ECON 101 Introduction to Economics 1 Session 1 Introduction I Lecturer: Mrs. Hellen Seshie-Nasser, Department of Economics Contact Information: haseshie@ug.edu.gh College of Education School of Continuing and Distance Education 2014/2015 2016/2017
Session Overview This session introduces the student to Economics as a discipline; focusing on the nature and scope of economics, the economic way of thinking, the method of economics, and the principles that guide economic analysis. Mrs. Hellen Seshie-Nasser, Dept of Economics, Slide 2
Session Objectives At the end of the session, the student should be able to: Define economics. Describe the economic way of thinking, including definitions of rational behaviour, marginal cost, marginal benefits and how these concepts may be used in decision making. Identify the three basic economic questions and describe how the market system answers each of these three basic questions. identify and explain the factors of production State some important reasons for studying economics. Explain how economists use the scientific method to formulate economic principles. Differentiate between microeconomics and macroeconomics. Differentiate between positive and normative economics. Explain and give examples of some hidden fallacies. Mrs. Hellen Seshie-Nasser, Dept.of Economics, Slide 3
Session Outline The key topics to be covered in the session are as follows: Definition of Economics The Economic way of thinking The Scientific Method The Economist as a Policy Advisor Common Fallacies in Economics Principles of Economics Mrs. Hellen Seshie-Nasser, Dept of Economics, Slide 4
Reading List Lipsey R. G. and K. A. Chrystal. (2007). Economics. 11 th Edition. Oxford University Press. Bade R. and M. Parkin. (2009). Foundations of Microeconomics. 4 th Edition. Boston: Pearson Education Inc., Begg. D. Fischer S. and R. Dornbusch. (2003). Economics. 7 th Edition. McGraw-Hill Mrs. Hellen Seshie-Nasser, Dept of Economics, Slide 5
Some Definitions of Economics Adam Smith (1776) The Wealth of Nations defined Economics as, An enquiry into the nature and causes of wealth of nations Slide 6
Some Definitions of Economics Alfred Marshal - Economics is the study of mankind in the ordinary business of life. It explains that part of individual and social action that is closely related to the attainment and with the use of material requisite of wellbeing. Slide 7
Some Definitions of Economics A.C. Pigou: Economics is the means of studying how total production could be increased so that the standard of living of the people might be improved. Slide 8
Some Definitions of Economics Paul Samuelson (Nobel Laurette, 1970) The study of how man and society end up choosing, with or without the use of money, to employ scarce, productive resources which have alternative uses to produce various commodities and distribute them for consumptions now or in the future among various people and groups in society. Slide 9
Key Emerging Issues: Samuelson s Definition Man and society:- Economics broadly divided into two branches; microeconomics and macroeconomics Microeconomics focuses on the individual parts of the economy; how individuals, households and firms make decisions and how they interact in specific markets Macroeconomics looks at the economy as a whole. It involves economy-wide phenomena, including inflation, unemployment, and economic growth, interest rate, BOP. etc. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 10
Key Emerging Issues - Samuelson s Definition: Choosing: Choice making is a direct result of a fundamental problem of scarcity. As a result of limited resources confronting unlimited wants, society is compelled to make choices among the alternative uses of the resources. With or without the use of money: Choices are made with or without the use of money. Example is a Barter system Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 11
Key Emerging Issues - Samuelson s Definition Choices are made to employ scarce productive resources. It means that resources (land, labour, capital and entrepreneur) are scarce Distribution: Production is incomplete if the commodities do not reach the final consumer Consumption could be undertaken in the present or in the future. It means that present consumption could be postponed to the future in order to maximize satisfaction Slide 12
Working Definition Economics is the study of how individuals and society in general allocate scarce resources among competing uses to maximize their satisfaction Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 13
The Economic Way of thinking Economics trains you to... a) Think in terms of alternatives. b) Evaluate the cost of individual and social choices. c) Examine and understand how certain events and issues are related. The economic way of thinking involves thinking analytically and objectively and makes use of scientific methods. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 14
The Methods of Economics The Scientific Method: Observation, Theory, and More Observation. The economic method: Uses abstract models to help explain how a complex real world operates. Develops theories, collects, and analyzes data to evaluate the theories. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 15
The Methods Cont d. What is a model? An abstract representation of reality Economics relies heavily on modeling Economic theories must have a well-constructed model While most models are physical constructs Economists use words, diagrams, and mathematical statements Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 16
The Art of Building Economic Models Guiding principle of economic model building Should be as simple as possible to accomplish its purpose Level of detail that would be just right for one purpose will usually be too much or too little for another Even complex models are built around a simple framework Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 17
Economic Models Economists use models to simplify reality in order to improve our understanding of the world Two of the most basic economic models include: The Circular Flow Diagram The Production Possibilities Frontier The Circular-Flow Diagram The circular-flow diagram is a visual model of the economy that shows how money (Cedis) flows through markets between households and firms. 18
The Circular Flow diagram Revenue MARKETS FOR GOODS AND SERVICES Firms sell Households buy Spending Goods and services bought FIRMS Produce and sell goods and services Hire and use factors of production HOUSEHOLDS Buy and consume goods and services Own and sell factors of production MARKETS FOR FACTORS OF PRODUCTION Labor, land, and capital Wages, rent, and profit Households sell Firms buy Income = Flow of inputs and outputs Slide 19 = Flow of Money ( Cedis)
Explanation for the Circular Flow Firms Produce and sell goods and services Hire and use factors of production Households Buy and consume goods and services Own and sell factors of production Markets for Goods and Services Firms sell Households buy Markets for Factors of Production Households sell Firms buy Factors of Production Inputs used to produce goods and services Land, labour, capital and entrepreneurship Slide 20
The PPF Model The Production Possibilities Frontier (PPF) is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. Concepts illustrated by the Production Possibilities Frontier include; Efficiency Trade-offs Opportunity Cost Economic Growth Slide 21
The Role of Assumptions Economists make assumptions in order to make the world easier to understand. The art in scientific thinking is deciding which assumptions to make. Economists use different assumptions to answer different questions. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 22
Assumptions and Conclusions Types of assumptions in an economic model Simplifying assumptions Way of making a model simpler without affecting any of its important conclusions Critical assumptions Affect conclusions of a model in important ways If critical assumptions are wrong model will be wrong All economic models have one or more critical assumptions Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 23
Two Fundamental Assumptions The economy is complex Economists make sense of all this activity in two steps First, the decision makers in the economy are divided into three broad groups: Households Business Government agencies In Microeconomic models Individual households Firms Government agencies In Macroeconomic models Household sector Business sector Government sector Foreign sector The next step in understanding the economy is to make two critical assumptions about decision makers Slide 24
First Fundamental Assumption Every economic decision maker tries to make the best out of any situation Typically, making the best out of a situation means maximizing some quantity While economists often have spirited disagreements about what is being maximized, there is virtually unanimous agreement that any economic model should begin with the assumption that someone is maximizing something The first fundamental assumption seems to imply that we are all engaged in a relentless, conscious pursuit of narrow goals An implication contradicted by much of human behavior In truth, we only rarely make decisions with conscious, hard calculations Why, then, do economists assume that people make decisions consciously, when, in reality, they often don t? Slide 25
First Fundamental Assumption This is an important question Economists answer it this way; The ultimate purpose of building an economic model is to understand and predict behavior» The behavior of households, firms, government, and the overall economy As long as people behave as if they are maximizing something, then we can build a good model by assuming that they are One last thought about the assumption that people maximize something It does not imply that people are selfish or that economists think they are Economics also recognizes that people often care about their friends, their neighbors, and the broader society in which whey live Slide 26
Second Fundamental Assumption Every economic decision maker faces constraints Society s overall scarcity of resources constrains each of us individually in much the same way as the overall scarcity of space in a crowded elevator limits each rider s freedom of movement Together, the two fundamental assumptions help define the approach economists take in answering questions about the world Economists always begin with the same three questions: Who are the individual decision makers? What are they maximizing? What constraints do they face? This approach is used so heavily by economists that it is one of the basic principles of economics. Slide 27
The Economist as a Policy Advisor When economists are trying to explain the world, they are scientists. When economists are trying to change the world, they are policy advisors. Slide 28
Positive Economics/Statements Study of how the economy works, e.g. descriptive analysis Positive statements are statements about how the economy works, whether they are true or not. Statements about what is, was or will be. Accuracy of positive statements can be tested by looking at the facts and just the facts. Examples: Ghana was the fastest growing economy in 2011 with GDP growth rate of 14%. If government wants to reduce unemployment,.. is an effective way of doing so. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 29
Normative Economics/Statements Study of what should be. It is also referred to as prescriptive analysis It is used to make value judgments, identify problems, and prescribe solutions Statements that suggest what we should do about economic facts, are normative statements Based on values Normative statements are statements about how the world should be. Statements about what ought to be. Normative statements cannot be proved or disproved by the facts alone Slide 30
Positive or Normative? These types of statements depend on value judgement about what is good and bad. They are informed by philosophical, cultural and religious positions E.g. Work hard to reduce the high incidence of unemployment in the country. Slide 31
Positive or Normative? An increase in the minimum wage will cause a decrease in employment among the least-skilled.? Higher government budget deficits will cause interest rates to increase.? The income gains from a higher minimum wage are worth more than any slight reductions in employment. State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.? Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 32
Fallacies of Composition and Division Fallacies are errors made in the course of making an argument. Three possible fallacies are usually committed in economic arguments, namely; Fallacy of composition: If something that is true for an individual economically is assumed to be true for the whole economy. E.g. Employment to economics graduates does not mean employment to all graduates. Slide 33
Fallacy of division: If something valid for the whole is assumed to be valid for the individual parts. For example, increased employment in an economy does not mean no individual is unemployed. A fall in inflation does not mean prices of all goods have experienced a fall in the rate of rise. Post-hoc fallacy: This fallacy occurs if an argument is made that because one-event follows the other there is a cause-and-effect relationship between the two events. E.g. anytime a budget is read, prices of goods rise. The act of reading a budget may have nothing to do with prices. There may or may not be increase in taxes in the budget. Slide 34
Why Economists Disagree In some cases, the disagreement may be positive in nature because Our knowledge of the economy is imperfect Certain facts are in dispute In most cases, the disagreement is normative in nature because While the facts may not be in dispute Differing values of economists lead them to dissimilar conclusions about what should be done Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 35
Principles of Economics Ten Basic Principles of Economics Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 36
Principles of Economics 1. There is no such thing as a free lunch To get one thing, we usually have to give up another thing. Making decisions require trading off one goal against another. 2. The cost of something is what you give up to get it Decision requires comparing costs (opportunity cost) and benefits of alternatives. E.g. Microsoft CEO, Bill Gates gave up college to start his own Software company. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 37
Principles Cont d. 3. Rational people think at the marginal Marginal changes are small, incremental changes to an existing plan of action. People make decisions by comparing costs and benefits at the margin. 4. People respond to incentives Marginal changes in costs or benefits motivate people to respond. The decision to choose one alternative over the other occurs when the alternative s marginal benefits exceed its marginal costs. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 38
Principles Cont d. 5. Trade can make everyone better off People gain from their ability to trade with one another. Competition results in gains from trading Trade allows people to specialize in what they do best. 6. Markets are usually a good way to organize economic activity Households decide what they want to buy. Firms decide who to hire and what to produce Prices get decision makers to reach outcomes that tend to maximize the welfare of society as a whole. Slide 39
Principles Cont d. 7. Government can sometimes improve market outcomes Market failure occurs when the market fails to allocate resources efficiently. Government can intervene to promote efficiency and equity when the market fails or break down. Market failure may be caused by an externality or market power. Slide 40
Principles Cont d. 8. The standard of living depends on a country s production Standard of living may be measured in different ways: By comparing personal incomes By comparing the total market value of a nation s production Most of the variations in living standards of countries are explained by differences in countries productivities. Slide 41
Principles Cont d. 9. Prices rise when the government prints too much money. Inflation is an increase in the overall level of prices in the economy. Growth of money is one of the causes of inflation. The value of money falls when the government creates large quantities of money. Slide 42
Principles Cont d. 10. Society faces a short-run trade-off between inflation and unemployment. The Philips curve illustrates the trade-off between inflation and unemployment. Mrs. Hellen Seshie-Nasser, Dept. of Economics, Slide 43