Principles of Economics EC 201 California State Polytechnic University, Pomona Dr. Bresnock

Fall, 2002

Lecture 2

Note: This is the first set of abbreviated class notes to accompany our class. Please remember to check the “Class Materials”, “Lecture Notes” listing for notes for each class prior to each upcoming lecture. It will be your responsibility to download and print a copy of the notes and bring them to class. Remember, the postings will be partial lecture notes. You must attend lecture to fill in additional tables, graphs, derivations of theoretical points, and applications. You will notice spaces throughout the posted notes that are place savers for material that we will add during class lecture. I will not be posting complete notes for the lectures, just the abbreviated notes. The intention is to economize on class lecture time so that we can devote more class time to the more difficult concepts.

What is Economics? Here are several definitions.

It is a social science concerned with the efficient use of limited, or scarce, resources to achieve maximum satisfaction of human material wants. (McConnell/Brue, p. 3)

It is the study of how people and society end up choosing, with or without the use of money, to employ scarce productive resources that could have alternative uses, to produce various commodities and distribute them for consumption, now or in the future among various persons and groups in society. (Samuelson)

An analysis of choice making. (Bresnock)

Fundamental Economic Problem

Unlimited Wants vs Limited Resources

Demands > Supplies Scarcities

Consumer Decision – maximizing satisfaction given their limited income, or budget.

Producer Decision – maximizing profit given their limited resources.

Government Decision – maximizing net benefits to society given limited budgets.

Private Sector = Consumers + Producers + Public Sector = All Levels of Government Mixed Market Economy , i.e. U.S. EC 201 Lecture 2 Fall, 2002 A. Bresnock

Types of Economies

Pure Market Pure Command (Capitalism) (Communism)

U.S., Canada Cuba, China

Pure Market – private property rights and decentralized decision making coordinated through markets. Pure Command – state ownership and control of economic resources and central planning.

Resources – also known as factors of production, inputs, productive inputs.

I. Human Resources A. Labor – many types. See “occupational triangle” below. Notice that there are more plentiful workers in the unskilled category. Consequently the wage for those workers will be quite low. At the top of the triangle there are far fewer workers in the “G”(short for genius or someone with unique talents), and such persons receive rather high salaries. “M & P” represents managers and other professional persons.

G

M & P

Skilled

Semi-Skilled

Unskilled

Note also that the Human Capital of the workers increases greatly as the workers move higher on the occupational triangle. Human capital is a measure of the workers education, training and skills.

2 EC 201 Lecture 2 Fall, 2002 A. Bresnock B. Entrepreneur – creative genius, the person or persons who put together all of the factors of production and produce a marketable product.

II. Non-Human Resources

A. Capital – tools, equipment, aka “investment goods”. Not stocks and bonds.

B. Land -- “Natural Capital”. Environmental and natural resource endowment.

Consumer Goods and Services

1. Durable Goods – i.e. TVs, cars, washing machines, relatively stable expenditure pattern over last 70 years. 2. Non-Durable Goods – i.e. food, clothing, decrease in expenditure pattern over last 70 years. 3. Services – i.e. dental work, manicures, car repairs, increase in expenditure pattern over last 70 years.

Public Goods and Services

1. Pure Public – i.e. national defense, lighthouses, only produced by government 2. Quasi-Public -- i.e. education, housing, medical care, produced in part by government and in part by the private sector

Key Microeconomic Questions

1. What to Produce? How are finite resources allocated to satisfy infinite societal wants?

A. Traditional wants – custom, institution, arrangement, societal B. Political/command wants – democracy, socialist, monarch rule C. Economic wants – determined by the market system

2. How to Produce? Efficiency goal.

A. Productive, or Technical Efficiency – achievement of maximum output with full usage of all inputs. Focuses on physical efficiency. B. Allocative Efficiency – production of the combination of goods and services that people prefer given their income. Focuses on market analysis.

3. How to Distribute? Equity, or fairness, goal. But who determines what is fair. Some possible equity goals… A. Pure Egalitarian – one person, one vote. B. Need – Marxian formula – “from each according to his ability, to each according to his need” C. Deed -- “get what you work for”

3 EC 201 Lecture 2 Fall, 2002 A. Bresnock

Micro vs Macroeconomics

Microeconomics analyses the behavior of specific economic units, i.e. how does an individual consumer decide how to spend his/her income, how does a business firm determine what to produce.

Macroeconomics analyzes the behavior of an entire economic system, i.e. aggregate economic analysis, study of U.S. economy as a whole

Key Macroeconomic Issues

A. Stable Prices – low inflation B. Full Employment – low unemployment C. Sustainable Economic Growth – that is consistent with low inflation and low unemployment

Is Economics an Art or a Science?

Art – creative ability to explain human behavior via economic models.

Science – follows the scientific method to develop economic models. The steps in the scientific method are: 1) Collection and classification of data – descriptive economics 2) State formal relationships based on data – principles and generalizations formed 3) Form hypothesis based on data – use of abstractions, i.e. “ceteris paribus” (all other things remaining the same) assumptions used 4) Test of hypothesis – determine statistical acceptance or rejection of hypothesis 5) If accepted, hypothesis may be used for prediction, policy development. If rejected, the hypothesis is reformed, retested.

Deductive vs Inductive Reasoning theory facts

facts theory

Dangers of Model Building – hyperabstractions to be avoided include:

A. Fallacy of False Cause (or post-hoc fallacy) – “after this, therefore because of this”, i.e. the Economics Dept. hires new faculty and enrollment increases – could have been caused by many other factors than the new hire B. Fallacy of Composition – what is true for the part is true for the whole, i.e. an increase in price in one industry may increase profits in that industry. This may

4 EC 201 Lecture 2 Fall, 2002 A. Bresnock Not be so if prices in general rise across industries and lead to widespread inflation.

C. Fallacy of Division – what is true for the whole is true for the part, i.e. low inflation may be good for the nation but could lead to unemployment in some areas. D. Dodging Values – hard to place #s on some things, often avoided as a result, i.e. clean air, scenic views, quiet E. Disciplinary Myopia – neglect of consideration for non-economic factors, i.e. cultural and societal values not included in analysis F. Bias – preconceptions that interfere with factual knowledge, i.e. oil companies make excessive profits, less government regulation is always preferred G. Loaded Terminology – choice of words to express a slant rather than a fact, i.e. “obscene” profits, “excessive wages”, corporate “greed”

Positive vs Normative Analysis

Factual Subjective What is, What should Was, or will be or ought to be Empirical analysis Intrusion of value judgment

Correlation vs Causation

2 events behave Dependent and in a systematic independent + dependable way variables involved

But one does not Independent necessarily influence variables effect the other the dependent variable

X does not in cause Y X causes Y Y does not cause X Y causes X But X and Y may move together

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