ECN 330 Lecture 1: “Markets and Economic Efficiency: an Economics Primer”
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ECN 330 Lecture 1: “Markets and Economic Efficiency: An Economics Primer” Economics is the study of how individuals, firms and societies deal with scarcity. In economics we can examine the notion of scarcity on two general levels: Microeconomics and macroeconomics. Microeconomics examines economic decisions at the individual consumer or firm level: • How consumers decide which goods and services to purchase, how to allocate scarce time, money and other resources toward purchases in order to maximize satisfaction. • How firms allocate their scarce productive resources (land, labor and capital) in order to decide which products to produce, and how to produce them – what inputs to use, in order to maximize profits. • When we put these two together (buyers and sellers) we get a “market”. Many markets together comprise and economy. Thinking ahead… What are some environmental and natural resource scarcity issues that might fall under microeconomics? - local pollution issue - local or regional species preservation issue - regional fishery management problems We can also expand up to a larger level and look at Economic decisions at the society or economy-wide level, which are covered under Macroeconomics. • How markets interact to determine production in an entire economy • How nations interact to allocate goods and services through trade • How government intervenes in markets through policy • How interest rates are determined • How inflation, unemployment and economic growth are determined and measured Thinking ahead… What are some environmental and natural resource scarcity issues that might fall under macroeconomics? - The contribution of a nations natural resource endowments to a nations GDP (“ecological economics”) - National management of oil reserves and the implication of management alternatives for the general price level and inflation. - Highly migratory (eg: pelagic) fisheries management In this course we’re going to be studying both levels… Most of what we’ll cover will be more micro-focused, but when we get into things such as migratory fisheries issues, we might have to expand our focus to a more macro level. It’s important to recognize that the two are not separate – most of the tools, models and intuition we get from microeconomics carries over and are used in macro, just in a larger context. Within both branches of economics, we spend a great deal of time engaged in something known as positive analysis. Positive analysis is analyzing or predicting the effects or consequences of actions that take place within economic systems (households, firms, markets, nations) without making subjective judgments. Basically positive analysis is completing “if…then” statements. Positive analysis is objective analysis completed without personal opinion or personal bias, such as examining and analyzing facts, data and theory without interjecting our personal beliefs or opinions. We can break positive economics into 2 general ideas: • descriptive economics (describing facts based on specific data) • economic theory (generalizations about relationships that are commonly held true based on a collection of observations) Examples of questions that might be addressed with positive analysis: • What will happen to tourism revenues if reef quality decreases by 10%? • What are tourists willing to pay to visit a marine park? • What will happen to employment and wages in the fishing industry if stocks decrease by 20%? • What will happen to employment and wages in the hotel industry if beach width decreases by 25%? Macro egs: • What will happen to housing purchases if interest rates fall next quarter? • What happens to the price of U.S. goods if trade restrictions with other nations are imposed? These are all examples of positive analyses • looking at cause and effect • what is actually going on • what exists BLACKBOARD DISCUSSION EXERCISE: 1. Construct 2 micro-level environmental/natural resource questions that could be addressed with positive analysis. 2. Construct 2 macro-level environmental/natural resource questions that could be addressed with positive analysis. In contrast to positive analysis where we don’t have subjective opinion or judgment, we can talk about “NORMATIVE ANALYSIS” where we do. Normative analysis: making value judgments as to whether the effects or consequences of a particular action are a good thing or a bad thing. Trying to determine “what ought to be”. As we study economics throughout the semester we’re going to do a ton of “real-world” examples - and we’re going to encounter issues where normative-type questions are raised. We’re going to discuss pro’s and con’s a lot this semester (benefits vs. costs) But for the most part we’re going to avoid making any normative conclusions, simply because we’re all individuals and we have our own opinions as to what “ought to be”. I consider it my job to teach you how to do the positive part – how to use the tools and theories of economics to see what’s happening and what the effects are or may be. But I’ll leave it up to you when we get to deciding whether or not the effects are a good or bad thing. Typically economists do not do much normative analysis. Economists engage in positive analysis and report the results to politicians and policy makers who can then use their own normative analysis (or that of their voters) to weigh the results and make policy decisions. “Models” Much of what we’re going to be doing in this course involves modeling … models are descriptive, graphical or mathematical simplifications of reality. In order to construct these models, we’ll have to make some assumptions in order to graphically or numerically represent some “real world” phenomenon or idea under simplified conditions that are easy to understand. Given the assumptions, we can then analyze the model (by doing positive analysis) and the phenomenon in order to use the results to make inference about the real situation. After the analysis we can then examine the importance of the assumptions, and whether or not the results of the modeling effort will change if the assumptions are relaxed. Another extremely important word in economics is: “MARGINAL” or “Margin” = on the edge, on the border… The marginal unit is the “next” unit, or the “incremental unit”, or the “additional” unit. Something we do a lot of in economics is measure and compare costs and benefits. Comparing costs and benefits helps us to make rational choices. We sometimes are faced with “yes” / “no” type choices. When this is the case, we simply look at total costs vs. total benefits. The decision rule is straightforward: if the benefits of a given choice outweigh the costs (including the opportunity costs) then you can gain from making the choice. If you get more out than you put in there is a net gain. Benefits go up. We can conclude that this action is a good idea. This is common sense – you don’t even think about it – but this is the fundamental way we make decisions: Eg: Should you get up at 4:00 in the morning today? Likely No. The costs will outweigh the benefits Eg: Should you show up at class today and miss going to the beach? Likely yes. The benefits of going to class outweigh the costs. This common sense decision-making process that you do all day every day can be a very powerful tool for economics when it is applied “at the margin”. Sometimes choices are not as simple as “yes/no”, but rather are a decision of “how many”? What is the best quantity? • How many slices of pizza to eat? • How many cups of tea to drink? • How big of a house to purchase or build? When this is the type of decision we have to make, comparing total costs and total benefits doesn’t work as well. We have to look at marginal costs vs. marginal benefits – This is a type of positive analysis called “Marginal Analysis”. Example of marginal analysis with numbers: Suppose you are sitting at a pizza restaurant eating slices of pizza. Decision: how many slices should you buy to maximize your satisfaction from a limited budget? … 2, 3, 4….?? Let’s say you eat 3 – why don’t you eat the 4th slice? – It costs too much and you’re full. In other words the costs of the 4th slice (the next slice, the additional slice, the marginal slice) outweigh the benefits. To make the example more complete, let’s assume that the price of one slice = $1.50 (in other words, the additional or marginal cost of each slice is $1.50) and let’s also assume that we can measure the benefit of each slice (the marginal benefit of each slice) in dollars: Slice marginal benefit marginal cost net gain 1 4.50 1.50 3.00 2 2.75 1.50 1.25 3 1.51 1.50 0.01 4 0.75 1.50 -0.75 Before we get to the marginal analysis, notice something about the marginal benefit numbers: Marginal benefit decreases as quantity increases. Why is this the case? Marginal benefit decreases as we consume more of a good (be it slices of pizza or any other good), because we get more full, or satisfied with each unit. Hence, the additional benefit gained from the second unit is likely to be lower than the first, and so on. This is a fundamental principle of economics known as the principle of diminishing marginal benefit. This principle relies on the assumption that each unit is of the same quality (as is the case with our pizza example). Back to the example: - What is the benefit from the 1st slice? - What is the cost of the 1st slice? - Benefit from the second slice? - Cost of the second slice? Compare the additional cost with the additional benefit of each slice and decide how many slices to consume.