Lecture 1: Introductionyluo/teaching/2016Econ1220FG/Introduction.pdf · Lecture 1: Introduction Yulei Luo SEF of HKU January 17, 2016 Luo, Y. (SEF of HKU) ECON1220F/G January 17,

Lecture 1: Introduction

Yulei Luo

SEF of HKU

January 17, 2016

Luo, Y. (SEF of HKU) ECON1220F/G January 17, 2016 1 / 16

Economics, Microeconomics and Macroeconomics

Economics: The study of the choices people (consumers, businessmanagers, and governments) make to attain their goals, given theirscarce resources.

Microeconomics: The study of how households and �rms makechoices, how they interact in markets, and how the governmentattempts to in�uence their choices.

Macroeconomics: The study of the economy as a whole, includingtopics such as in�ation, unemployment, economic growth, businesscycles, and the e¤ects of monetary and �scal policies.


Economics: Foundations and Models

Scarcity: The situation in which unlimited wants exceed the limitedresources available to ful�ll those wants.

Economic model: Simpli�ed version of reality used to analyzereal-world economic situations.

Market: A group of buyers and sellers of a good or service and theinstitution or arrangement by which they come together to trade.

Trade-o¤: The idea that because of scarcity, producing more of onegood or service means producing less of another good or service.


Three important economic ideas

As we study how people make decisions and interact in markets, we willuse the following three ideas:

People are rational

Economists assume that consumers and �rms use all availableinformation as they make optimal decisions, weighing the bene�ts andcosts of each action, and choosing an action only if the bene�tsoutweigh the costs� even if it is not always the �best�decision.It does not mean that everyone knows everything.Note that not everyone behaves rationally all the time; most of thechoices that people make are rational.

People respond to economic incentives

Changes in bene�ts or costs


(continued.)

Optimal decisions are made at the margin

Some decisions are just �all or nothing�: to be entrepreneur or worker;to enter a graduate school or take a job.Most decisions involve doing a little more or a little less.Marginal: an extra or additional bene�t or cost of a decisionMarginal analysis: Analysis that involves comparing marginal bene�ts(MB) and marginal costs (MC ).The optimal decision is to continue any activity up to the point wherethe MB = MC . If MB > (<)MC , increases (decreases) inputs.


The Economic Problem That Every Society Must Solve

Trade-o¤s The idea that because of scarcity, producing more of one goodor service means producing less of another good or service.Opportunity cost The highest-valued alternative that must be given up toengage in an activity. They forces society to make choices, particularlywhen answering the following three fundamental questions:

What goods and services will be produced?

The answer is determined by the choices made by consumers, �rms,and the government.They all face the problem of scarcity by trading o¤ one good foranother. Each choice made comes with an opportunity cost, measuredby the value of the best alternative given up.


(conti.) How will the goods and services be produced?

Firms choose how to produce the goods and services they sell. E.g.,�rms face a trade-o¤ between using more workers or using moremachines.

Who will receive the goods and services produced?

In the U.S., who receives the G&S produced depends largely on howincome is distributed. There is disagreement over whether the currentattempts to redistribute income are su¢ cient or whether there shouldbe more or less redistribution.


Societies organize their economies in two main ways to answer the abovethree questions:

Centrally planned economy: An economy in which the governmentdecides how economic resources will be allocated.

E.g., the pre Soviet Union (1917-1991), the government decided whatgoods to produce, how to produce them, and who would receive them.Government employees managed factories and stores; these managersfollowed the orders from the government, not from the demands ofconsumers in markets.

Market economy (ME): An economy in which the decisions ofhouseholds and �rms interacting in markets allocate economicresources.

All high-income countries are ME. MEs rely primarily on privatelyowned �rms to produce goods and services (G&S) and to decide howto produce them.Markets determine who receives the G&S produced.Firms must produce G&S that meet the demands of consumers. Thatis, consumers determine what G&S will be produced.


(continued.)

Mixed economy: An economy in which most economic decisions resultfrom the interaction of buyers and sellers in markets, but in which thegovernment plays a signi�cant role in the allocation of resources.

Some economists argue that the extent government intervention hasexpanded since the Great Depression of the 1930s makes it no longeraccurate to refer to the U.S., Canadian, Japanese, and WesternEuropean economies as pure market economies.The U.S. government has played an important role in a¤ecting the realeconomy since the Great Depression.Monetary and �scal policies are used to �ght recessions and highin�ation.


E¢ ciency and Equity

Productive e¢ ciency: A situation in which a good or service isproduced at the lowest possible cost.

Allocative e¢ ciency: A state of the economy in which production is inaccordance with consumer preferences; in particular, every good orservice is produced up to the point where the last unit provides amarginal bene�t to society equal to the marginal cost of producing it.

Voluntary exchange: A situation that occurs in markets when both thebuyer and seller of a product are made better o¤ by the transaction.

Equity: The fair distribution of economic bene�ts.

There is often a trade-o¤ between e¢ ciency and equity.


Economic Models

To develop a model, economists generally follow these steps:

Decide on the assumptions to be used in developing the model.

Economic models make behavioral assumptions about the motives ofconsumers and �rms.

Formulate a testable hypothesis.

An economic hypothesis is about a causal relationship. It is a statementthat may be either correct or incorrect about a economic variable.Economic variable: Something measurable that can have di¤erentvalues, such as the wages of workers.

Use economic data to test the hypothesis.

Before accepting a hypothesis, we must use data to test it.

Revise the model if it fails to explain well the economic data.

Retain the revised model to help answer similar economic questions inthe future.


Economics as a Social Science

The process of developing models, testing hypotheses, and revisingmodels is often referred to as the scienti�c method, which economicsapplies to the study of the interactions among individuals.

Because economics studies the actions of individuals, it is a socialscience. Economics is therefore similar to other social sciencedisciplines, such as psychology, political science, and sociology.

As a social science, economics considers human behavior� particularlydecision-making behavior� in every context, not just in the context ofbusiness.


Normative and Positive Analysis

Positive analysis: Analysis concerned with what is.

Normative analysis: Analysis concerned with what ought to be.

Economics is about positive analysis, which measures the costs andbene�ts of di¤erent courses of action.


A Preview of Important Economic Terms

Goods: Goods are tangible merchandise, such as books, computers, orMP4.Services: Services are activities done for others, such as investmentadvice or haircuts.Entrepreneur: An entrepreneur is someone who runs a business. In amarket system entrepreneurs decide what goods and services toproduce and how to produce. In the U.S., about half of newbusinesses close within four years. Economic progress would beimpossible in a market system without entreprenuers taking risks.Firm, company, or business: A �rm is an organization that produces agood or service for pro�t. Most �rms produces G&S to earn pro�ts,but there are also non-pro�t �rms (e.g., some universities andhospitals). Economists use these terms interchangeably.Household: A household consists of all persons occupying a home.HHs are suppliers of factors of production such as labor. HHs alsodemand goods and services produced by �rms and governments.Luo, Y. (SEF of HKU) ECON1220F/G January 17, 2016 14 / 16

(continued.)

Technology: A �rm�s technology is the processes it uses to producesgoods and services.

Revenue: A �rm�s revenue is the total amount received for selling agood or service: price per unit�units sold.Opportunity cost: it is the highest-valued alternative that must begiven up to engage in that activity. E.g., a professor gave up histeaching job with a salary of $80, 000 and started a new business. Inthis case, the OC of his entrepreneurial activity is $80, 000.Pro�t: the di¤erence between its revenue and its costs.


(continued.)

Factors of production or economic resources: Firms use factors ofproduction to produce goods and services. The main factors ofproduction are labor, capital, human capital, natural resourcesincluding land, and entrepreneurial ability. Households earn income bysupplying the factors of production to �rms.

Capital: �capital� can refer to ��nancial capital�or to �physicalcapital�.

Financial capital includes stocks and bonds issued by �rms, bankaccounts (savings or checking), and holdings of money.In economics, capital refer to physical capital, which includesmanufactured goods that are used to produce other G&S. E.g.,computers, factory buildings, machine tools, trucks, etc. The totalamount of physical capital available in a country is referred to as thecountry�s capital stock.

Human capital: It refers to te accumulated training and skills thatworkers possess. E.g., workers with higher deduction generally havemore skills and are more productive.


25 of 41© 2013 Pearson Education, Inc. Publishing as Prentice Hall

Figure 1A.1 Bar Graphs and Pie Charts

Graphs of One Variable

Values for an economic variable are often displayed as a bar graph or as a pie chart.In this case, panel (a) shows market share data for the U.S. automobile industry as a bar graph, where the market share of each group of firms is represented by the height of its bar. Panel (b) displays the same information as a pie chart, with the market share of each group of firms represented by the size of its slice of the pie.


Figure 1A.2 Time-Series GraphsBoth panels present time-series graphs of Ford Motor Company’s worldwide sales during each year from 2001 to 2010. Panel (a) has a truncated scale on the vertical axis, and panel (b) does not. As a result, the fluctuations in Ford’s sales appear smaller in panel (b) than in panel (a).


Graphs of Two Variables

Figure 1A.3Plotting Price and Quantity Points in a Graph

The figure shows a two-dimensional grid on which we measure the price of pizza along the vertical axis (or y-axis) and the quantity of pizza sold per week along the horizontal axis (or x-axis). Each point on the grid represents one of the price and quantity combinations listed in the table. By connecting the points with a line, we can better illustrate the relationship between the two variables.


Figure 1A.4Calculating the Slope of a Line

We can calculate the slope of a line as the change in the value of the variable on the y-axis divided by the change in the value of the variable on the x-axis. Because the slope of a straight line is constant, we can use any two points in the figure to calculate the slope of the line.

Slopes of Lines

RunRise

axis horizontal on the in value Changeaxis verticalon the in value ChangeSlope =

ΔΔ

==xy


Figure 1A.4Calculating the Slope of a Line

For example, when the price of pizza decreases from $14 to $12, the quantity of pizza demanded increases from 55 per week to 65 per week.So, the slope of this line equals –2 divided by 10, or –0.2.

Slopes of Lines

2.010

2)5565(

)14$12($pizza ofQuantity

pizza of PriceSlope −=−

=−−

=ΔΔ

=

RunRise

axis horizontal on the in value Changeaxis verticalon the in value ChangeSlope =

ΔΔ

==xy


Taking into Account More than Two Variables on a Graph

Figure 1A.5Showing Three Variables on a Graph

The demand curve for pizza shows the relationship between the price of pizzas and the quantity of pizzas demanded, holding constant other factors that might affect the willingness of consumers to buy pizza.



If the price of pizza is $14 (point A), an increase in the price of hamburgers from $1.50 to $2.00 increases the quantity of pizzas demanded from 55 to 60 per week (point B) and shifts us to Demand curve2.

Figure 1A.5Showing Three Variables on a Graph



Or, if we start on Demand curve1 and the price of pizza is $12 (point C), a decrease in the price of hamburgers from $1.50 to $1.00 decreases the quantity of pizza demanded from 65 to 60 per week (point D) and shifts us to Demand curve3.

Showing Three Variables on a Graph

Figure 1A.5


Positive and Negative Relationships

In a positive relationship between two economic variables, as one variable increases, the other variable also increases.This figure shows the positive relationship between disposable personal income and consumption spending.As disposable personal income in the United States has increased, so has consumption spending.

Figure 1A.6Graphing the Positive Relationship between Income and Consumption


Figure 1A.7 Determining Cause and Effect

Using graphs to draw conclusions about cause and effect can be hazardous. In panel (a), we see that there are fewer leaves on the trees in a neighborhood when many homes have fires burning in their fire places.We cannot draw the conclusion that the fires cause the leaves to fall because we have an omitted variable—the season of the year.

In panel (b), we see that more lawn mowers are used in a neighborhood during times when the grass grows rapidly and fewer lawn mowers are used when the grass grows slowly. Concluding that using lawn mowers causesthe grass to grow faster would be making the error of reverse causality.


Are Graphs of Economic Relationships Always Straight Lines?

The relationship between two variables is linear when it can be represented by a straight line.

Few economic relationships are actually linear. If we carefully plot data on the price of a product and the quantity demanded at each price, holding constant other variables that affect the quantity demanded, we will usually find a curved—or nonlinear—relationship.

In practice, it is often useful to approximate a nonlinear relationship with a linear relationship. If the relationship is reasonably close to being linear, the analysis is not significantly affected.


Figure 1A.8a The Slope of a Nonlinear Curve

The relationship between the quantity of iPhones produced and the total cost of production is curved rather than linear.In moving from point A to point B, the quantity produced increases by 1 million iPhones, while the total cost of production increases by $50 million. Farther up the curve, as we move from point C to point D, the change in quantity is the same—1 million iPhones—but the change in the total cost of production is now much larger: $250 million.Because the change in the y variable has increased, while the change in the x variable has remained the same, we know that the slope has increased.


Here we measure the slope of the curve at a particular point by the slope of the tangent line. The slope of the tangent line at point Bis 75, and the slope of the tangent line at point C is 150.

75175

QuantityCost

==ΔΔ

1501

150Quantity

Cost==

ΔΔ

Figure 1A.8b The Slope of a Nonlinear Curve


Formulas

Formula for a Percentage Change

100 periodfirst in the Value

periodfirst in the Valueperiod second in the Valuechange Percentage ×−

=

One important formula is the percentage change, which is the change in some economic variable, usually from one period to the next, expressed as a percentage.


Formulas for the Areas of a Rectangle and a Triangle

Figure 1A.9Showing a Firm’s Total Revenue on a GraphThe area of a rectangle is equal to its base multiplied by its height.Total revenue is equal to quantity multiplied by price. Here, total revenue is equal to the quantity of 125,000 bottles times the price of $2.00 per bottle, or $250,000.The area of the green-shaded rectangle shows the firm’s total revenue.

HeightBaserectangle a of Area ×=


Figure 1A.10The Area of a Triangle

HeightBase21 trianglea of Area ××=

The area of a triangle is equal to 1⁄2 multiplied by its base multiplied by its height.The area of the blue-shaded triangle has a base equal to 150,000 –125,000, or 25,000, and a height equal to $2.00 –$1.50, or $0.50.Therefore, its area equals 1/2 × 25,000 × $0.50, or $6,250.


Summary of Using Formulas

1. Make sure you understand the economic concept the formula represents.

2. Make sure you are using the correct formula for the problem you are solving.

3. Make sure the number you calculate using the formula is economically reasonable. For example, if you are using a formula to calculate a firm’s revenue and your answer is a negative number, you know you made a mistake somewhere.

Whenever you must use a formula, you should follow these steps:

Documents

Lecture 1: Introductionyluo/teaching/2016Econ1220FG/Introduction.pdf · Lecture 1: Introduction Yulei Luo SEF of HKU January 17, 2016 Luo, Y. (SEF of HKU) ECON1220F/G January 17,