econ topic 1.0

Welcome to Principles of Economics

(ECN30205)

Do you know…

• According to the Bureau of Labor Statistics, since the 2009 financial crisis, there are now 9.6 million people in the U.S. who are still unemployed?

Do you know…

• … Who are the richest people in the world?

Do you know…

• Answer (from Forbes):

No 1: Bill GatesUSD$79.2B

No 2: Carlos Slim Helu

USD$77.1B

No 3: WarrenBuffett

USD$72.7B

Do you know…

• … what was the best-selling smart phone in the world in 2014? What is the retail price for the item?

Do you know…• Which movie has the highest grossing in

2014?

Do you know…

• Answer:

Transformers 4USD $1.1 billion

Do you know…

• …What food would you recommend at the campus? What is the price?

What is Economics?

What is Economics?• The word “economics” comes from the Greek

word “oikonomia” – meaning the management of a household.

• As it turns out, managing an economy (today) and a household have much in common – they both involve making decisions.

What is Economics?Household

• How much salary should mom and dad earn?

• How much money to spend on food, clothes, and rent?

• Who does the cooking?• Should we hire a maid?• Where to go on vacation?

Economy• How many goods and

services to be produced in Malaysia this year?

• How many units of cars should be manufactured next year?

• How many doctors and engineers should be trained?

• Should we import more goods from China? Or India?

What is Economics?

• Why are these decisions relevant to us?

• Or put it another way, what do all these decisions involve?

What is Economics?• All of these decisions involve the managing of

scarce/limited resources!

• Example: time, money and energy. Nobody has unlimited supply.

Can you name other types of scarce resource?

What is Economics?• Since these resources are limited, one must

use them with care.

• E.g. How would you spend your monthly allowance? On food? Clothes? Transport? Latest phones?

What is Economics?• E.g. How would you spend your time in a day?

Work/study hard? Watch “The Walking Dead” marathon? Etc.

What is Economics?• E.g. Only 1 percent of the world’s water

supply is drinkable. Should we use it for farming or producing luxury items instead?

1000 liter of water 1 T-Shirt

=

What is Economics?

• Specifically, managing scarce resources involve:

– Deciding on how to use it… (e.g. using money to buy food, instead of Iphone).

– Deciding who should get it (e.g. Mom gets more food because she is pregnant).

What is Economics?

1. Scarce Resources

2. How to use it?

3. Who gets to use it?

What is Economics?

• Definition:

Economics is therefore “a study of how individual and economies make decisions about the use and allocation of their scarce resources”.*

* Principles of economics (7th International Edition), K.E. Chase & R.C. Fair (2004)

Microeconomics vs.

Macroeconomics

Microeconomics

• The word “micro” means… small or very small.

• Microeconomics is the study of how individual households and businesses function or behave in a market.

Microeconomics

• Example: How much does your family spend on basic necessities a day? Month?

• Example: How many movies should Marvel Studios produce next year?

Macroeconomics

• The word “Macro” means… well, you should have guessed what it means by now!!

• Macroeconomics studies the workings of an economy (national, regional) as a whole.

Macroeconomics

• E.g. How much did Malaysia’s economy produce in 2013? Did it grow or contract? What was the amount of tax revenue collected?

Sources: IMF, Department of Statistics Malaysia.

GDPRM1 Trillion

(2013)

GDP+ 6.2%

(2013 vs. 2012)

InflationRate

2.1%(2013)

Positive Economics vs.

Normative Economics

Positive Econs Vs Normative Econs

• Since the economy affect our everyday lives (from the price for a kilo of sugar to national unemployment rate), economists and governments are interested in studying and managing them.

• To do so, 2 methods of study are used.

Positive Economics…

• …attempts to understand how economic systems work or behave without making judgments.

• Example: What causes inflation rate go up? What causes long-term unemployment?

Positive Economics…

• Positive economics is divided into 2 subcategories:

– Descriptive economics - the gathering of data that describe facts and statistics.

– Economic theory - a tool to make sense of the data and predict a cause and effect relationship. E.g. Theory of demand and supply (lecture 2).

In contrast, Normative Economics…

• …attempts to find out if an economic outcome or behaviour is good or bad, and whether they can be made better.

• Example: A high inflation rate is bad for the economy. How can it be reduced?

• Example: High employment rate is good. How can we sustain it?

Positive Econs Vs Normative Econs

• Of course, most normative issues are related to positive issues.

• Example: To judge whether high inflation is good or bad (normative), economists needs to first observe the effect of inflation on the economy (positive).

Economic Principles

Economic Principles• 1st Principle: People face tradeoffs

– To get something we want, we must give up another thing in return.

– E.g. Should you spend your evening studying or go to a party with your friends?

– For every hour you spend on studying, you lose one hour on spending time with your friends.

Economic Principles• 1st Principle (continued)…

– Businesses also face the same principle.

– E.g. Apple Inc. has $1 billion to spend on research. For every $ it spends on researching a new iPhone model, it has less $ to spend on researching Macbooks.

Economic Principles• 2nd Principle : Opportunity Cost

– If individuals and businesses face trade-offs, then how do they decide what is the best choice?

Economic Principles• 2nd Principle : Opportunity Cost

– First, they have to know the opportunity cost for each choice.

– Then they will compare the opportunity costs of these choices.

Economic Principles• 2nd Principle : Opportunity Cost

– What is an opportunity cost?

- An opportunity cost is the benefit you lose when choosing one decision over another.

Economic Principles• 2nd Principle : Opportunity Cost

– The best choice is the one where your opportunity cost (or benefits lost) is the lowest or smallest.

Economic Principles• 2nd Principle (continued)…

– If you decide to study, the opportunity cost (or benefit lost) is missing out fun times…

– If you decide to go out with friends, the opportunity cost (or benefit lost) is not getting good grades…

Economic Principles• 2nd Principle (continued)…

– So which decision has the lowest opportunity cost for you? Would you rather lose some fun or lose some good grades?

Economic Principles• 2nd Principle (continued)…

– For Apple Inc., if it spends $1 billion on IPhone research, it can make better IPhone and generate $2 billion profit.

– If it spends the money on MacBook research, it can sell more upgraded Macs and make $1.5 billion.

Economic Principles• 2nd Principle (continued)…

– If Apple does research on IPhone, its opportunity cost is $1.5b profit lost from the better MacBook.

– If research is done on MacBook, the opportunity cost is $2b profit lost from researching better IPhone.

Economic Principles• Which option has a lower opportunity cost?

Research iPhone

Research MacBook

Lose $1.5 Billion Lose $2 Billion

Economic Principles• 2nd Principle (continued)…

– The production possibility frontier (PPF)

Economic Principles• 2nd Principle (continued)…

– The PPF can be used to illustrate the concepts of tradeoff and opportunity cost.

– The PPF curve (see point A, B and C) shows the different possible combinations of Product A and B that can be produced by a firm when resources are used efficiently.

Economic Principles• 2nd Principle (continued)…

– Due to scarce resources, if a firm wants to produce more of Product A, then it must produce less of Product B (see point A).

– On the other hand, if a higher amount of Product B is produced, then there will be less resource for Product A (see point C).

– This is Tradeoff!

Economic Principles• 2nd Principle (continued)…

– The PPF can also be used to find out the opportunity cost of Product A and Product B.

– For example, if the firm wants to increase Product A by 10 units but needs to give up 20 units of Product B to do so, then the opportunity cost of each unit of Product A is 2 units of Product B.

20 units of Product B10 units of Product A = 2 B : 1 A

Economic Principles• 2nd Principle (continued)…

– Conversely, this also means that the opportunity cost for producing an extra unit of product B is ½ unit of Product A:

10 units of Product A20 units of Product B = ½ A : 1 B

Economic Principles• 2nd Principle (continued)…

– Point X, on the other hand, shows a production combination that is not efficient as it is below the curve.

– For example, point X could be caused by outdated technology, inadequate management skills or practices that waste resources.

Economic Principles• 2nd Principle (continued)…

– Point Y shows a production combination that cannot be reached yet as it require more resources than what the firm can currently obtain, or it requires technology that is beyond what is currently technically possible.

Economic Principles• 2nd Principle (continued)…

– However, Point Y can be achieved (eventually) in the following means:

• A) The firm or economy acquires new resources e.g. a bigger labor force, discovery of a new energy source.

• B) The firm or economy continues to use better and better production technology.

Economic Principles• 2nd Principle (continued)…

– The best way to think about point Y is to compare our country through the last 50 years… Was there a difference in our standard of living? This is known as economic growth!

Economic Principles• 3rd Principle: People respond to incentives

– Let’s go back to our earlier example on choosing between study and going out.

– What if, while choosing between studies or going out, you were told that your dream girl (guy) will be there as well?

Economic Principles• 3rd Principle: People respond to incentives

– Now your opportunity cost has changed - if you study, your opportunity cost is missing out fun and meeting that special person.

– Now, you may become more motivated to choose going out with friends.

Economic Principles• 3rd Principle (continued)…

– Another example: you can get rid of your garbage by the usual means or travel extra 5km to a recycle center.

Opportunity Cost:Pollution

Opportunity Cost:Time and energy

Economic Principles• 3rd Principle (continued)…

– But what if you were told that every Kg of garbage that you recycle earns you an extra $5?

– This would indeed motivate more people to recycle instead of disposing the usual way.

Economic Principles• 4th Principle: Marginal Cost and Benefit

– Let’s say that you have decided to spend the evening study for your exams (instead of going out).

– The following is a table showing the relationship between hours studied and the expected exam score:

Hours Hours studiedstudied 22 33 44 55ExpecteExpected scored score 6565 8585 9595 9999MarginaMarginal score l score

increaseincrease00 2020 1010 44

Economic Principles• 4th Principle (continued)…

– As you can see, even after you have made your choice by comparing the opportunity cost, it does not mean that repeating the same decision will keep giving you the same benefits.

Economic Principles• 4th Principle (continued)…

– If you continue to study more than 5 hours, the 6th hour (the marginal cost) onwards will not provide better exam scores (marginal benefit).

– In fact, you might even get a headache and ruin your exam performance the next day!

Economic Principles• 4th Principle (continued)…

– In that case, you can decide to go out with your friends after studying for 4 - 5 hours – hopefully they haven’t gone home yet!!

Economic Principles• 4th Principle (continued)…

– Marginal cost is the additional input needed to produce an extra unit of output (e.g. each hour of study).

– Marginal benefit is the additional benefit/output generated from an extra unit of input (e.g. extra test score).

Economic Principles• 4th Principle (continued)…

– Imagine that Apple has decided to spend the $1 billion to research on IPhone. If Apple was to spend more research money on IPhone, its expected marginal (extra) profit will decrease (for example, the upgraded model may become more and more complicated for customers)Amount Amount Spent Spent $1b$1b $2b$2b $3b$3b $4b$4b

ExpecteExpected d

revenuerevenue$2b$2b $3.3b$3.3b $3.5b$3.5b $3b$3b

MarginaMarginal profit l profit

increaseincrease00 $1.3b$1.3b $0.2b$0.2b -$0.5b-$0.5b

Types of Economic System

Types of Economic Systems

• Most countries these days practice the free market system or capitalistic system.

• In this market system, people have the freedom to set up, grow, sell or shut down their businesses.

• Likewise, buyers have the freedom of choice (i.e. what to buy and at what price & quantity).

Types of Economic Systems

• On the other hand, there are a few countries that practice(d) planned economy.

• In an planned economy the government decides what to produce and sell. It controls all the factors of production (e.g. labour, raw materials, and machinery).

Types of Economic Systems

• Although buyers in a planned economy can still decide what to buy, etc., their choices are very limited.

• Example of planned economies: former Soviet Union, China (under Mao) and North Korea.

Types of Economic Systems

• However, it is probably more correct to say that most countries these days adopt a “mixed market” approach that combines the 2 systems above.

• For instance, although you are free to set up a shop to sell cigarettes, you are controlled by the government as to whom you can sell it to i.e. no minors.

Summary• Economics is the study of how people and societies

choose to use the scarce resources available to hem• Microeconomics vs. Macroeconomics• Normative vs. Positive Economics• Economic Concepts

– Tradeoffs– Opportunity Costs– People Respond to Incentives– Marginal Benefits and Costs

• Types of Economic Systems