Introduction to Economics
Tutor Center: Tory 828
Monday, Wednesday, Friday 93
Tuesday, Thursday 9:30 – 3:30
Closes April 9 , and closed February 1721
Economics: The study of the choices people make and the actions they take in
order to make the best use of the scarce resources in meeting individual wants
and needs. How do economists decide what is the “best”?
Alfred Marshall defined economics as “the study of mankind in the ordinary
business of life”
John Maynard Keynes saw economics as “a method rather than a doctrine, an
apparatus of the mind, a technique of thinking” and it is applied to the study of
Economics is about value, distribution, growth, stabilization, evolution, and
Lionel Robbins defined economics as “a science, which studies human behavior
as a relationship between ends and scarce means which have alternative uses”. It
is “behavior conditioned by scarcity”.
• Economic choices
o Consider some activity X. Then a simple rule of economics is
If Benefits (activity X) > Costs (activity X) then do activity X
If Costs (activity X) > Benefits (activity X), then do not do activity
Activity X = Policy
Policy set the speed limit on the highway Edmonton ▯Calgary to 10 km/hr
• Time costs
• Traffic congestion
• Speed tickets ▯enforcement
• Change signs
• Increase in CO 2
• Increase in gas expenditures
• Shipping costs go up
Benefits • Less deaths
Microeconomics: the study of the choices and actions of individual economic units
such as households, firms, consumers etc. How do you make your decisions? How
does government influence these decisions? (ex: unemployment of teachers ▯a
specific market). Deals with the issue of scarcity. What should be produced? What
quantity of resources should be allocated to a given activity or to a given consumption
good? Who should get the resources or final products?
o Prices reflect the degree of scarcity
o Scarce materials = more expensive
o Opportunity costs of a decision are the value of the next best alternative that
must be given up because of that decision. Working full time vs. school full
o Most of microeconomics and some of macroeconomics, are about searching
for efficiency ▯ constrained optimization.
Macroeconomics. The study of the behavior of the aggregate economy, including
issues like unemployment, inflation and changes in the level of national income. (ex:
unemployment in general). Why are some nations rich and others poor? How can we
avoid wasting the productive capabilities of unemployed labor?
o Macroeconomists deal with aggregates: the production of an entire economy
such as Canada.
o It also deals with government policies that affect the entire economy:
monetary policy and fiscal policy.
o Macroeconomics owes its existence to the fallacy of composition which is
the error of believing that what is true of each part of a system will be true of
the system as a whole.
Meaning of Theory in Economics
o A theory is a deliberate simplification of relationships used to explain how
those relationships work. Some questions require theorizing, not jus to
examination of the facts, because we need to consider possibilities that have
Judging Economic Allocations
o Allocations of resources can evaluated on the basis of;
1) Efficienc : Allocative efficiency is present when society’s resources are so
organized that it is impossible to make someone better off without hurting
someone else. (This is Pareto Efficiency). (Ex: Dividing 500,000 dollars
between every student which is Pareto Efficient, once it’s divided you can’t
give more to any one student or someone else will lose out. Somebody will
always lose and somebody will always win). 2) Equit : Distributing goods and services in a manner considered by society to
be fair. Economists struggle with equity.
3) Moral and Political Consequences : Looking at the reality of a situation:
What’s going to happen and should it happen.
January 14, 2014
1. Economics as a Science
o Economics as a social science that seeks to explain how people act. Like any
other science, it uses models, theories and assumptions to describe how people
o A model is a simplified description of the way things work. Models and
theories are meant to provide an understanding and explanation. They also
should be useful in predicting behavior.
⇒ Ockham’s Razor ▯the principle that irrelevant detail should be cut
o Assumptions are made in the formulation of all models. Essentially,
assumptions simplify complexities. The true test of a model is not the realism
of the assumptions it uses but rather the ability of the model to explain and
predict behavior (how well it explains).
o The model used in this course is called the Neoclassical Paradigm.
(Neoclassical Paradigm dominates microeconomics)
o Economics is an empirical science (has to go back to observation ▯how does
this theory apply in real world? How does it go back to real world
observation?). Therefore we must be concerned about real world data, so we
must be concerned about:
1) Correlation Fallacy
• Two variables are correlated if they tend to go up and down
together. Correlation does NOT imply causation.
• Incorrect belief that correlation implies causation
o Ex: Ice cream prices go up, as well as crime rate. Does
this mean that we should outlaw ice cream? No, this
means that the warmer weather is causing an increasing
in both variables. Statistical coincidence.
2) The Post Hoc Fallacy
• From the Latin phrase “post hoc ergo propter hoc”, meaning:
after this because of this. • An error of reasoning that a first event causes a second event
because the first occurred before the second.
o Ex: Wearing an Islander’s hat during an exam ▯gets an
A+. The two things are not actually related. The belief
that the first event causes the second event.
o Ex: People shopping in early December and the
opening of gifts and celebrating on Christmas Day.
Does shopping cause Christmas?
3) The Fallacy of Composition
• The incorrect view that what is good for the individual is good
for the group.
2. Production Possibilities Frontier
o A graph that shows all the combinations of goods and services that a society
can possibly produce given its resources and its level of technology.
Everything you are capable of doing, not necessarily what you are doing ▯
shows the limits available to you.
o Trying to draw up one of these for Canada would be very difficult. We can try
to distill the goods down into groups ▯or we could look at a simpler economy,
such as Fredonia.
• Fredonia (fictional country) only produces two goods:
o Bottled water and CD’s
• Graph: Combinations of bottled water and CD’s that can be produced.
Combinations, a, b, c, d, e, f, and h are attainable. 1) Combination g is unattainable n▯ ot enough resources or
2) Combinations a, b, c, d, e and f are efficient.
3) Combination h is attainable but inefficient
o The PPF illustrates key concepts in economics.
o Scarcity ▯combinations like g are unattainable
o Opportunity Costs
o The foregone benefits that arise when the resources are not used In the
next best alternative way.
o Ex: consider the opportunity cost of this lecture.
We could be:
• Sleeping ($16), working (1$4), studying ($20), recreational
activity ($17), watching TV ($0.10), with friends.
• The next best thing would be studying; therefore our
opportunity cost is $20.
o Ex: cost of a 4year degree at the U of A
Books and supplies ($1,500)
⇒ 34,000 for a 4year degree
⇒ Food and shelter are not included because we have to do that
whether or not we are doing a 4year degree
⇒ Opportunity costs:
o Suppose, instead of going to the U of A, you could work for
$40,000 a year.
o Total cost of a 4year degree
= $34,000 + $160,000
= $194,000 total opportunity cost Opportunity cost (1 bottle) = what is given up
what is gained
(1) Economics ▯88% Sociology ▯72%
(2) Sociology ▯96%
*** 26 points were given up ▯opportunity cost
Optimal decision: One that best serves the objectives of the decision maker, whatever
those objectives may be. It is selected by explicit or implicit comparison with the possible
o Law of Increasing Costs:
• In order to produce extra amounts of one good, society must give up
ever increasing amounts of the other good.
• This occurs because resources are not equally productive in all
activities. Ex: really good at bottled water production but really bad at
** Bottom two graphs are not possible
Resource industry’s have deeper cycles than manufacturing industries, so when Alberta
wanted to diversify our production industry, they tried to move from oil products to
forestry products but there would still be quite a bit of fluctuation. ▯Risk spreading.
o What will cause a PPF to shift out?
1) Technological Innovation: If our technology improves ▯we could
take what resources we have and make more things
2) More labor
3) Labor productivity increases: our workers are more skilled
4) More resources: example ▯discovery of more oil
o What would cause PPF to shift in?
• The opposite of the above causes and:
o Wars, natural disasters ⇒ How do we decide which combination to choose?
o The market, signals from consumers (Market Economy)
o The Command Economy ▯government decides everything
o Canada is a mixed economy ▯market decisions are guided by the hand
of government (ex: you can become a sociologist but you cant raise
oxen in your backyard)
January 16, 2014
Reading Chapter 4
1) The Market Economy
3. The Market Economy
o What is the market?
• Answer the question; what combination of goods should the society
1) Rationality Assumption
Individuals do not intentionally make decisions that will leave them worse
off (carful: this does not dismiss things such as altruism or charity)
Players In the Game
o Demand goods and services
o Supply factors and labor (they are producers in that sense)
o Objective: maximize satisfaction (achieve happiness)
o Supply goods and services
o Demand factors (materials and workers)
o Objective: maximize profits Government
o Objective: we don’t really know ▯in a market system it doesn’t really
matter that much for us to know
o Prevent people from exploitation (referee)
o Optimize the objectives of both players
o Uphold the values of society
o Get reelected
Main Characteristics of Market Economies
1) Selfinteres : Individuals pursue their own selfinterest, buying and selling
what seems best for them and their families.
2) Incentives : People respond to incentives. (Which one are we really after in a
market economy? Money and changes in prices)
3) Market Prices and Quantities : Prices and quantities are determined in open
markets in which would be sellers compete to sell their products to would be
4) Institution : All of these activities are governed by a set of institutions largely
created by government. These institutions include;
a. Individualist Institutions of Property and Decision Making. Before
people can begin to think about making an exchange, they must be
clear about what belongs to whom. For decentralized exchange to take
place people must have individually held private property, which is the
ownership of assets by nongovernmental economic agents. Private
property is an institution that we created to make a market work.
b. Social Institutions of Trust. Trust must exist between buyers and
sellers. This trust may be established through cultural norms, through
direct onetoone relationships or through the establishment of
c. Infrastructure for the Smooth Flow of Goods and Services. This refers
to the physical infrastructure of transportation and storage.
d. Money as a Medium of Exchange. To facilitate the flow of exchange,
we need a generally accepted means of payment. The actual institution
of money ▯we used to have something called double coincidence of
want (clumsy trading, finding someone who wants what you have and has what you want). Salt, and fish were used as money, as well as gold,
silver and bronze that became commodity money.
Circular Flow Model
Purple lines are physical flows, green lines are financial flows o
o Outputs of a firm or an economy are the goods and services it produces
o Inputs used by a firm or an economy are the labor, raw materials,
electricity and other resources used to produce its outputs.
Summary Chapter 1 o There are many possible definitions of economics, in the past economics has been
defined as being concerned with:
1. The cause of the wealth of nations
2. The laws that regulate income distribution
3. The laws of motion and capitalism
o Two further definitions could be offered today:
1. Economics is a method of analyzing individual and social behavior, especially as
it relates to market phenomena.
2. Economics is the study of behavior conditioned by scarcity.
o Microeconomics deals with consumers, firms, industries or markets taken in isolation.
Macroeconomics deals with economic systems taken as a whole, and thus confronts
fallacies of composition.
o Because of the great complexity of human behavior, economists are forced to
abstract from many details, to make generalizations that they know are not quite
true, and to organize what knowledge they have in terms of some theoretical structure
called a model.
o Correlation need not imply causation, and the timing of events may not properly
reflect what is the cause and what is the effect.
o Economists use simplified models to understand the real world and predict its
behavior, much as a child uses a model railroad to learn how trains work.
o Although these models, if skillfully constructed, can illuminate important economic
problems, they rarely can answer the questions that confront policy makers. Value
judgments are needed for this purpose, and the economist is no better equipped than
anyone else to make them.
o Economists agree among themselves on several fundamental issues, but as the
reading of any newspaper will demonstrate, they disagree on some issues of doctrine
and on many policy issues. There are several reasons that can explain such a situation:
1. The facts are uncertain or statistics hard to come by
2. Different economists may start with different assumptions
3. Models or theories are hard to disprove, so different economic theories will be
held and promoted concurrently by various schools of thought.
4. Economists come in all political stripes
o There are two views of science, the naïve and the modern view. In the naïve view, all
economists should end up accepting the same model. By contrast, the modern view
says that value judgments, political opinions, and vested interests influence every step
of scientific research, which helps explain why there are disagreements among
economists. Still, economists use the method of justifying ever step