ISE Economics summary
Chapter 1
The economic perspective
Scarcity and choice
The economic resources needed to make goods and services are in limited supply
(scarcity). There is no such thing as free lunch, someone bears the costs. The inputs
could have been used to create something else. This is opportunity costs: To obtain
more of one thing, society forgoes the opportunity of getting the next best thing that
could have been created with those resourses. That sacrifice is the opportunity cost of
the choice.
Purposeful behaviour
Individuals want to increase their utility (pleasure, happiness of satisfaction obtained
from consuming a good or service. This is called purposeful behaviour, people make
decisions with some desired outcome in mind. This is not the same as selfishness.
Self-interested behaviour is simply behaviour designed to increase personal
satisfaction, however it may be derived.
Marginal analysis: comparing benefits and costs
Marginal analysis are comparisons of marginal benefits and marginal costs, usually for
decision making. Marginal means extra, additional or a change in.
Theories, Principles and models
Economics relies on the scientific method. That precede consists of several elements:
- Observing real-world behavior and outcomes
- Based on those observations, formulating a explanation of cause and effect
(hypothesis)
- Testing this explanation by comparing the outcomes of specific events to the
outcome predicted by the hypothesis
- Accepting, rejecting, and modifying the hypothesis, based on these comparisons
- Continuing to test the hypothesis against the facts. If favorable results accumulate,
the hypothesis evolves into a theory. A very well-tested and widely accepted theory
is referred to as an economic law or an economic principle: a statement about
economic behavior or the economy that enables prediction of the probable effects of
certain actions. Combinations of such laws or principles are incorporated into
models, which are simplified representations of how something works, such as a
market or segment of the economy.
Good theories do a good job of explaining and predicting. They are supported by facts
concerning how individuals and institutions actually behave in producing, exchanging,
and consuming goods and services.
Things to know about economic principles
- Generalizations: Economic principles are generalizations relating to economic
behavior or to the economy itself. Economic principles are expressed as the
tendencies of typical or average consumers, workers, or business firms.
- Other-things-equal assumption: The assumption that factors other than those being
considered do not change.
- Graphical expression: Many economic models are expressed graphically. Be sure to
read the special appendix at the end to this chapter as a review of graphs.
Microeconomics and macroeconomics
Microeconomics
,Microeconomics is a part of economics concerned with decision making by individual
customers, workers, house-holds, and business firms.
Macroeconomics
Macroeconomics examines the performance and behavior of the economy as a whole.
An aggregate is a collection of specific economic units treated as if they were one unit.
Positive and normative economics
Both microeconomics and Macroeconomics contain elements of positive economics
and normative economics. Positive economics focuses on facts and cause-and-effect
relationships. Normative economics, which incorporates value judgments about what
the economy should be like or what particular policy actions should be recommended
to achieve a desirable goal.
Individual’s Economizing Problem
Economizing problem is the need to make choices because economic wants exceed
economic means.
Limited income
We all have a finite amount of income, even the wealthiest among us. The majority of
us have much more limited means
Unlimited wants
For better or worse, most people have virally unlimited wants. We desire various
goods and services that provide utility. But because we have only limited income but
insatiable wants, it is in our self-interest to economize: to pick and choose goods and
services that maximize our satisfaction given the limitations we face
Budget line
We can clarify the economizing problem facing consumers by visualizing a budget line.
It is a schedule or curve that shows various combinations of two products a consumer
can purchase with a specific money income.
Attainable and Unattainable combinations: All the combinations of movies and books
on us inside the budget line are attainable. In contrast all the combinations beyond the
budget line are unattainable with the 120€.
,Trade-offs and Opportunity costs: The budget line in the figure illustrates the idea of
trade-offs arising from limited income. To obtain more movies, you have to give up
some books. The opportunity costs for 1 movie is 2 books.
Choice
You will evaluate your marginal benefits and marginal costs to make choices that
maximize your satisfaction.
Income changes
The location of the budget line varies with money income. An increase in money
income shifts the budget line to the right; a decrease in money income shifts it to the
left.
Society’s Economizing Problem
Scarce Resources
Society has limited or scarce economic resources, meaning all natural, human, and
manufactured resources that go into the production of goods and services.
Resource categories
- Land: To the economist land includes all-natural resources used in the production
process
- Labor: The resource labor consists of the physical actions and mental activities that
people contribute to the production of goods and services
- Capital: For economists, capital includes all manufactured aids used in producing
consumer goods and services. Economists use the term investment to describe
spending that pays for the production and accumulation of capital goods.
- Entrepreneurial ability: A human resource. It is supplied by entrepreneurs, who
perform several critically important economic functions:
- The entrepreneur takes the initiative in combining the resources of land, labor,
and capital to produce a good or a service
- The entrepreneur makes the strategic business decisions that set the course of an
enterprise
- The entrepreneur innovates
- The entrepreneur bears the risk
Because land, labor, capital, and entrepreneurial ability are combined to produce
goods and services, they are called the factors of production, or simply ‘inputs’
Production possibilities Model
The alternatives and choices society faces can best be understood through a
macroeconomic model of production possibilities:
- Full employment: The economy is employing all of its available resources
- Fixed resources: The quantity and quality of the factors of production are fixed
- Fixed technology: The state of technology is constant
- Two goods: The economy is producing only two goods: pizzas and industrial robots.
Pizzas symbolize consumer goods, products that satisfy our wants directly; industrial
robots symbolize capital goods, products that satisfy our wants indirectly by making
possible more efficient production of consumer goods
Production possibilities table
A production possibilities table lists the different combinations of two products that
can be produced with a specific set of resources, assuming full employment.
, Generalization: At any point in time, a fully employed economy must sacrifice some of
one good to obtain more of another good. Scarce resources prohibit a fully employed
economy from having more of both goods
Production possibilities curve
The data presented in a production possibilities table are shown graphically as a
production possibilities curve.
Law of Increasing Opportunity Costs
As the production of a particular good increases, the opportunity cost of producing an
additional unit rises
- Shape of the curve: The law of increasing opportunity costs is reflected in the shape
of the production possibilities curve: the curve is bowed out from the origin of the
graph
- Economic rationale: The law of increasing opportunity costs is driven by the fact that
economic resources are not completely adaptable to alternative uses. Many
resources are better at producing one type of good than at producing others.
Optimal Allocation
Of all the attainable combinations of pizzas and industrial robots, which is optimal?
That is, what specific quantities of resources should be allocated to pizzas and what
specific quantities should be allocated to industrial robots in order to maximize
satisfaction?
The economic decisions center won comparisons of marginal benefit and marginal
costs. Any economic activity should be expanded as long as marginal benefit exceeds
marginal cost and should be reduced if marginal cost exceeds marginal benefit. The
optimal amount of the activity occurs where MB = MC. Society needs to make a similar
assessment about its production decision.
Unemployment, Growth, and the Future
A growing economy
When we drop the assumptions that the quantity and quality of resources and
technology are fixed, the production possibilities curve shifts positions and the
potential maximum output of the economy changes
- Increase in resource supplies: Although resource supplies are fixed at any specific
moment, they change over time. The net result of these increased supplies of the
factors of production is the ability to produce more of both consumer goods and
capital goods. Thus, when an increase in the quantity or quality of resources occurs,
the production possibilities curve shifts outward and to the right. This sort of shift
represents growth of economic capacity, which, when used, means economic
growth: a larger total output.
- Advances in technology: An advancing technology brings both new and better goods
and improved was of producing them.
- Conclusion: Economic growth is the result of increases in supplies of resources,
improvements in resource quality, and technological advances. The consequence of
growth is that a full-employment economy can enjoy a greater output of both
consumption goods and capital goods. Whereas static, no-growth economies must
sacrifice some of one good to obtain more of another, dynamic, growing economies
can have larger quantities both goods.
Present choices and future possibilities
An economy’s current choice of positions on its production possibilities curve helps
determine the future location of that curve.
A qualification: International trade
