BBA Principles of Economics Notes Introduction
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Economy. . .
. . . The word economy comes from a Greek word for “one who manages a household.”
BBA Principles of Economics Notes Introduction :-
Ten principles of economics
• A household and an economy face many decisions:
• Who will work?
• What goods and how many of them should be produced?
• What resources should be used in production?
• At what price should the goods be sold? Ten principles of economics 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. Ten principles of economics Economics is the study of how society manages its scarce resources. Ten principles of economics.
• 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. Ten principles of economics
• How people interact with each other.
• Trade can make everyone better off.
• Markets are usually a good way to organize economic activity.
• Governments can sometimes improve economic outcomes. Ten principles of economics.
• The forces and trends that affect how the economy as a whole works.
• The standard of living depends on a country’s production.
• Prices rise when the government prints too much money.
• Society faces a short-run trade off between inflation and unemployment.
Principle of Economic : People Face Trade offs.
“There is no such thing as a free lunch!” Making decisions requires trading off one goal against another.
Principle of Economic : People Face Trade offs.
To get one thing, we usually have to give up another thing.
• Guns v. butter
• Food v. clothing
• Leisure time v. work
• Efficiency v. equity
Principle #1: 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 of Economic : the cost of something is what you give up to get it.
• Decisions require comparing costs and benefits of alternatives.
• Whether to go to college 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.
Principle of Economic Notes : The cost of something is what you give up to get it.
LA Laker basketball star Kobe Bryant chose to skip college and go straight from high school to the pros where he has earned millions of dollars. People make decisions by comparing costs and benefits at the margin.
Principle of Economic Notes : Rational people think at the margin.
• Marginal changes are small, incremental adjustments to an existing plan of action.
Principle of Economic notes 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!
Principle of Economic notes 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.
Principle of Economic Notes : Markets are usually a good way to organize economic activity.
• A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
• Households decide what to buy and who to work for.
• Firms decide who to hire and what to produce.
Principle of Economic Notes : Markets are usually 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.
Principle of Economic Notes : Governments Can Sometimes Improve Market Outcomes.
• Market failure occurs when the market fails to allocate resources efficiently.
• When the market fails (breaks down) government can intervene to promote efficiency and equity.
Principle of Economic Notes : Governments Can Sometimes Improve Market Outcomes.
• 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.
Principle of Economic Notes : 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.
Principle of Economic Notes : The Standard of Living Depends on a Country’s Production.
• Almost all 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.
Principle of Economic Notes : The Standard of Living Depends on a Country’s Production.
• Standard of living may be measured indifferent ways:
• By comparing personal incomes.
• By comparing the total market value of a nation’s production.
Principle of Economic Notes : Prices Rise When the Government Prints Too Much Money.
• Inflation is an increase in the overall level of prices in the economy.
• One cause of inflation is the growth in the quantity of money.
• When the government creates large quantities of money, the value of the money falls.
Principle of Economic Notes : Society Faces a Short-run Tradeoff Between Inflation and Unemployment.
• The Phillips Curve illustrates the tradeoff between inflation and unemployment:
Inflation Unemployment It’s a short-run tradeoff! Summary
• When individuals make decisions, they face trade offs among alternative goals.
• The cost of any action is measured in terms of foregone opportunities.
• Rational people make decisions by comparing marginal costs and marginal benefits.
• People change their behavior in response to the incentives they face. Summary
• Trade can be mutually beneficial.
• Markets are usually a good way of coordinating trade among people.
• Government can potentially improve market outcomes if there is some market failure or if the market outcome is inequitable.
Summary
• Productivity is the ultimate source of living standards.
• Money growth is the ultimate source of inflation.
• Society faces a short-run trade off between inflation and unemployment.
Thinking Like an Economist
BBA Principles of Economics Notes Introduction :-
• Every field of study has its own terminology
• Mathematics
• integrals, axioms, vector spaces
• Psychology
• ego id cognitive dissonance
• Law
• promissory estoppel torts venues
• Economics
• supply opportunity cost elasticity consumer surplus demand comparative advantage deadweight loss
Thinking Like an Economist
• Economics trains you to. . . .
• Think in terms of alternatives.
• Evaluate the cost of individual and social choices.
• Examine and understand how certain events and issues are related.
The economist as a scientist
• The economic way of thinking . . .
• Involves thinking analytically and objectively.
• Makes use of the scientific method.
The Scientific Method : Observation, Theory, and More Observation
• Uses abstract models to help explain how a complex, real world operates.
• Develops theories, collects, and analyzes data to evaluate the theories.
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.
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
Our First Model: The Circular-Flow Diagram
• The circular-flow diagram is a visual model of the economy that shows how dollars flow
through markets among households and firms.
Our First Model: The Circular-Flow Diagram
• Factors of Production
• Inputs used to produce goods and services
• Land, labor, and capital
Our Second Model: The Production Possibilities Frontier
• The production possibilities frontier 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 Figure 2 The Production Possibilities Frontier
• Microeconomics focuses on the individual parts of the economy.
• How households and firms make decisions and how they interact in specific markets
• Macroeconomics looks at the economy as a whole.
• Economy-wide phenomena, including inflation, unemployment, and economic growth The economist as policy advisor.
• When economists are trying to explain the world, they are scientists.
• When economists are trying to change the world, they are policy advisor.
Positive versus normative analysis
• Positive statements are statements that attempt to describe the world as it is.
• Called descriptive analysis
• Normative statements are statements about how the world should be.
• Called prescriptive analysis Positive versus normative analysis
• Positive or Normative Statements?
• An increase in the minimum wage will cause a decrease in employment among the leastskilled.
• Higher federal budget deficits will cause interest rates to increase.
• Positive or Normative Statements?
• 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.
NORMATIVE PRINCIPLES OF ECONOMIC
BBA Principles of Economics Notes Introduction :-
Positive versus normative analysis?
• serve as advisers in the policymaking process of the three branches of government:
• Legislative
• Executive
• Judicial
• Some government agencies that collect economic data and make economic policy:
• Department of Commerce
• Bureau of Labor Statistics
• Congressional Budget Office
• Federal Reserve Board
WHY ECONOMISTS DISAGREE
BBA Principles of Economics Notes Introduction :-
• They may disagree about the validity of alternative positive theories about how the world works.
• They may have different values and, therefore, different normative views about what policy should try to accomplish. Table 2 Ten Propositions about Which Most Economists Agree
• Economists try to address their subjects with a scientist’s objectivity.
• They make appropriate assumptions and build simplified models in order to understand the world around them.
• Two simple economic models are the circularflow diagram and the production possibilities frontier.
• Economics is divided into two subfields:
• Microeconomists study decision-making by households and firms in the marketplace.
• Macroeconomists study the forces and trends that affect the economy as a whole
• A positive statement is an assertion about how the world is.
• A normative statement is an assertion about how the world ought to be.
• When economists make normative statements, they are acting more as policy advisors than scientists.
• Economists who advise policymakers offer conflicting advice either because of differences in scientific judgments or because of differences in values.
• At other times, economists are united in the advice they offer, but policymakers may choose to ignore it.
Interdependence and the Gains from Trade Consider your typical day
• You wake up to an alarm clock made in Korea.
• You pour yourself orange juice made from Florida oranges and coffee from beans grown in Brazil.
• You put on some clothes made of cotton grown in Georgia and sewn in factories in Thailand.
• You watch the morning news broadcast from New York on your TV made in Japan.
• You drive to class in a car made of parts manufactured in a half-dozen different countries.
• . . . and you haven’t been up for more than two hours yet!
• Remember, economics is the study of how societies produce and distribute goods in an attempt to satisfy the wants and needs of its members.
Interdependence and the Gains from Trade
BBA Principles of Economics Notes Introduction :-
• How do we satisfy our wants and needs in a global economy?
• We can be economically self-sufficient.
• We can specialize and trade with others, leading to economic interdependence. Interdependence and the Gains from Trade
• Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity.
• But this gives rise to two questions:
• Why is interdependence the norm?
• What determines production and trade? Interdependence and the Gains from Trade.
• Why is interdependence the norm?
• Interdependence occurs because people are better off when they specialize and trade with others.
• What determines the pattern of production and trade?
• Patterns of production and trade are based upon differences in opportunity costs.
A PARABLE FOR THE MODERN ECONOMY
• Imagine . . .
• only two goods: potatoes and meat
• only two people: a potato farmer and a cattle rancher.
• What should each produce?
• Why should they trade? Production Possibilities
• Self-Sufficiency
• By ignoring each other:
• Each consumes what they each produce.
• The production possibilities frontier is also the consumption possibilities frontier.
• Without trade, economic gains are diminished.
(a) The Farmer ’s Production Possibilities Frontier If there is no trade, the farmer chooses this production and consumption.
Table 2 The Gains from Trade: Who can produce potatoes at a lower cost the farmer or the rancher?
• Differences in the costs of production determine the following:
• Who should produce what?
• How much should be traded for each product?
THE PRINCIPLE OF
COMPARATIVE ADVANTAGE
• Differences in Costs of Production
• Two ways to measure differences in costs of production:
• The number of hours required to produce a unit of output (for example, one pound of potatoes).
• The opportunity cost of sacrificing one good for another.
• The comparison among producers of a good according to their productivity— absolute advantage
• Describes the productivity of one person, firm, or nation compared to that of another.
• The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. The Rancher has an absolute advantage in the production of both meat and potatoes.
Absolute Advantage Principles of Economics
• The Rancher needs only 10 minutes to produce an ounce of potatoes, whereas the Farmer needs 15 minutes.
• The Rancher needs only 20 minutes to produce an ounce of meat, whereas the Farmer needs 60 minutes. Opportunity Cost and Comparative Advantage
• Compares producers of a good according to their opportunity cost.
• Whatever must be given up to obtain some item.
• The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
• Who has the absolute advantage?
• The farmer or the rancher?
• Who has the comparative advantage?
• The farmer or the rancher?
Table 3 The Opportunity Cost of Meat and Potatoes
BBA Principles of Economics Notes Introduction :-
Opportunity Cost of: 1 oz of Meat 1 oz of Potatoes Farmer 4 oz potatoes 1/4 oz meat Rancher 2 oz potatoes 1/2 oz meat
• The Rancher’s opportunity cost of an ounce of potatoes is ¼ an ounce of meat, whereas the Farmer’s opportunity cost of an ounce of potatoes is ½ an ounce of meat.
• The Rancher’s opportunity cost of a pound of meat is only 4 ounces of potatoes, while the Farmer’s opportunity cost of an ounce of meat is only 2 ounces of potatoes……so, the Rancher has a comparative advantage in the production of meat but the Farmer has a comparative advantage in the production of potatoes.
• Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.
• Whenever potential trading parties have differences in opportunity costs, they can
each benefit from trade.
Comparative Advantage and Trade
• Benefits of trade
• Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage. FYI—The Legacy of Adam Smith and David Ricardo
• Adam Smith
• In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith performed a detailed analysis of trade and economic interdependence, which economists still adhere to today.
• David Ricardo
• In his 1816 book Principles of Political Economy and Taxation, David Ricardo developed the principle of comparative advantage as we know it today.
• Should Tiger Woods Mow His Own Lawn?
APPLICATIONS OF COMPARATIVE ADVANTAGE
BBA Principles of Economics Notes Introduction :-
• Should the United States Trade with Other Countries?
• Each country has many citizens with different interests. International trade can make some individuals worse off, even as it makes the country as a whole better off.
• Imports—goods produced abroad and sold domestically
• Exports—goods produced domestically and sold abroad
• Each person consumes goods and services produced by many other people both in our country and around the world.
• Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services.
Principles of Economics Summary
• There are two ways to compare the ability of two people producing a good.
• The person who can produce a good with a smaller quantity of inputs has an absolute advantage.
• The person with a smaller opportunity cost has a comparative advantage. Summary
• The gains from trade are based on comparative advantage, not absolute advantage.
• Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage.
• The principle of comparative advantage applies to countries as well as people.
BBA Principles of Economic Question Paper 2019-2021
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