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Basic Economic Principles and Tools

Colin F. Bullock

Some Basic Questions


Why do we pay for water but not air? How do supermarkets decide what to sell and shoppers decide what to buy? Why do prices at Coronation market go up and down? If whole wheat is nutritionally superior, why do people prefer white bread? Why is there so much poverty and unemployment in Jamaica and what can Government so about it? Why does Jamaica buy so many things from the rest of the world and what can Jamaica sell to the rest of the world?

Basic Definition of Economics


Economics is the study of decision making on the allocation of scarce resources in the face of competing ends. Important point resources are scarce Important point- human wants are unlimited (especially relative to available resources) This implies that individuals and societies must choose

Core Principles-Bernanke and Frank


The Scarcity Principle: more of one=>less of other. Everyone has a budget constraint Cost-Benefit: Act only if marginal benefit>marginal cost Incentive: Cost-benefit drives peoples actions. Comparative Advantage: Everyone does best if each person specializes where they are most productive relative to others.

Core Principles contd


Opportunity cost: the best alternative use of an economic resource. Increasing opportunity cost: Use resources with lowest opportunity cost first e.g Efficiency: Getting most out of resources: maximize output and satisfaction. Equilibrium; Market in equilibrium leaves no unexploited opportunities.- No unsatisfied demand and no unsold supply.

Microeconomics vs Macroeconomics?
Micro study of individual units, eg. households and firms Micro How much of a commodity is produced, how is it prices, how are the costs and benefits of production distributed Macro study of the economy as a whole Macro- aggregate output, general price level, aggregate resource utilization including empolyment/unemployment. Macro some aggregation from micro but relative prices given and recognize market imperfection

Positive versus Normative Analysis


Positive = what is or will be = objective, factual, reality. e.g. If I raise the price of milk by 10% quantity demanded will fall by 20%. Normative = what should be = subjective, desirable, someones value judgement of what is right or good for people or society. e.g. Government should subsidize the cost of producing milk so that it does not become unaffordable for poor families with children.

Basic Economic Concepts and Tools


An economic theory is a set of ideas about the economy that has been organized in a logical framework A general view of how things relate to each other. e.g. the theory of the firm, the law of demand. An economic model is a specific logical representation of the behaviour of a household, a firm, a market, national income or employment or the general price level. A model gives more precise quantitative form to a theory. An economic model will involve abstraction and may be represented more precisely in mathematical format.

Logical hypothesis: If (assumption)..then (logic)...out turn. Natural sciences form and test hypotheses under controlled laboratory conditions. Social sciences form hypotheses by abstraction and test them by use of statistics. Abstraction: A simplified representation of an problem in a form that is more easily understood but without loss of essential information. It involves ignoring non-vital details in order to focus on the most important aspects of a problem. E.g. A road map of the route from Kingston to Montego Bay. The use of ceteris paribus (other things constant) in economics

Scientific Method and Abstraction

The Fundamental Economic Problem


Scarcity the problem of infinite human needs and wants in a world of finite resources Therefore choices have to be made This leads us to the concept of opportunity cost: the value of the next best alternative that the decision maker is forced to forgo If resources are fixed, in order to produce more of one good a country must produce less of something else

Possible Interpretations of Economic Efficiency


Efficiency is the absence of waste Economic efficiency is the concept that nothing more can be accomplished or achieved given the available resources It is impossible to make anyone better off without making someone worse off It is impossible to produce more output without using more input Production occurs at the lowest possible per unit cost

Take Away
Economics about Scarcity and Choice Rationality; maximization from scarce resources=> Efficiency and Benefit-Cost Specialization; all benefit if each does what they do best relative to others Increasing opportunity cost; use resources with lowest opportunity cost first. Market in equilibrium leaves no unexploited opportunities Micro vs. macroeconomics; segment vs. whole The use of abstraction; other things constant

References
Baumol & Blinder Chs 1 & 3 Frank & Bernanke Ch 1 & 2 Case, Fair & Oster Chs 1 & 2

Course Outline
1. 2. 3. 4. Basic Economic Tools and Concepts (including Coordinate Geometry (Graphs) and Demand and Supply) Macroeconomics vs Microeconomics and the Central Macroeconomic Questions Economic Growth and the Measurement of Output (National Income Accounting) Nominal vs Real GDP and the Measurement of Price Changes (Inflation) Planned Aggregate Expenditure = Output and the Multiplier Inflationary Expectations, Short Run and Long Run Aggregate Supply Income Equilibrium, Full Employment, Inflationary and Deflationary Gaps The Role of Public Policy: Fiscal Multipliers and Policy and Money Multipliers and Policy. International Economics: International Trade and Balance of Payments.

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Books
Baumol, William and Blinder, Alan: Economics Principles and Policies (Thomson South Western) Case, Karl E., Fair, Ray C., and Oster, Sharon M: Principles of Economics Frank Robert H., and Bernanke, Ben S. : Principles of Economics (Mc Graw-Hill Irwin)