Chp 1: Introduction
Scarcity: the limited nature of society’s resources
Economics: the study of how society manages its scarce resources, e.g.
▪ how people decide what to buy,
how much to work, save, and spend
▪ how firms decide how much to produce,
how many workers to hire
▪ how society decides how to divide its resources between national defence, consumer
goods, protecting the environment, and other needs
Economists also study how people interact with one another.
▪ I.e. examine the multitude of buyers and sellers of a good together determine the price at
which the good is sold and the quantity that is sold.
▪ They also analyze forces and trends that affect the economy as a whole, including the
growth in average income, the fraction of the population that cannot find work, and the
rate at which prices are rising.
How People make Decisions
Principle #1: People Face Trade-offs
- There is no free lunch. Making decisions requires trading off one goal against another.
- The classic trade-off is b.w “guns and butter.” The more we spend on national defence
(guns) to protect our shores from foreign aggressors, the less we can spend on consumer
goods (butter) to raise our standard of living at home.
Concept 1: Facing Trade off
Scarcity in relation to wants means you face tradeoffs; therefore, you have to make choices
#2: Opportunity Costs
The cost of the choice you make is what you give up for it, or the opportunity cost
#3: Choosing the a Little More or Less
Choices are usually made at the margin; we choose a “little” more or a “ little” less of something
#4: The influence of Incentive
The choices you made are influenced by incentives
Interaction among Individuals
#5: Specialization and trade will improve the well-being of all participants #6: The effectiveness of Market
Markets usually do a good job of coordinating trade among individuals, group, and nations.
#7: The Role of Governments
Governments can occasionally improve the coordinating function of markets
The Economy as a Whole and the Standard of Living
#8: Production and Standard of Living
The standard of living of the average person in a particular country is dependent on its
production of goods and services. A rise in the standard of living requires a rise in the output of
goods and services
#9: Money and Inflation:
If the monetary authorities of a country annually print money in excess of the growth of output
of goods and services it will eventually lead to inflation
#10: Inflation-Unemployment Trade-off
In the short run, society faces a short-run trade-off b.w inflation and its level of unemployment.
The Economic Way of Thinking
Scarcity and Choice
Economic Perspective: A viewpoint that envisions individuals and institutions making rational
decisions by comparing the marginal benefits and marginal costs associated with their actions.
No free lunch
Opportunity Cost: The amt of other products that must be forgone or sacrificed to produce a unit
of a product.
- To get more of one thing, you forgo the opportunity of getting the next best thing.
Firms offer free trial and product for marketing purposes.
Utility: The satisfaction a person gets from consuming a good or service
Assume human behaviour reflects “rational self-interest”
Individuals look for and pursue opportunities to increase their utility
They weigh costs and benefits, their decisions are purposeful or rational, not random or chaotic
Purposeful behaviour does not assume that people and institutions are immune from faulty logic
and therefore are perfect decision makers. They sometimes make mistakes. Nor does it mean that
people’s decisions are unaffected by emotion or the decisions of those around them. “Purposeful
behaviour” simply means that people make decisions with some desired outcome in mind. Rational self-interest is not the same as selfishness. Increasing one’s own wage, rent, interest, or
profit normally requires identifying and satisfying somebody else’s want!
People make sacrifices for others.
I.e. Parents help pay for their children’s education for the same reason
Help increase personal satisfaction
Marginal Analysis: Benefits and Costs
Marginal analysis: The comparison of marginal “extra” benefits and marginal costs, usually for
Most choices or decision involves changes in the status quo (the existing state of affairs)
Theories, Principles, and Models
Scientific method: the systematic pursuit of knowledge through formulating a problem,
collecting data, and formulating and testing hypotheses to obtain theories, principles, and laws
Procedure consists of several elements:
- Observing real-world behaviour and outcomes
- Based on those observations, formulating a possible explanation of cause and effect
- Testing this explanation by comparing the outcomes of specific events to the outcome
predicted by the hypothesis.
- Accepting, rejecting, or modifying the hypothesis based on these comparison
- Continuing to test the hypothesis against the facts. As favourable results accumulate, the
hypothesis evolves into a theory. A very well tested and widely accepted theory is
referred to as an economic law or an economic principle- a statement about economic
behaviour or the economy that enables prediction of the probable effects of certain
actions. Combinations of such laws or principles are incorporated into models, which are
simplified representations of how parts of the economy works, such as a market or
segment of the economy.
Theories, principles, models are “purposeful simplifications”
Develop theories of behaviour of individuals (consumer, workers) and institutions (business,
gov’t) engaged in the production, exchange, and consumption of goods and services
Some other things you should know about economic principles:
Generalizations related to economic behaviour or to the economy itself.
Economic principles are expressed as the tendencies of typical or average consumers, workers,
or business firms.
Other Things Equal Assumption Economists use the ceteris paribus or other things equal assumption- the assumption that factors
other than those being considered do not change. They assume that all variable except those
under immediate consideration are held constant for a particular analysis.
Many economic models are expressed graphically. Be sure to read the appendix at the end of this
chapter as a review of graphs.
Microeconomics and Macroeconomics
Microeconomics: the part of economics concerned with such individual units as industries, firms,
- Individual units (household, firm or industry) and their decision making process
- The specifics
Macroeconomics: the part of economics concerned with the economy as a whole.
- the whole economy
- the subdivisions or aggregates: collection of specific economy units treated as if they
were one unit.
- Gov’t, household, business sectors
- Lump the millions of consumers in the Canadian economy and treat them as if they were
one huge unit called “ consumers”
Positive and Normative Economics (exist in both macro and micro)
Positive Economics: The analysis of facts to establish cause-and-effect relationships.
- Description, theory development, and theory testing
- What is
- W.o value judgement
Normative Economics: The part of economics involving value judgement about what the
economy should be like.
- Looks at desirability of certain aspects of the economy
- What ought to be
- Subjective feelings
- What particular policy actions should be recommended
The Economic Problem
- The need to make choices because society’s material wants for goods and services are
unlimited but the resources available to satisfy these wants are limited (scarce)
- We have a finite amount of income
- In the form of wages, interest, rent, and profit
-people have virtually unlimited wants
- extend to necessities, luxuries
- only limited income but seemingly insa