economics notes - basic concepts

8/2/2019 Economics Notes - Basic Concepts

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Basic Economic Concepts

Professional Development Course in Knowledge Enrichment for

Senior Secondary Economics Teachers

Outline of Lecture 1 Basic Economic Concepts

Topics covered:

I. Concept of cost

II. Interest as the cost of earlier availability of resources

III. Positive and normative statements

IV. Brief introduction to methodology

I. Concept of cost

A. How People make decisions

Teaching advice

Begin by pointing out that economics is a subject that students must encounter in their everyday

lives.

Point out that they have already spent a great deal of their time thinking about economic issues:

prices, buying decisions, use of their time, etc. Teacher may want to start the semester by explaining to students that we start learning

economics by studying a number of new terminologies and definitions.

Economists generally use very precise (and sometimes different) definitions. To avoid confusion,

it will be helpful to students if teachers follow the definitions provided in the text as much as

possible.

(i) Principle 1 : People Face Tradeoffs

Making decisions requires trading off one goal for another.

Examples include how a student spends her time, how a family decides to spend

its income, how the H.K. government spends tax revenue, how regulations may

protect the environment at a cost to firm owners.

A special example of a tradeoff is the tradeoff between efficiency and equity.

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For example, tax dollars paid by wealthy HK taxpayers and then distributed to

those less fortunate may improve equity but lower the return to hard work. It

therefore reduces the level of output produced by our resources.

This implies that the cost of increased equity is a reduction in the efficient use of

our resources.

Recognizing that tradeoffs exist does not indicate what decisions should be made.

(ii) Principle 2: The cost of something is what you give up to get it

Making decisions requires individuals to consider the benefits and costs of some

actions.

B. Definition of cost: opportunity cost is the highest-valued option forgone.

Teaching advice

One of the hardest ideas for students to grasp is that free things are not truly free.

Thus, teacher will need to provide students with numerous examples of such free things with

implicit costs, especially the value of time.

(i) Principle 3: Rational People Think at the Margin

Definition of marginal changes: small incremental adjustments to a plan of actions.

(ii) Principle 4: People Respond to Incentives

Since people make decisions by weighing costs and benefits, their decisions may

change in response to changes in costs and benefits.

Teaching advice

If you include any incentive-based criteria on your syllabus, discuss it now.

For example, if you reward class attendance (or penalize students who do not attend

class), explain to students how this change in marginal benefit of attending class can

be expected to alter their behavior.

C. Concept of sunk cost, implicit cost, explicit cost and full cost

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Teaching advice

Students rarely have trouble in understanding the concept of explicit costs.

However, they do often have difficulty in understanding the nature of implicit costs.

Definition ofsunk cost: a cost that has been committed and cannot be recovered.

- Once a cost is sunk, it is no longer an opportunity cost.

Total opportunity costs include both implicit and explicit costs.

- Definition of explicit costs: input costs that require an outlay of money by the firm.

- Definition of implicit costs: input costs that do not require an outlay of money by the

firm.

II. Interest as the cost of earlier availability of resources

Meaning of interest from the perspective of investor, borrower and lender

a) Investors Interest is the return on capital

b) Borrowers Interest is the price of earlier availability or the cost of borrowing

c) Lenders Interest is a compensation for postponement of consumption, which is an

extra value of entity owned today over the entity owned in future.

Meaning of Time Preference

- If more people prefer current consumption to future consumption, more people will be

borrowers and less will be lenders, and interest rate will increase.

Discussion on the tradeoff in borrowing

III. Positive and normative statements

Teaching advice

Use several examples to illustrate the differences between positive and normative statements and

stimulate classroom discussion.

Possible examples include:

Minimum wage

Budget deficits

Tobacco taxes

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Legalization of marijuana

Seat-belt laws.

Ask students to bring in newspaper articles and ask them to form groups. Identify some

statements in an editorial and ask students to state whether they are positive or normative

statements.

Discuss the difference between straight news stories and editorials and the analogy to economists

as scientists and as policy advisers.

Distinction between positive statements and normative statements

a) Definition of positive statements: claims that attempt to describe the world as it is.

b) Definition of normative statements: claims that attempt to prescribe how the world

should be.

Examples of positive statements

Examples of normative statements

IV. Brief introduction to methodology

Teaching advice

To illustrate to the class how simple but unrealistic models can be useful, bring a road map to

class. Point out how unrealistic it is.

For example, it does not show where all of the stop signs, gas stations, or restaurants are located.

It assumes that the earth is flat and two-dimensional.

But, despite these simplifications, a map usually helps travelers get from one place to another.

Thus, it is a good model.

Discussion on economic model, assumption of an economic model, the relationship among

model, theory and reality.

Discuss how theories are developed.

4How theories are developed


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Discuss how economists apply the methods of science.

Discuss how assumptions and models can shed light on the world.

Deduce implications

Make predictions

Test predictions

Economi

c

Theory

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Predictions are inconflict with facts

REALITY

Facts: observations of economic

phenomena to be explained

Make assumptionsEconomi

cModel

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