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
Reeses 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 everyones 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.

2.

basic physical and biological

properties of the world in
which the agent lives,
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,
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 wellbeing 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.