Overheads
Principles of Economics
Economics
Economics is the study of choice …
under conditions of scarcity.
Economics is the study of choice…
with constraints.
Economics is the study of how individuals
and societies choose
to employ scarce resources
that could have alternative uses
to produce goods and services,
and to distribute them, now or in
the future,
among various individuals and
groups in society.
The fundamental unit of analysis
in economics is the economic agent.
The underlying assumption in economic
analysis is that all economic agents
possess a
preference ordering
which allows them to rank alternative
states of the world.
Examples
Basketball versus wrestling
Candy
Snickers - Butterfinger
Reese’s Pieces - DOTS
The behavioral assumption in
economics is that all agents make
choices that are consistent
with their underlying preferences.
Scarcity
Scarcity is a situation in which the
amount of something available
is insufficient
to satisfy everyone’s desire for it.
Resources are anything that can
be used directly or indirectly to
satisfy human wants.
We sometimes call resources
factors of production
because they are utilized
to produce the goods and services
we use for consumption.
Three types of resources
land, which is physical space together
with the natural resources found above
or beneath it
labor, which is the time
human beings spend producing
goods and services
capital, which is a long-lasting resource
(not used up in the process) used to
produce goods and services
physical capital, which is tools, machines,
buildings, terraces
human capital, which is the natural
abilities, skills, and training of labor
Production systems,
goods, services, and factors
A production system or technology
is a description of the set of outputs
that can be produced by a given set of
factors of production (or inputs) inputs
using a given method of production
or production process.
A factor of production (input) is a good or
service that is employed in the production
process.
A product is a good or service that is
the output of a particular production
process.
There are three types of factors of production (inputs)
Expendables
Capital
Capital Services
Expendable factors of production
Expendable factors of production are
raw materials or produced factors
that are completely used up or
consumed during a single production
period.
Capital is a stock that is not used up
during a single production period,
provides services over time,
and retains a unique identity.
Capital services are the flow of
productive services that can be obtained
from a given capital stock during a
production period.
They arise from a specific item of capital
rather than from a production process.
It is usually possible to separate the
right to use services
from ownership of the capital good.
The economic environment and “outcomes”
of the economic system
Actions taken by any agent depend on the
opportunities presented to that agent.
These opportunities depend on the
economic environment of the agent.
The economic environment is determined
(constrained) by:
1. basic physical and biological
properties of the world in
which the agent lives,
2. the man-made technologies
available and in use,
3. the actions of other agents,
4. the institutional framework
of the economic system, and
5. other legal, social or moral
limits on choice.
Outcomes for each Agent in the System
Outcomes are the things that happen
in an economic system.
Receive paycheck, buy a bike wheel, get wheel
Quit job, move, get new job, get fired
Given a particular economic
environment and a set of choices for
each agent,
we can determine the outcome
for each agent,
depending on the actions
of all the agents in the system.
Market Example
Agent 1 with candy
Agent 2 with candy
Agent 3 who is a trader
Positive, Normative and
Conditionally Normative Economics
Positive economics
Positive economics deals with how
(why) the economy works.
Positive economic analysis is the process
of under-standing, describing,
and predicting economic behavior.
Examples
Price of gasoline
What happens to corn supply when the
price of corn rises?
What happens to the supply of housing
if rent controls are imposed?
Normative economics
Normative economics concerns itself
with what should be.
Normative economic analysis is the
process of determining what "ought to
be" or how to use resources optimally
so as to achieve the maximum well-
being for individuals in society.
Examples
Should we build a bridge over the Snake River?
Should a tariff on textiles be removed?
Should the government pay workers
displaced by mechanical tomato harvesters?
Should Farmer Oleson plant wheat or oats?
Conditional normative analysis
Conditional normative economics concerns
itself with under-standing, describing
and predicting economic behavior . . .
by assuming that agents make choices
according to some rule, determining their
optimal response given that rule,
and then using these derived expressions
to test various positive hypotheses.
Examples
Chocolate content assumption
Which food is chosen?
Distance from campus assumption?
Which apartment is chosen?
Economic Models
A model is an abstract representation of reality.
A model represents the real world.
We follow the principle that a model should be
as simple as possible
to accomplish its purpose.
The model should contain necessary details,
but no unnecessary ones.
We call this “no fat’ modeling.
Example
Types of maps
Ames to Lincoln
Find 2818 Sunset Drive
Assumptions are things that we
take to be true in forming a model,
without necessarily providing
evidence that they are true.
simplifying assumption –
any assumption that makes a model simpler
without affecting any of its important
conclusions.
critical assumption -
any assumption that affects the conclusions of
a model in an important way.
Two fundamental assumptions in economics
Every economic agent tries to make the
best out of any situation.
(Maximization hypothesis)
Every economic agent faces constraints.
The End
What are the 3 types of factors of production?
(Not resources)
Think of a couple examples of each
Economics is the study of how individuals
and societies _________
to employ ________ ____________
that could have alternative uses
to __________ _________ and ______,
and _________ them, now or in
the future,
among various __________ ______
____________ in society.
