Lesson 1

Prof. Rushen Chahal

INTRODUCTION TO ECONOMICS

The Goal of this Course

Make you able to understand the news and informations about economics, politics and social events in a different way compared to whom has no knowledge about economics The benefit: you will understand better the other subjects studied at university and have a more valuable contribution at work

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The Method
Take a look at the chapter before coming to the class Study during the course, gradually Review before a new lesson and prepare your questions if you have any Ask questions during the classes or come to see me during the office hours Exercise by yourselves, there are plenty of exercises in your textbook
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What is economics and what does it do?

A study of mankind in the ordinary business of life Examines how to make choices well Studies how a society manages its resources Studies how the societies deal with the problem of relative scarcity Explains and answers questions

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What is economics and what does it do?

Answers questions like:

How does the economic system work? When does it go wrong? Why are there ups and downs? Why are there mainly ups in the long term?

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Economics analisys method

Models are used, they are a simplified version of reality, we will study a few important and useful models during the course

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Courses outline
The course is divided in 2 parts: microeconomics and macroeconomics Microeconomics: it is the branch of economics that studies how people makes choices and how these decisions interact. It studies one goods market, single producer and single consumers decisions and their interactions. Macroeconomics: it is the branch of economics that is concerned with overall ups and downs in the economy. It studies economy at an aggregated level, all goods aggregated market, topics at national lavel
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Courses outline
What we will study: microeconomics How individuals make choices Models: Supply and Demand, Production Possibility Frontier, Circular Flaw Diagram Producers decisions Taxes and their effects and benefits Trade, why is it beneficial Different kinds of markets: Oligopoly, Monopoly and Perfect Competition
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Courses outline
What we will study: macroeconomics The national economy: GDP, Real GDP, Unemployment, Inflation, Public Debt and Deficit Models:Circular Flaw Diagram, AD/AS and more About money: Demand and Supply, Central Banking, Interest Rates Policies: Monetary policy and Fiscal Policy
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First Concepts
Economy: it is a system for the coordination of a societys production activities Adam Smith and the invisible hand: the way the individual pursuit of self interest can lead to good results for society as a whole, an individual will promote an end that was not in his intentions There are mainly two kinds of economies: market economy and command (planned) economy

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First Concepts
Market economy No one is in charge, there is no central authority deciding what people must do Decentralized decisions by firms and individuals Resources allocation is decided by simple persons: what to produce, how and to whom give the products Each producer produces what he thinks is profitable and each consumer buys what he choses
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First Concepts

Command Economy Planned economic systems: a central authority decides production and consumption Problems: the producers cant always find the raw materials, the consumers may not find what they want to buy (long queues), the goods may be produced, but no one wants to buy them

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First Concepts
The invisible hand isnt always good: Individual interests sometime make society worse off, we say that there is a market failure Examples are traffic jams, pollution, overexploitation of resources Microeconomics help to find a solution

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Chapter 1
Objectives A set of principles for understanding the economics of how individuals make choices A set of principles for understanding how individual choices interact

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Chapter 1
Individual Choice
Individual choice: it is the decision by an individual of what to do, which necessarily involves a decision of what not to do. Example: you receive 100 Rmb petty cash, what do you buy? Cant buy everything you want you must chose! Choices are done at different levels: family, companieseverybody makes choices, even rich people! Principles That Underlie the Economics of Individual Choice: 1. Resources are scarce. 2. The real cost of something is what you must give up to get it. 3. How much? is a decision at the margin. 4. People usually exploit opportunities to make themselves better off.

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Chapter 1
Individual Choice 1. Resources Are Scarce:
A resource is anything that can be used to produce something else. Resources are scarcethe quantity available isnt large enough to satisfy all productive uses. The society thus needs to chose how to employ such scarce resources, this choice is the result of many individual choices (sometime there are exceptions) Examples: limited income (the100 Rmb), time (24h a day), natural resources, air, water
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Chapter 1
Individual Choice
2. Opportunity Cost: The Real Cost of Something Is What You Must Give Up to Get It All costs are opportunity costs The opportunity cost is an add on to the monetary cost of an item Sometime money is a good indication, sometime not. Think of college studies: tuition fee plus housing, books and the forgone income for those years!Sport champions dropping out from university Example: 100 yuan petty cash, DVD (100Y) and Book(80Y) DVDs opportunity cost= book + what you can buy with 20yuan.
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Chapter 1
Individual Choice
3. How Much? Is a Decision at the Margin Trade Off: You make a trade-off when you compare the costs with the benefits of doing something. Its an either or choice. A famous one is the Phillips Curve. Decisions about whether to do a bit more or a bit less of an activity are marginal decisions. You decide on one more or one less of something, when the benefit from it is higher than the cost you should do it. The study of such decisions is known as marginal analysis.
An example is the the time allocation to prepare 2 different exams, what to study the next hour?How to spend or invest the next yuan? If the benefit from it is higher than the cost you should do it.
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Chapter 1
Individual Choice: People Usually Exploit Opportunities to Make Themselves Better Off 4. People Usually Exploit Opportunities to Make Themselves Better Off, and Will Continue Until They Are Fully Exhausted People make decision comparing costs and benefits, their behavior may change when costs and benefits change. When change in opportunities offers reward to those who change their behavior we say that people face new incentives. An incentive is anything that offers rewards to people who change their behavior.
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Chapter 1
Individual Choice: People Usually Exploit Opportunities to Make Themselves Better Off

Examples: Gasoline price increase: people will take the bus, change living place, drive more fuel efficient cars, to be better off If the income of people having an MBA increases, more people will go to business school

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Chapter 1
Individual Choice: Summing Up
There are 4 basic principles of individual choice: Resources are scarce. It is always necessary to make choices. The real cost of something is what you must give up to get it. All costs are opportunity costs. How much? is a decision at the margin. Usually the question is not whether, but how much. And that is a question whose answer hinges on the costs and benefits of doing a bit more. People usually exploit opportunities to make themselves better off. As a result, people will respond to incentives.
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Chapter 1
Interaction: How Economies Work
Interaction of choicesmy choices affect your choices, and vice versais a feature of most economic situations. The results of this interaction are often quite different from what the individuals intend. Principles that underlie the interaction of individual choices:
1. There are gains from trade. 2. Markets move toward equilibrium. 3. Resources should be used as efficiently as possible to achieve societys goals. 4. Markets usually lead to efficiency. 5. When markets dont achieve efficiency, government intervention can improve societys welfare.

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Chapter 1
Interaction: How Economies Work 1. There Are Gains from Trade In a market economy, individuals engage in trade: They provide goods and services to others and receive goods and services in return. Trade can make everyone better off: think of a family producing what it needs by itself, it is very hard, it is better to trade
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Chapter 1
Interaction: How Economies Work
There are gains from trade: people can get more of what they want through trade than they could if they tried to be self-sufficient. This increase in output is due to specialization: each person specializes in the task that he or she is good at performing. Adam Smith and the pin factory: pointing out the gains from specialization. People specialize and give up self sufficiency because they can always trade and find what they need in the market. An economy can produce more when each person specializes and trades.
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Chapter 1
Interaction: How Economies Work
2. Markets Move Toward Equilibrium An economic situation is in equilibrium when no individual would be better off doing something different. Usually the equilibrium in the markets is reached through changes in prices, wich will move until there are no more opportunities to be better off. Change leads to a new equilibrium: markets thus work in a predictable way Examples: checkout lines in the supermarket,people rushing to the new opened one, until its not convenient anymore to change till, supermarket suppliers rushing to fill a gap in the supermarkets supplies
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Chapter 1
Interaction: How Economies Work
3. Resources Should Be Used as Efficiently as Possible to Achieve Societys Goals An economy is efficient if it takes all opportunities to make some people better off without making other people worse off. An economy is efficient when it gets the most it can from its scarse resources An example: the classroom problem, if a small classroom is used for a big class and a big classroom is free, for an efficient use of the schools resources the big class should be moved to it
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Chapter 1
Interaction: How Economies Work

If the economy is efficient there is no way to rearrange how resources are used without making someone worse off. About trade: if an economy is efficient it will have the maximum gains from trade.

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Chapter 1
Interaction: How Economies Work Efficiency isnt the only way to measure how well is an economy doing: Equity is another way Equity means that everyone gets his or her fair share. Since people can disagree bout whats fair, equity isnt as well-defined a concept as efficiency. Equity is for policymakers while economists are only concerned with efficiency or the most efficient use of the resources
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Chapter 1
Interaction: How Economies Work There is actually a trade off between equity and efficiency: Think of this example in your book, the parking place for disbled people. It is fair to help some persons with walking difficulties, but at the same time some inefficiency is involved: the assigned places may be sometime empty and could be used by non disabled drivers.

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Chapter 1
Interaction: How Economies Work 4. Markets Usually Lead to Efficiency There is no government branch to enforce efficiency! The incentives built into a market economy already ensure that resources are usually put to good use, that opportunities to make people better off are not wasted. If people can get better off they will take the opportunity for it, all the existing opportunities will be taken leading to efficiency.
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Chapter 1
Interaction: How Economies Work 5. When Markets Dont Achieve Efficiency, Government Intervention Can Improve Societys Welfare Individual pursuit of self interests may make society worse off, the market is inefficient in such case There is a market failure: the market left on its owns fails to allocate resources efficiently

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Chapter 1
Interaction: How Economies Work Markets fail for 3 reasons: Individual actions have side effects that are not properly taken into account by the market. One party prevents mutually beneficial trades from occurring in the attempt to capture a greater share of resources for itself. Some goods, by their very nature, are unsuited for efficient management by markets.
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Chapter 1
Interaction: How Economies Work
A government intervention may improve the societys welfare, make individuals better off. How can he do this? The government will change the existing incentives and thus improve societys welfare. He may raise taxes, tolls, create a welfare system, subsidize some goods or services Example: traffic jams, taxes and tolls and subsidies to public transports, this will change the incentives and push people to take the public transportation.
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