INTRODUCTION TO ECONOMICS

Chapter 1

What is Economics?
What is Economics?
…is NOT the study of money or getting rich.

….is NOT the stock market.

What is Economics?
…is an 20 year old girl who is deciding whether to work or go
to university and how that affects her future income.

…is a company deciding whether to produce smartphones or

tables and how that’s influenced by what we consumers
want to buy.

…is the government deciding whether to increase its

spending when there is a recession and if it is worth going
into debt.

No matter who you are, you will be using economics!

Economy. . .
. . . The word economy comes from a Greek word for “one
who manages a household.”
The Economy and Economic Systems
In the economy we are faced with many decisions; many of
them involves an exchange sometimes using money as the
medium.

• Households purchase final goods and services for final

consumption and also provide the inputs into production
– land, labor and capital
• The organizations which buy these factors and use them
to produce goods and services are referred to collectively
as firms.
The Economy and Economic Systems
The economy is all the production and exchange activities that
take place every day (all the buying and selling).

Economic activity is how much buying and selling goes on in

the economy over a period of time.

The economy exists at different scales

• Local, İstanbul
• National e.g. the UK, Turkey
• International e.g. EU
The Economic Problem
The four big questions are:
◦ What goods and services should be produced?
◦ How should it be produced (see resources)?
◦ Who should get the goods and services produced?
◦ At what price should the goods be sold?
Scarcity and Choice
Society and Scarce Resources:
◦ The management of society’s resources is important
because resources are scarce.
◦ Scarcity means that society has limited resources and
therefore cannot produce all the goods and services people
wish to have.
◦ If everybody could reach whatever they want: then there will
be no need to economics

◦ Economics is the study of how society manages its scarce

resources.
What is Economics?
Economics is the study of how society manages its scarce
resources.
Economics ...
is the study of how society decides:
◦ What
•to produce...
◦ For whom
◦ How

•Therefore, economics is a social science which determines

the production, consumption, distribution and
accumulation of wealth of the society.
 What is Economics?
• Production: What to produce? How much? Which technology do
we need and how to produce?
• Distribution: Who gets what portion of total production? How to
distribute total income amongst different social groups (religion,
region, gender, etnical)
• Consumption: How individuals get consumption and saving
decisions? What type of goods and services are consumed by
individuals?
• Accumulation: How fast can wealth be accumulated (economic
growth)? What factors cause rapid growth? Why economic crises
ocur? How can individuals living conditions be improved?
Economic Agents
Households/Individuals: the decisions of consumption,
savings and labor supply
◦ Households: All persons living under one roof or occupying a
separate housing unit – co-consumption decisions

Firms: the decisions of production, investment and labor

demand

Government: economic policies (fiscal, monetary, social,

development plans, macroeconomic targets)
E ECONOMY AS A WHOLE WORKS
Macroeconomics and Microeconomics

Microeconomics Branch of economics that deals with the behavior of

individual economic units—consumers, firms, workers, and investors—
as well as the markets that these units comprise.

Macroeconomics. Branch of economics that deals with aggregate

economic variables, such as the level and growth rate of national
output, interest rates, unemployment, and inflation.

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION

9781473725331 © CENGAGE EMEA 2017
How People Make Decisions
◦ People face tradeoffs.
◦ The cost of something is what you give up to get it.
◦ Rational people think at the margin.
◦ People respond to incentives.

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION

9781473725331 © CENGAGE EMEA 2017
Principle #1: People Face trade-offs
Principle Tradeoffs.
“There is no such thing as a free lunch!”
People Face trade-offs
To get one thing, we usually have to give up another thing.
◦ Food v. clothing
◦ Leisure time v. work
◦ Efficiency v. equity

Making decisions requires trading

off one goal against another.

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION

9781473725331 © CENGAGE EMEA 2017
 People Face trade-offs
Society and Scarce Resources:
The management of society’s resources is important because resources are scarce.

Consumers
Consumers have limited incomes, which can be spent on a wide variety of goods and
services, or saved for the future.
Workers
Workers also face constraints and make trade-offs. First, people must decide whether and
when to enter the workforce. Second, workers face trade-offs in their choice of
employment. Finally, workers must sometimes decide how many hours per week they
wish to work, thereby trading off labor for leisure.
Firms
Firms also face limits in terms of the kinds of products that they can produce, and the
resources available to produce them.
People Face trade-offs
Efficiency v. Equity

◦ Efficiency means society gets the most that it can from its
scarce resources.

◦ Equity means the benefits of those resources are distributed

fairly among the members of society.
 Principle #2: The Cost of Something Is What
You Give Up to Get It.
Opportunity Cost
Decisions require comparing costs and benefits of alternatives.
◦ Whether to go to university or to work?
◦ Whether to study or go out on a date?
◦ Whether to go to class or sleep in?
The opportunity cost of an item is what you give up to obtain that
item.
The Cost of Something Is What You Give Up to
Get It.

LA Laker basketball star Kobe

Bryant (former basketball player)
chose to skip college and go
straight from high school to the
pros where he has earned millions
of dollars.

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION

9781473725331 © CENGAGE EMEA 2017
Principle #3: Rational People Think at the
Margin.
Marginal changes are small, incremental adjustments to an
existing plan of action.

People make decisions by comparing costs and benefits at

the margin.
Principle #4: People Respond to Incentives
Marginal changes in costs or benefits motivate people to
respond.
The decision to choose one alternative over another occurs
when that alternative’s marginal benefits exceed its
marginal costs!
Public policies can create incentives or disincentives that
alter behaviour.
Markets Can Be a Good Way to Organize
Economic Activity
Market
a shorthand expression for the process by which …
• households’ decisions about consumption of alternative
goods
• firms’ decisions about what and how to produce
• and workers’ decisions about how much and for whom
to work
… are all reconciled by adjustment of prices.
Markets Can Be a Good Way to Organize
Economic Activity
Prices and Markets
• How prices are determined?
• The price is an important factor for resource allocation.

• Resource allocation is crucial for a society and is handled in

different ways in different societies, e.g.:
• Central planned economy
• Mixed economy
• Free market economy
Markets Can Be a Good Way to Organize
Economic Activity
Prices and Markets
• How prices are determined?
• The price is an important factor for resource allocation.

• Resource allocation is crucial for a society and is handled in

different ways in different societies, e.g.:
• Central planned economy: by government
• Mixed economy
• Free market economy: by economic agents
Markets Can Be a Good Way to Organize
Economic Activity
•Efficiency or Equity?

In market economies, efficiency is more of a concern whereas

the planned economies gives more emphasis on equity.

Since the prices are not free in the planned economies a

central office decides the prices and the production. A heavy
bureaucracy is required for this process. Lack of competition
decreases the productivity and quality in planned economies.
 Markets Can Be a Good Way to Organize
Economic Activity
Market Orientation

•China •Sweden •USA

•Hungary
•Cuba •United
•Kingdom

•Free Market
•Central Planned
Economy
Economy
Markets Can Be a Good Way to Organize
Economic Activity
Pure market economy has no government intervention.
Centrally planned economy is where those in charge guide
economic activity.
◦ They have failed because they did not allow the market to
work.
Markets Can Be a Good Way to Organize
Economic Activity
Adam Smith made the observation that households and
firms interacting in markets act as if guided by an “invisible
hand.”

◦ Because households and firms look at prices when

deciding what to buy and sell, they unknowingly take into
account the social costs of their actions.

◦ As a result, prices guide decision makers to reach

outcomes that tend to maximize the welfare of society as
a whole.
 Governments Can Sometimes Improve Market
Outcomes
Market failure occurs when the market fails to allocate resources
efficiently.
When the market fails government can intervene to promote
efficiency and equity.
Market failure may be caused by
◦ an externality, which is the impact of one person or firm’s
actions on the well-being of a bystander.
◦ market power, which is the ability of a single person or firm to
unduly influence market prices.
 Real Versus Nominal Prices

● nominal price Absolute price of a good, unadjusted for inflation.

● real price Price of a good relative to an aggregate measure of prices;

price adjusted for inflation.

● Consumer Price Index Measure of the aggregate price level.

● Producer Price Index Measure of the aggregate price level for

intermediate products and wholesale goods.
 Real Versus Nominal Prices

Table 1.1 The Real Prices of Eggs and of a College Education

1970 1975 1980 1985 1990 1998
Consumer Price Index 38.8 53.8 82.4 107.6 130.7 163.0
Nominal Prices
Grade A large eggs $0.61 $0.77 $0.84 $0.80 $1.01 $1.04
College education 2530 3403 4912 8156 12,800 19,213
Real Prices ($1970)
Grade A large eggs $0.61 $0.56 $0.40 $0.29 $0.30 $0.25
College education 2530 2454 2313 2941 3800 4573

The real price of eggs in 1970 dollars is calculated as follows:

CPI1970 38.8
Re al price of eggs in 1975   nominal price in 1975   $0.77  $0.56
CPI1975 53.8
CPI1970 38.8
Re al price of eggs in 1980   nominal price in 1980   $0.84  $0.40
CPI1980 82.4
While the nominal price of eggs rose during these years, the real price of eggs actually fell.
Real Versus Nominal Prices
Table 1.1 The Real Prices of Eggs and of a College Education
1970 1975 1980 1985 1990 1998
Consumer Price Index 38.8 53.8 82.4 107.6 130.7 163.0
Nominal Prices
Grade A large eggs $0.61 $0.77 $0.84 $0.80 $1.01 $1.04
College education 2530 3403 4912 8156 12,800 19,213
Real Prices ($1980)
Grade A large eggs $1.30 $1.18 $0.84 $0.61 $0.64 $0.53

•The real price of eggs in 1980 dollars is calculated as follows:

CPI1980 82.4
Re al price of eggs in 1975   nominal price in 1975   $0.77  $1.18
CPI1975 53.8
CPI1980 82.4
Re al price of eggs in 1985   nominal price in 1985   $0.80  $0.61
CPI1985 107.6
 Real Versus Nominal Prices

Figure 1.1

The Minimum Wage

In nominal terms, the

minimum wage has
increased steadily
over the past 70
years.
However, in real
terms its expected
2010 level is below
that of the 1970s.
An Economy’s Standard of Living Depends on
its ability to produce goods and services

Economic growth - the increase in the amount of goods and

services in an economy over a period of time.
Gross domestic product per head - the market value of all final
goods and services produced within a country in a given period
of time divided by the population of a country to give a per
capita figure
An Economy’s Standard of Living Depends on
its ability to produce goods and services
Standard of living - a measure of welfare based on the amount
of goods and services a person’s income can buy.
◦ Usually measured by the inflation adjusted (real) income per
head of the population.
◦ Most variations in living standards are explained by
differences in countries’ productivities.
Productivity is the amount of goods and services produced
from each hour of a worker’s time.
 WHY STUDY MICROECONOMICS?
Corporate Decision Making: Ford’s Sport Utility Vehicles

The design and efficient production of Ford’s SUVs involved not only
some impressive engineering, but a lot of economics as well.

First, Ford had to think carefully about how the public would react to the
design and performance of its new products.

Next, Ford had to be concerned with the cost of manufacturing these

cars.

Finally, Ford had to think about its relationship to the government and
the effects of regulatory policies.
 WHY STUDY MICROECONOMICS?
Corporate Decision Making: Ford’s Sport Utility Vehicles

Questions needed to be answered:

– How strong is demand and how quickly will it grow? Consumer
Preferences and Demand
– Given all costs of production, how many should be produced each
year? The cost of Production Pricing Strategies
– Uncertainty of the future prices (the level of petroleum and wages):
Risk analysis
– The integration of all divisions of production: Organizational decisions
– Emissions standards and the effects of other policies: Government
regulation
 WHY STUDY MICROECONOMICS?
Public Policy Design: Automobile Emission Standards for
the Twenty-First Century

The design of a program like the Clean Air Act involves a good deal of
economics.

First, the government must evaluate the monetary impact of the

program on consumers.

The government must determine how new standards will affect the
cost of producing cars.

Finally, the government must ask why the problems related to air
pollution are not solved by our market-oriented economy.
Summary
① When individuals make decisions, they face trade-offs among
alternative goals.
② The cost of any action is measured in terms of foregone
opportunities.
③ People often make decisions by comparing marginal costs
and marginal benefits.
④ People change their behavior in response to the incentives
they face.
⑤ Government can potentially improve market outcomes if there
is some market failure or if the market outcome is inequitable.
⑧ Productivity is the ultimate source of living standards.