Economics Notes

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Economics

It studies how individuals, firms, government, and other organizations within our society make choices, and how these choices determine society’s use of its resources. To understand how choices are made and how these choices affect our society’s use of resources, we must examine five concepts that play an important role: trade-offs, incentives, exchange, information, and distribution.

Trade-offs

It is means that to get more of one thing involves having less of some thing else. We are forced to make trade-offs because of scarcity. In short, resources are scarce, so trade-offs is a basic fact of life.

Each of us is constantly making choices;

To study at the library rather than in the dormitory;

To have pizza rather than sushi;

To go to university rather that work full-time;

Societies are constantly making choices;

To preserve open spaces rather than provide more housing;

To produce computers and import televisions rather than produce televisions and import computers;

Government agencies are constantly making choices;

To cut taxes rather than increase government expenditures;

There is no free lunch. Having more of one thing requires giving up something else. Scarcity means that trade-offs are a basic fact of life.

Scarcity figures prominently in economics, Choices matter because resources are scarce. Scarcity is a fact for everyone.

Our limited income forces us to make choices;

we cannot afford anything that we might want to get;

Spending more on rent house means there is less available for clothes and entertainment;

Time is also a resource.

Incentives  

Incentives are benefits (including reduced costs) that motivate a decision maker in favor of a particular choice. In short, in making choices, decision makers respond to incentives.

Many things can affect incentives, but among them the most important things are prices.

If the price of gasoline rises, people have great incentive to drive less;

If the price of MP3 falls, people have great incentive to buy more;

When the price of a good rises, firms are induced to produce more of that good and increase their profits;

When the price of a good falls, firms are induced to produce less of that good and reduce their costs;

Incentives are affected also by the return people expect to earn from different actities.

Exchange   

Voluntary exchanges in markets are important. Economists describe any situation in which exchange takes place as a market. Exchange in markets is a key to understanding how resources are allocated, what is produced, and who earn what. In short, people benefit from voluntary exchange, and in market economies, market exchange lead to the efficient use of resources.

when manufactures purchase the materials they need for production, they exchange money for them but not other goods.

Most goods, from cameras to clothes, are not directly sold from producers to consumers. Usually goods are sold from producers to distributors; from distributors to retailers; from retailers to consumers.

All of the transactions are embraced by the concept of markets and a market economy.

In market economy, like the US, most exchanges take place through markets, and these exchanges are guided by the prices of the goods and services involved.

The goods and services that are scarcer, or require more resources for their production, come at a higher price.

An economy such as in US is often called a mixed economy – one that relies primarily but not exclusively on the free interaction of producers and consumers to determine what is produced, how, and for whom. In some areas, the government makes the decisions, in others it imposes regulations that affect incentives firms and householders face, and in many areas, both the private and the public sector are involved (education is a good example).

Information    

Information, or its absence, plays a key role in determining the shape of markets and the ability of private markets to ensure the economy’s scarce resources are used sufficiently.

The structure that markets take and how well they can function depend critically on the information available to decision makers.

Distribution   

Markets determine how the goods and services produced by the economy are allocated to members of society.

The market economy not only determines what goods are produced and how they are produces but also determines for whom they are produced;

What market participants are willing and able to pay depends on their income. Incomes are differ markedly across occupations.

Efforts by the government to redistribute may reduce economy efficiency.

The Three Major Markets

Product Market

The markets in which firms sell their outputs to households are referred to collectively as the product market. Many firms also sell goods to other firms; the output of the first firm becomes the input of the second firm. These transactions are also said to occur in the product market. The product market is the market in which firms sell the goods they produce.

Labor market

On the input side, firms need some combination of labor and machinery to produce their output. They purchase the services of workers in the labor market. The labor market is the market in which householders sell labor services and firms buy labor services.

Capital market

On the input side, firms need some combination of labor and machinery to produce their output. They raise funds to buy inputs in the capital market. Land has become the second important thing in modern industry society. Capital market is the market in which funds are borrowed and lent.

The relationship among the three markets is depicted as follows:

The Two Branches of Economics

Microeconomics

Microeconomics focuses on the behavior of the units – the firms, households, and individuals – that make up the economy. It is concerned with how the individual units make decisions and what affects those decisions. Micro id derived from the Greek word meaning small.

Microeconomics focuses on the decisions of households and firms and the detailed study of prices and production in specific industirs.

Macroeconomics

Macroeconomics focuses on the behavior of the economy as a whole, in particular the behavior of such aggregate measures as the overall rates of unemployment, inflation, and economic growth and the balance of the trade. The aggregate numbers do not tell us what any one firm or household is doing. They tell us what is happening in total, or on average. In a dynamic economy, there are always some industries expanding and others contracting.

Macroeconomics focuses on the behavior of the economy as a whole and the behavior of aggregate variables such as overall employment, output, economic growth, the price level and inflation.

The Science of Economics

Economics is a social science

Economics studies the social problem of choice from scientific viewpoint, which means that it is built on a systematic exploration of the problem of choice. This systematic exploration involves both the formulation of theories and examination of data.

Theory

A theory consists of a set of assumptions (or hypotheses) and conclusions derived from those assumptions. Theories are logical exercises: if the assumptions are correct, then the results are correct. Economists make predictions with their theories. In developing their theories, economists use models. Economists construct different models of the economy – in words or equations – to depict particular features of the economy. An economic model might describe a general relationship or a quantitative relationship.

Variable

A variable is any item that can be measured and that changes. Prices, wages, interest rates, and quantities sold or bought are variables.

Correlation

Correlation is a systematic relationship between variables. Economists use statistical tests to measure and test correlations.

Causation and Correlation

Causation is a causal relationship between variables. Changes in one variable may cause the changes in another variable. Economists would like to different variables between causal variables and result variables.

 

Positive and Normative Economics

Positive Economics

Positive economics is concerned with what “is”, with describing how the economy functions.

Normative Economics

Normative economics deals with what “should be”, with making judgments about the desirability of various course of action.

Example: A person might say "Everybody ought to be paid the same hourly wage, because it is just that each person should be rewarded in proportion to her labor." This is clearly normative economics -- it has to do with what should be.   Normative Economics

"Positive" economist might observe that this rule would be inefficient, in the following sense.

·  Some occupations require more training, more effort, or more talent than others; or they are more responsible.

·  If these occupations are better rewarded, they will be better performed, and overall productivity of labor will increase as a result.

·  This increase in productivity will be more than enough to pay the higher wages for the skilled, talented, effortful and responsible occupations, with something left over that might make everyone better off.

Price Controls 

 Price controls are usually justified as a way to help consumers, but those who advocate them often ignore their incentive effects. It is a governmental impositions on the prices charged for goods and services in a market, usually intended to maintain the affordability of staple foods and goods, and to prevent price gouging during shortages, or, alternately, to insure an income for providers of certain goods.

Two primary forms of price control, 

Price ceiling, the maximum price that can be charged

Price floor, the minimum price that can be charged.