1.) Discuss each of the economic ideas: People are rational, people respond to incentives, and optimal decisions are made at the margin. Please give an example of each.2.) What is scarcity? Why is scarcity central to the study of economics? Please give a real world example of scarcity.3.) What is a positive economic statement? What is a normative economic statement? Provide an example of each. 4.) Explain how consumer surplus is derived from the difference between the willingness to pay and the market equilibrium price. Please use examples to support your posting.https://util.wwnorton.com/jwplayer?type=video&msrc…https://util.wwnorton.com/jwplayer?type=video&msrc…https://wwnorton.com/college/econ/principles-of-ec…https://util.wwnorton.com/jwplayer?type=video&msrc…https://util.wwnorton.com/jwplayer?type=video&msrc…https://util.wwnorton.com/jwplayer?type=video&msrc…
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1
The Five
Foundations of
Economics
Big Questions
1. What is economics?
2. What are the five foundations of
economics?
Here’s a question for you…
• When you hear the term “economics,”
what words come to mind?
Purpose of This Course
• Provide you with the tools to
– Discover how the world works
– Be an informed citizen
– Live your life to the fullest
– Understand markets
– Make better personal decisions
Economics in Ferris Bueller
• Here is a stereotypical representation of a
“boring” economics class. Hopefully, you’ll
enjoy this course a little more.
What Is Economics?
• Scarcity
– The limited nature of society’s resources
given society’s unlimited wants
• Economics
– The study of how people allocate their limited
resources to satisfy their unlimited wants
– The study of how people make decisions
Practice What You Know—1
• What can be said about scarcity?
A. Scarcity forces us to make choices.
B. Scarcity doesn’t affect the super-wealthy.
C. Scarcity only affects commodities such as
oil.
D. Scarcity generally doesn’t affect our dayto-day living.
Microeconomics and
Macroeconomics
• Microeconomics
– The study of individual units that make up the
economy
• Focus on individuals, businesses, industries
• Macroeconomics
– The study of the overall aspects and workings of
an economy
• Focus on “big picture”
The Five Foundations of
Economics—2
1. Incentives matter
2. Life is about trade-offs
3. Opportunity costs
4. Marginal thinking
5. Trade creates value
Incentives Matter—1
• Incentives
– Factors that motivate you to act or exert effort
• People respond to incentives!
Incentives Matter—2
• Positive incentives
– Encourage action by offering rewards or
payments
• Negative incentives
– Discourage action by providing undesirable
consequences or punishments
Incentives Matter—3
• Direct incentive
– “Here is what I want you to do, and here is
what I am going to do in order to get you to do
it.”
• Generally easy to recognize
• Indirect incentive
– A secondary change in behavior brought on
by the original incentive
• More difficult to recognize
Incentives Matter—4
• Unintended consequence
– An unplanned result (usually negative and
unwanted) of an incentive
Practice What You Know—2
• Which of the following situations
illustrates an incentive?
A. Dave snacks all afternoon and isn’t
hungry for dinner.
B. Dirk’s children misbehave during dinner.
C. Lee gives his children candy if they
behave during dinner.
D. Jaime goes to a restaurant for dinner.
Life Is About Trade-offs
• Scarcity implies choice
Scarcity → Choice
– Every decision incurs a cost
– To have one thing, you have to give up
another thing
Practice What You Know—3
• The governor decides to increase
funding for education. However, this will
mean decreasing funding for
infrastructure. This situation illustrates
A. trade-offs.
B. comparative advantage.
C. incentives.
D. markets.
Opportunity Cost—1
• Opportunity Cost
– The highest-valued alternative that must be
sacrificed to get something else
• Not all alternatives—just the next-best choice
Scarcity → Choice → Opportunity Cost
Opportunity Cost—2
• What is the opportunity cost of
attending college?
– Tuition and fees
– Books
– Earnings from full-time work
• What about room and board?
Practice What You Know—4
• The opportunity cost of buying a good is
A. the sum of values of all the other goods you
could have purchased.
B. the value of the next-best alternative you could
have purchased.
C. irrelevant since you will purchase your highestvalued good.
D. the average of values of all the other goods you
could have purchased.
Marginal Thinking—1
• Economic thinking
– Requires a purposeful evaluation
of available opportunities to make
the best decision possible
• Marginal thinking
– Requires decision-makers to
evaluate whether the benefit of
one more unit of something is
greater than the cost
Marginal Thinking—2
• Suppose you are vacuuming your living
room. Will you move the couch and china
cabinet to vacuum under them?
– Marginal benefit
• Small additional amount of carpet is cleaned
– Marginal cost
• Much more time and effort
Economics in Grey’s
Anatomy
• “Into You Like a Train” Episode
• A train accident occurs, and two patients
end up with a pole stuck between them
– Doctors have to choose who to save
Practice What You Know—5
• With regards to marginal thinking, an
individual will do an action if
A. the probability of success is greater than
50 percent.
B. the action has positive benefits.
C. the costs of the action are small.
D. marginal benefits ≥ marginal costs.
Trade Creates Value—1
• Markets
– Bring buyers and sellers together to exchange
goods and services
• Trade
– The voluntary exchange of goods and
services between two or more parties
The Circular Flow—1
• Circular Flow
– Shows how resources and final goods and
services flow through the economy
• Resource market
• Product market
The Circular Flow—2
The Circular Flow—3
• Barter
– Individuals trading a good or service in
exchange for something they want
• Double coincidence of wants
– Occurs when each party in an exchange
transaction has what the other person desires
The Circular Flow—4
Trade Creates Value—2
• Without trade, you would have to
produce everything you consume.
• Trade fosters exchange of goods
and promotes specialization.
• Comparative advantage
– The situation in which an individual,
business, or country can produce at a
lower opportunity cost than a
competitor
Conclusion
• Economists ask, and answer, big questions
about life. This is what makes the study of
economics so fascinating.
• Economics is the study of how people allocate
their limited resources to satisfy nearly unlimited
wants.
• The five foundations of economics:
1.
2.
3.
4.
5.
Incentives
Trade-offs
Opportunity cost
Marginal thinking
Trade creates value
2
Model Building
and Gains from
Trade
Previously
• Economics is the study of how people
allocate their limited resources to satisfy
their nearly unlimited wants.
• “Scarcity” refers to the limited nature of
society’s resources.
• Incentives are factors that motivate a
person to act or exert effort.
Big Questions
1. How do economists study the economy?
2. What is a production possibilities frontier?
3. What are the benefits of specialization
and trade?
4. What is the trade-off between having
more now and having more later?
Here’s a question for you…
• What are the benefits and costs of a being
here in college?
The Scientific Method in Economics
• Economists use the scientific method to
explain economic phenomena:
– Observe a phenomena
– Develop a hypothesis
– Construct a model to test the theory
– Design an experiment to test how well the
model works and collect data
– Revise or refute the theory based on evidence
Positive and Normative Analysis
• Positive statement
– Can be tested and validated
– Describes “what is”
• Normative statement
– An opinion that cannot be tested or validated
– Describes “what ought to be”
• Economists are concerned with positive
analysis.
Practice What You Know—1
• Is the statement positive or normative:
1. Rich people should be taxed more.
2. More taxes on the rich will increase tax
revenues.
3. Everyone should donate to charity.
4. Government intervention in markets is bad.
5. Economics majors earn more on average than
sociology majors do.
Economic Models—1
• Economists use models to understand the
complex real-world economy.
• Models
– Simplified versions of reality
– Built with some assumptions
– Are considered good if they predict accurately
Economic Models—2
• Ceteris paribus
– Latin: Means “other things being equal”
– Used to build economic models
– Allows economists to examine a change in
one variable while holding everything else
constant
Economic Analysis
• Endogenous factors
– Variables that can be controlled for inside a
model
• Exogenous factors
– Variables that cannot be accounted for in a
model
Models and Ceteris Paribus—1
• Who gets paid more…
– Educated or uneducated individuals?
– Skilled or unskilled labor?
– Worker right out of college or older worker?
– New employee or veteran employee?
– Safe or dangerous job?
Models and Ceteris Paribus—2
Education




Age




Experience

W = f
Skills


 Pleasant conditions 




Female


Positive effect
Positive or negative effect?
Positive effect
Positive effect
Negative effect
A negative effect here may be
indicative of discrimination.
Danger of Faulty Assumptions
• When building a model, you must decide:
– What variables to include
– What variables to exclude
• These aren’t known with certainty.
• Model assumptions are also important for
the model’s success in predicting
outcomes.
– It is necessary to often examine and reevaluate the assumptions in models.
Practice What You Know—2
• What is a possible problem with using
faulty assumptions when building an
economic model?
A. The model could become too popular.
B. It could lead to poor economic decisions.
C. It means we never have to rebuild the
model.
D. It could cause too much wealth.
Production Possibilities
Frontier—1
• Production possibilities frontier
– Illustrates the combinations of outputs that a
society can produce if all of its resources are
being used efficiently
• Assumptions (ceteris paribus):
– Technology fixed
– Quantity of resources fixed
– Society produces only two goods:
• Pizza and wings
Production Possibilities Frontier—2
Practice What You Know—3
• With regard to the PPF, an efficient
point is a point that is
A. impossible to reach.
B. inside the PPF.
C. outside the PPF.
D. on the PPF.
PPF and Opportunity Cost—1
• Why is the PPF downward-sloping?
– Must give up one good to increase production
of another
• Recall opportunity cost
– Highest-valued alternative given up to pursue
an action
Practice What You Know—4
• If we move down and to the right along
a PPF, the opportunity cost of this
movement can be measured in terms of
A. how much of the x-axis good we gain.
B. how much of the y-axis good we gain.
C. how much of the x-axis good we give up.
D. how much of the y-axis good we give up.
PPF and Opportunity Cost—2
• Not all resources are perfectly adaptable for
producing both goods
– The PPF will not have a constant slope.
– The opportunity cost of producing a good will
rise as we produce more of it.
• The slope will get steeper as we move from left to
right.
PPF and Opportunity Cost—3
• Law of increasing opportunity cost
– The opportunity cost of producing a good
rises as society produces more of it.
– The PPF will not have a constant slope.
• The slope will rise (in absolute value) as we move
from left to right.
PPF and Opportunity Cost—4
The PPF and Economic
Growth—1
• Economic growth
– The process that enables a society to produce
more output in the future
– Can be shown by a shift outward of the PPF
• Some previously unattainable good combinations
would now be possible to produce
The PPF and Economic
Growth—2
• The PPF could shift graphically in two
ways.
– New resources or technology could be
introduced that either
• affect the production of one good, or
• affect the production of both goods.
The PPF and Economic
Growth—3
• The PPF could shift out because of
– New technology
– New (or better) resources available
• These changes in technology or resources
could affect the production of
– Only one good
– Both goods
The PPF and Economic Growth—4
Shift in the PPF
Practice What You Know—5
(True/False) Point A represents the amounts of
cars and bicycles that will be sold.
False.
Bicycles
It represents how
many cars and
bicycles are
produced, not
sold.
A
Cars
Practice What You Know—6
(True/False) Movement along the curve from point
A to point C shows us the opportunity cost of
producing more bicycles.
True.
Bicycles
C
A
Cars
Practice What You Know—7
(True/False) If we have high unemployment,
then the curve shifts in.
False.
Bicycles
?
Cars
Practice What You Know—8
(True/False) If an improved process for
manufacturing cars is introduced, society will be
able to produce more cars and more bicycles.
Bicycles
True.
Cars
Practice What You Know—9
• Suppose there is high unemployment.
With respect to the PPF, what will
happen?
A. The PPF will shift inward.
B. The PPF will shift outward.
C. We will produce at a point inside the PPF.
D. We will produce at a point outside the
PPF.
Specialization and Trade—1
• Improvements in technology and
resources can make an economy more
productive.
• Specialization and trade can also create
gains for society.
• Specialization
– The limiting of one’s work to a particular area
Specialization and Trade—2
• Assume now:
– Two goods (pizza and wings)
– Two people with different abilities in the
production of pizza and wings
Specialization and Trade—3
Daily Production
Person
Pizzas
Wings
Debra Winger
60
120
Mike Piazza
24
72
• Absolute advantage
– One person can perform one task more
effectively than the other person can.
– Who has the absolute in pizza? In wings?
Specialization and Trade—4
Specialization and Trade—5
Without Trade
Person
Good
Debra
Pizza
40
40
Wings
40
40
Pizza
18
18
Wings
18
18
Mike
Production Consumption
• Without specialization and trade:
– Mike and Debra each have to produce their own
wings and pizza
– Each person can only consume what they produce
Specialization and Trade—6
With Trade
Gains from
Trade
Person
Good
Production
Consumption
Debra
Pizza
60
41 (keeps)
+1
Wings
0
47 (from Mike)
+7
Pizza
0
19 (from Debra)
+1
Wings
72
25 (keeps)
+7
Mike
• With specialization and trade:
– Debra produces pizza and gives 19 pizzas to Mike
– Mike produces wings and gives 47 wings to Debra
– Each person consumes more with trade
Gains from Trade—1
Gains from Trade—2
Daily Production
Person
Pizzas
Wings
Debra Winger
60
120
Mike Piazza
24
72
Opportunity Cost
Person
1 Pizza
1 Wing
Debra Winger
2 wings
(120 ÷ 60)
1/2 pizzas
60 ÷ 120)
Mike Piazza
3 wings
(72 ÷ 24)
1/3 pizzas
(24 ÷ 72)
Gains from Trade—3
Opportunity Cost
Person
1 Pizza
1 Wing
Debra Winger
2 wings
(120 ÷ 60)
1/2 pizzas
(60 ÷ 120)
Mike Piazza
3 wings
(72 ÷ 24)
1/3 pizzas
(24 ÷ 72)
• Comparative advantage
– The ability to produce a good at a lower
opportunity cost
• Debra: pizza
• Mike: wings
Gains from Trade—4
• How did we know that Debra and Mike
would both be willing to trade 19 pizzas for
47 wings?
• Terms of trade
– The relative prices or exchange rate of goods
– We can express this as a ratio (Pizza:wings)
– For Debra, it is 1:2
– For Mike, it is 1:3
Gains from Trade—5
Person
Opportunity Cost
Ratio
Debra Winger
1 pizza equals 2 wings
1:2 = 0.50
Terms of trade
19 pizzas for 47 wings
19:47 = 0.40
Mike Piazza
1 pizza equals 3 wings
1:3 = 0.33
• As long as the terms of trade are between
the opportunity costs of the trading
partners, the trade benefits both sides.
Practice What You Know—10
• We often think of specialization and trade
occurring between countries.
• However, it can occur on much smaller
levels as well.
• Examples…
– Within a home?
– At a gathering of friends and/or family?
Economics in Cast Away
• Cast Away (2000)
– Imagine a world in which there was no
specialization and trade.
• Your consumption = your production
Trade-off Between Present
and Future—1
• Short run
– The period in which we make decisions that
reflect our immediate or short-term wants, needs,
or limitations
• Consumers can only partially adjust behavior
• Long run
– The period in which we make decisions that
reflect our needs, wants, and limitations over a
long time horizon
• Consumers have time to fully adjust to market
conditions
Trade-off Between Present
and Future—2
• Consumer goods
– Goods produced for current
consumption
• Capital goods
– Goods that help produce other
valuable goods
• Investment
– Using resources to create or buy
new capital
Capital Goods and Future
Growth—1
Capital Goods and Future
Growth—2
Visualizing Investment—1
• Suppose that instead of producing
pizza, we spent resources in order to
improve pizza-making technology.
• What happens…
– Today?
– Tomorrow?
Visualizing Investment—2
Investment in
Capital Goods
Time Period
1
2
3
4
No Investment
Visualizing Investment—3
• Other examples of long-term investment:
Practice What You Know—11
• What is the opportunity cost of
producing capital goods instead of
consumer goods?
A. We give up consumption today.
B. We give up consumption tomorrow.
C. We have less employment today.
D. We have a lower standard of living
tomorrow.
Conclusion
• Economists use simplified models to understand
how the economy works.
• The production possibilities frontier (PPF)
illustrates the benefits of trade and allows us to
describe ways to grow the economy.
• When producers specialize, they focus their
efforts on those goods and services for which
they have the lowest opportunity cost and trade
with others who are good at making something
else.
3
The Market at Work:
Supply and Demand
Previously
• “Scarcity” refers to the limited nature of
society’s resources.
• The production possibilities frontier (PPF)
is an illustration of the goods and services
an economy is capable of producing.
• Trade is mutually beneficial for both
parties involved.
Big Questions
1. What are the fundamentals of markets?
2. What determines demand?
3. What determines supply?
4. How do supply and demand shifts affect a
market?
Here’s a question for you…
• What factors
affect the price of
gasoline?
Fundamentals of Markets—1
• Firms
– Supply goods (or services)
• Consumers
– Purchase goods supplied by firms
• Exchange happens
– Through prices established in markets
– Supply or demand factors can change the
market price
Fundamentals of Markets—2
• Market
– Place where buyers and sellers meet
• Doesn’t have to be a physical place
Fundamentals of Markets—3
• Market economy
– Resources are allocated among households
and firms with little or no government
interference.
– Producers and consumers are motivated by
self-interest.
• The invisible hand of the market guides
resources to their highest valued uses.
Competitive Markets
• Characteristics of a competitive market:
– Many buyers and sellers
– The goods sold by each vendor are similar
– No one individual has any influence over the
price
Imperfect Markets
• Imperfect market
– Buyer or seller has an influence on the price
• Market power
– The firm’s ability to influence price
• Monopoly
– A single company that supplies the entire market
for a good or service
Demand—1
• Quantity demanded
– The amount of a good buyers are willing and
able to produce at the current price
• Law of demand
– All else equal, there is an inverse relationship
between price and quantity demanded
• If price , quantity demanded 
• If price , quantity demanded 
Demand—2
• Demand schedule
– Table showing the relationship between price
and quantity demanded
• Demand curve
– Graph of the relationship between price and
quantity demanded
Demand Schedule
Higher price
Lower price
Ryan’s Demand Schedule
for Salmon
Price of
Pounds of
Salmon
Salmon
(per pound)
Demanded
$20. …
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