CHAPTER 1: What is Economics? Summary. Def. Scarcity

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1 CHPTER 1: What is Economics? Def. Scarcit ccording to the neoclassical wa of thinking, wants or desires are unlimited but goods and resources are limited. In this sense, goods and resources are scarce and acquire price tags. Sasan Faazmanesh Summar This chapter is an introduction to economics from the perspective of the neoclassical school. It introduces a number of concepts from this perspective, such as definition of economics, micro/macro distinction, theor and abstraction, and positive/normative economics. Choice Consumers, who have a limited income, have to make a choice between purchasing goods. Producers, who have a limited budget, have to make a choice between emploing resources. What is economics? Economics is the stud of choice under conditions of scarcit This is a neoclassical definition of economics. Def. Resources/ factors of production / inputs: labor, land and capital Labor: hours of work / individual worker Land: natural resources Capital : goods (human made) that are used to produce other goods / Mone? Some books have also entrepreneur as the 4 th factor. 1

2 Factors of production each have a price : Labor: wages and salaries Land: rent Capital : profit and interest What is the tetbook distinction between micro and macroeconomics? Microeconomics is a set of theories dealing with the decisions made b individual consumer (buer) and producer (seller, firm). The result of this decision making is the determination of prices, distribution of income and allocation of resources. Neoclassicals believe that consumers and producers make their choices rationall. Rational behavior means that both consumers and producers optimize : Macroeconomics is a set of theories dealing with the overall performance of the econom or the econom as a whole, such as national income, average prices, and emploment level. Consumers maimize utilit. Producers maimize profit. What is a theor? In optimizing, both consumers and producers use marginal analsis. Def. theor (model or law) is a statement or a set of statements intended to eplain or describe realit. Def. Marginal analsis: an analsis involving incremental, infinitel small changes. 2

3 Eamples of theories Newton s universal law of gravitation: F= G (m 1.m 2 / r 2 ) The neoclassical law of demand : price is inversel related to quantit demanded Price per unit of good X The neoclassical law of demand : as price per unit increases, quantit demanded decreases. p 1 p 2 Demand for good X Q 1 Q 2 Quantit of good X ll theories involve abstraction bstraction in art Def. bstraction: setting aside that which is not essential The concept of abstraction is related to the concept of generalization. Mark Rothko No. 14, 1960 It is also related to ceteris paribus. The law of universal gravitation: Distance traveled b an object is D = ½ gt 2 ssumptions in theories Theories involve certain assumptions. H&L divide these assumptions into two kinds: 1) Simplifing assumptions: make the model simple without changing its fundamental conclusions. 2) Critical assumptions: can fundamentall change the conclusion of a model. 3

4 What are positive and normative analses? Def. Normative analsis: involves value judgment, i.e., it deals with what ought to be. Def. Positive analsis: does not involves value judgment, i.e., it deals with what is. Fractions Eamples Real wage (w) = Nominal wage (W)/ Price inde (P) W= $60/labor P =$2/loaf of bread w=? w= ($60/labor)/ ($2/loaf of bread) = 30 loaf of bread/labor Eamples 1) The US government should not worr about the rising unemploment rate. 2) Inflation and unemploment are inversel related. Linear equations linear equation, = f(), takes values from the set of real numbers, (independent variable), to the set of real numbers, (dependent variable). 3) It is best to worr about the rising inflation rate than the declining rate of growth in GDP. Mathematical ppendi review of what ou should have learned ver well before taking this class Specificall, a linear equation is given b: = m+b where b is intercept and m is the slope of the line, that is, m= / = ( 1 0 )/ ( 1-0 ). 4

5 =f() Eamples: = This is a negative relation: as increase, decreases. Eamples: = This is a positive relation: as increase, increases. = = Shifts or changes in curves In the equation = m+b, b is constant. 10 What would happen if b is a variable? = m+z, where z is changing. Then the line shifts or changes 5

6 = = =f() Eample Room temperature f () f() The heater is set at a higher temperature Slope of a non-linear equation =f() Number of students in the room Non-linear equations In this case the slope of the curve changes. 1) Slope between and : Slope of h() =h() =f() 6

7 2) Slope at =h() C =f() + _ =f() 0 2) Slope at =h() Concave and conve curves =f() 0 2) Slope at : slope of g() =g() Concave curve =f() =h() Moving from the ais to the ais, the slope of h() increases in absolute value. 0 7

8 Conve curve =g() 0 Moving from the ais to the ais, the slope of g() decreases in absolute value. Quotient rule If = / C, then % in = % in % in C. Percentage change Geometric series If our grade changes from 0 to 1, then: % in grade = ( 1 0 ) / 0 Eample: Your grade changes from 25 to 35. Relative to the first grade, the percentage increase in our grade is equal to what? If S = 1 + 1/2 + 1/4 + 1/ Then S converges to what? S=2! % in grade = (35 25) / 25 = 10/25 = 40 % Product rule Geometric series in general If = C, then % in = % in + % in C. If S = a + ar + ar 2 + ar 3 + and 0<r<1, then S = a /(1 r) 8

9 Eample, Net stop: Chapter 2! If S = 1 + 1/2 + 1/4 + 1/ Then S converges to what? S = a /(1 r) = 1/ (1- ½) = 1/(½) = 2 nother eample, If S= 7+ 7/3 + 7/9 + 7/ Then S converges to what? S= a /(1 r) = 7/ (1-1/3) = 7/(2/3) = 21/2 = 10.5 Proof: 1) S = a +ar + ar 2 + ar 3 + 2) r S = ar + ar 2 + ar 3 +. Subtract 2 from 1: Factor S Divide b (1-r) S - r S = a S (1-r)=a S = a/1-r 9