1. What is economics?
The word economy comes from the Greek
word for “one who manages a household”
A HH faces many decisions
•
Who cooks dinner
•
Who does laundry
•
Who gets extra dessert at dinner

2. What is economics?
A society faces many decisions too, what jobs
will be done and who will do them
•
Some people should grow food
•
Some make clothing
•
Others computer software
Management of society’s resources is
important because resources are scarce.

3. • Scarcity means that society has less to offer
than people wish to have.
• Economics is the study of how society
manages its scarce resources.

4. A choice is a tradeoff -- to get something we
have to give up something else
Think of a student allocating her must valuable
resource – time
• She can spend all her time studying economics
• She can spend all her time studying mathematics
• Or divide her time between the two.
• For every hour she studies econ., she gives up an
hour she could have used studying math.
• For every hour she spends studying, she gives up
an hour she could have spent sleeping, bike riding,
watching TV.

5. Society’s tradeoff
• National defense versus increased
production
• Clean environment versus cheaper goods

6. Another tradeoff
Efficiency versus equity
• Efficiency: getting the most from your
resources
• Equity: distributing economic prosperity
fairly among members

7. Opportunity Cost
• Opportunity cost is that which we give up
or forgo, when we make a decision or a
choice.

8. Opportunity Cost
The cost of something is what you give up to get it:
Consider the decision to go to university.
Intellectual enrichment and better job opportunities.
What is the cost:
• Tuition
• Books
• Room and board

9. Opportunity Cost
• But even if you quit school you still need a
place to stay.
•
• Wages given up should be considered as
part of the cost of going to university.
•
• the highest valued alternative we give up is
the opportunity cost of the activity chosen

10. We make choices in small steps, or at
the margin
• suppose your cousin asks you whether he should
go to school one more year.
• What is the benefit he gets if goes to school for
one more year? Marginal benefit MB
• What is the cost associated with going to school
for one more year? Marginal cost MC
• If MB>MC he should go to school for another
year
• If MB<MC he should not go to school for another
year.

11. Microeconomics vs.
Macroeconomics
Microeconomics is:
• the study of the choices of individuals
• the study of decisions made by enterprises, such
as businesses firms
• and the interaction of those choices and decisions
in social frameworks, such as markets.
Macroeconomics is the study of the national
economy and the global economy as a whole.

12. Examples of microeconomic and macroeconomic concerns
Production
Macroeconomics
Income
Employment
Production/Output
in Individual
Industries and
Businesses
Price of Individual
Goods and Services
Distribution of
Income and Wealth
How much steel
How many offices
How many cars
Microeconomics
Prices
Price of medical
care
Price of gasoline
Food prices
Apartment rents
Wages in the auto
industry
Minimum wages
Executive salaries
Poverty
Employment by
Individual
Businesses &
Industries
Jobs in the steel
industry
Number of
employees in a firm
National
Production/Output
Aggregate Price
Level
National Income
Total wages and
salaries
Employment and
Unemployment in
the Economy
Total Industrial
Output
Gross Domestic
Product
Growth of Output
Consumer prices
Producer Prices
Rate of Inflation
Total corporate
profits
Total number of
jobs
Unemployment rate

13. Positive vs normative statements
• Positive statements: claims that attempt to
describe the world as it is
• Normative statements: claims that attempt
to prescribe how the world should be

14. Positive vs normative statements
• Ahmet- minimum wage laws cause unemployment
• Mustafa- the govt should raise the minimum wage.
Difference between positive and normative statement
• Positive: can test their validity
• Normative: value judgment

15. Economic Models
Economists use economic models to
understand the world
A model is a formal statement of a theory.
Models are descriptions of the relationship
between two or more variables

16. First model: circular flow
diagram
Millions of people buying, selling, working,
hiring
Economy has two types of decisionmakers
• Firms: produce G&S using FoP (factors of
production)
• HHs: own FoP and consume

17. Factors of Production
• The basic resources that are available to a
society are factors of production:
– Land
– Labor
– Capital

18. • Production is the process that transforms
scarce resources into useful goods and
services.
• Resources or factors of production are the
inputs into the process of production; goods
and services of value to households are the
outputs of the process of production.

19. The Circular-Flow Diagram
Market for Goods and
Services
Goods and
services sold
Revenue
Goods and
services bought
Firms
Wage, rent,
and profit
Spending
Households
Inputs for
production
Labor, land
and capital
Market for Factors of
Production
Income

20. Production Possibilities Frontier
• The production possibilities frontier (ppf)
is a graph that shows all of the
combinations of goods and services that can
be produced if all of society’s resources are
used efficiently

21. The Production Possibilities Frontier
Quantity of
Computers
Produced
3,000
X
If we look at production
of both computers and cars,
the straight line joining X
and Y shows the combinations
assuming that there is only a
single factor of production =>
constant trade off between goods
Y
0
1,000
Quantity of
Cars Produced

22. The Production Possibilities
Frontier
Quantity of
Computers
Produced
4,000
If we look at production
of both computers and cars,
the concave line joining X
and Y shows the combinations
assuming that there is more
than one factor of production
=> changing trade-off.
3,000
2,100
2,000
A
0
700 750
1,000
Quantity of
Cars Produced

23. The Production Possibilities Frontier
Note: changing slope =>
changing trade-off.
Quantity of
Computers
Produced
3,000
D
C
2,200
A
2,000
1,000
0
Production
possibilities
frontier
B
300
600 700
1,000
Quantity of
Cars Produced

24. The Production Possibilities
Frontier: Growth
Quantity of
Computers
Produced
4,000
Change means that more
computers can be produced
relative to cars
3,000
2,100
2,000
A
0
700 750
1,000
Quantity of
Cars Produced

25. Scarcity and Choice
in an Economy of Two or More
• A producer has an absolute
advantage over another in the
production of a good or service if it
can produce that product using fewer
resources.

26. Scarcity and Choice
in an Economy of Two or More
• A producer has a comparative
advantage in the production of a
good or service over another if it can
produce that product at a lower
opportunity cost.

27. Comparative Advantage
and the Gains From Trade
Daily Production
Wood
(logs)
Mary
Bill
Food
(bushels)
10
4
10
8
• Mary has an absolute advantage in the production of
both wood and food because she can produce more of
both goods using fewer resources than Bill.

28. Comparative Advantage
and the Gains From Trade
Daily Production
Wood
(logs)
Mary
Bill
•
Food
(bushels)
10
4
10
8
In terms of wood:
– For Bill, the opportunity cost of 8 bushels of food is 4 logs.
– For Mary, the opportunity cost of 8 bushels of food is 8 logs.
•
In terms of food:
– For Mary, the opportunity cost of 10 logs is 10 bushels of food.
– For Bill, the opportunity cost of 10 logs is 20 bushels of food.

29. Comparative Advantage
and the Gains From Trade
• Suppose that Mary and Bill each wanted equal
numbers of logs and bushels of food. In a 30day month they (each separately) could
produce:
Monthly
Production with
No Trade
Daily Production
Wood
Food
(logs) (bushels)
Mary
Bill
10
10
4
A.
8
Wood
Food
(logs) (bushels)
Mary
150
150
Bill
80
B.
230
80
Total
230

30. Comparative Advantage
and the Gains From Trade
• By specializing on the basis of comparative
advantage, Mary and Bill can produce more of
both goods.
Monthly
Production with
No Trade
Monthly
Production after
Specialization
Wood
Food
(logs) (bushels)
Wood
Food
(logs) (bushels)
Mary
150
150
Mary
Bill
80
B.
230
80
Bill
230
Total
Total
270
0C.
270
30
240
270

31. Comparative Advantage
and the Gains From Trade
• To end up with equal amounts of wood and
food after trade, Mary could trade 100 logs for
140 bushels of food. Then:
Monthly Use After
Trade
Monthly
Production after
Specialization
Wood
Food
(logs) (bushels)
Wood
Food
(logs) (bushels)
Mary
170
170
Mary
270
30
Bill
100
100
Bill
0
C.
270
240
Total
270
D.
270
Total
270

32. Specialization, Exchange
and Comparative Advantage
• According to the theory of
competitive advantage,
specialization and free trade
will benefit all trading parties,
even those that may be
absolutely more efficient
producers.