics is concerned with three questions:
1
2
3
What to produce?
How to produce?
For whom to produce?
Every country must answer these questions.
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What?
What we produce changes over time.
70 years ago, 25% of Americans worked on farms.
Today only 3% of Americans work on farms.
The What questions deals with the decisions regarding what goods and
services to produce.
How many iPods, Beer, and Haircuts should we produce?
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How?
Goods and services are produced by using productive resources that
economists call factors of production:
1
Land - natural resources such as land, metal ores, oil, gas and coal,
water, and air.
2
Labor - The work time and work eort that people devote to
producing goods and services.
3
Capital - The tools, instruments, machines, buildings, and other
constructions that businesses use to produce goods and services.
4
Entrepreneurship - The human resource that organizes labor, land,
and capital.
The How question deals the decision regarding the uses of these factors of
production.
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For Whom?
Who gets the goods and services that are produced depends on the
incomes that people earn. People earn their incomes by selling the services
of the factors of production they own:
1
Land earns rent
2
Labor earns wages
3
Capital earns interest
4
Entrepreneurship earns prot
The For Whom question deals with the nal allocation of goods and
services among consumers.
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Macroeconomic Goals
Economists and society at large agree on three important macroeconomic
goals:
1
Economic Growth: The increase in the production of goods and
services that occurs over long periods of time.
2
Full Employment
3
Stable Prices: Avoiding high ination or deation
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Ideas for Beyond the Final Exam
By the end of the semester, you should understand these seven ideas.
1
How much does it really cost?
2
Attempts to Repeal the Laws of Supply and Demand
3
The Surprising Principle of Comparative Advantage
4
Trade is a Win-Win situation
5
Government policies can limit economic uctuations - but dont
always succeed
6
The short run trade-o between ination and unemployment
7
Productivity growth is (almost) everything in the Long Run.
These are drawn from Macroeconomics by Baumol and Blinder, 2007 .
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