ECONOMICS Chapter 1

What is Economics?

contents 1.1

Basic Nature of Economics

1.2

Rational Choice

1.3

Economic Resources and Commodities

1.4

Basic Structure of National Economy

1.5

Market and Price

1.6

Microeconomics and Macroeconomics

1.7

Economic Ways of Thinking

1.1 Basic Nature of Economics

economics

• subjects of interest in economics ‐ various economic phenomena such as unemployment, inflation, economic growth, poverty, exchange rate, labor relations, competition, environmental pollution

• Why should we learn economics? ‐ basic knowledge of economics is a prerequisite for those who live in this modern world

1.1 Basic Nature of Economics

economics – science of choice

• economics : a field of study which explores the ways to utilize economic resources efficiently to meet material needs of human beings • we can say that economics is a science of choice. • anything that is related to choice can be the subjects of exploration for economists ex) economics of family, economics of crime and punishment, economics of arts, economics of sports etc.

1.2 Rational Choice

rationality in economics

‐ basic assumption of economics : all economic agents are rational ‐ rationality in economics means rationality in means, not in purpose • How can we achieve a certain purpose most efficiently? ‐ example of a rational choice: “Should I go to college or not?” (benefits and costs of going to college)

1.2 Rational Choice

Opportunity Cost and Sunk Cost

opportunity cost

• accounting cost and opportunity cost ‐ the concept of accounting cost only includes what is actually spent ‐ for a rational choice, however, something that has the characteristic of cost must be counted as cost even though it is not actually spent → the concept of opportunity cost ‐ the opportunity cost of some decision is the value of the next best alternative that must be given up because of that decision

1.2 Rational Choice

Opportunity Cost and Sunk Cost

sunk cost

– a cost that has already been incurred and cannot be recovered by any means is called sunk cost – since there is no way of recouping it, we should not take this into consideration when we make a decision – an irrational choice could be made if we fail to ignore this – in actuality, however, many irrational choices are made when sunk cost is involved ex) Concorde fallacy

1.2 Rational Choice

Revenue and Cost of Running a Restaurant

• Mr. Park, Master Chef of the Shangri-La Hotel, decides to open his own restaurant ‐ presently, his annual salary is $90 thousand ‐ expected revenue and cost from his restaurant





– If he quits his present position, he has to give up $90 thousand of annual salary. Even though this is not actually spent, it should be counted as part of cost

1.3 Economic Resources and Commodities

economic resources

– broad sense : anything that we should use economically – narrow sense : factors of production • labor, capital, land • entrepreneurial efforts

1.3 Economic Resources and Commodities

commodities

‐ anything that is traded in the market is called a commodity ‐ include goods that we can see and services that we cannot see ‐ free goods vs. economic goods

1.4 Basic Structure of National Economy

3 Major Economic Agents demand for commodities and supply of the factors of production

collect taxes and provides various public services

supply of commodities and demand for the factors of production

1.4 Basic Structure of National Economy

households and firms

1.4 Basic Structure of National Economy

Three Major Tasks of National Economy efficiency in the process of resource allocation

• resource allocation → what, how, for whom? (1) what to produce?

(2) how to produce? (3) for whom to produce?

1.5 Market and Price

market and gains from exchange

– market • any institution or social relation whereby parties engage in trade can be called a market • some markets can be invisible ‐ gains from exchange • even though there is no change in other conditions, all the people engaged in trade can enjoy higher material wellbeing thanks to the gains from exchange

1.5 Market and Price

Market Economy

market economy

– economic system in which markets play critical roles • prices of all commodities are determined in the markets • establishment of property rights • free competition • free trade : division of labor and specialization

1.5 Market and Price

Market Economy

command economy mixed economy

‐ economic system in which the economy is controlled by government mandates – economic system in which both government and markets play important roles

1.5 Market and Price

Price Mechanism price mechanism two main roles price plays

‐ price mechanism → efficiency of the market economy ‐ A. Smith ‘Invisible Hands’ (1) transmission of signals • the level of price of a certain commodity conveys information about how eagerly it is wanted or how much it costs to produce it (2) provision of incentives • if the price of a certain commodity goes up, producers get the incentive to produce more

1.6 Microeconomics and Macroeconomics • two ways of observing a mountain 1) you stand at a long distance, and observe the outline of the entire mountain 2) you walk into the mountain, and closely observe trees, plants and soil in it • likewise, there are also two ways of observing an economy

• we can focus on either the overall workings of national economy or the particular movements of components of national economy

1.6 Microeconomics and Macroeconomics

(1) macroeconomics • focus is on the overall workings of national economy • main variables of interest : aggregate production, aggregate employment, price level, balance of payments

(2) microeconomics • focus is on the choices of individual economic agents and the movements of individual markets • main variables of interest : choices of consumers and firms, price of an individual commodity and its amount of transaction

1.7 Economic Ways of Thinking (1) There is no free lunch – if a certain cost is invisible, people fail to recognize it as cost – from the viewpoint of opportunity cost, nothing is costless

(2) All those who participate in exchange can get gains ‐ everyone who participate in exchange voluntarily can get gains

1.7 Economic Ways of Thinking (3) It is difficult to repeal the laws of supply and demand – paradox of water and diamond – examples of price ceiling and price floor

(4) It is important to think at the margin ‐ marginal utility, marginal cost, marginal revenue

(5) People respond to incentives sensitively ‐ government policies try to utilize this characteristic ex) energy tax, tax on tobacco

1.7 Economic Ways of Thinking (6) Markets are efficient, but not perfect – social costs of monopoly, environmental pollution – inadequate supply of national defense or police services

(7) Government can be helpful, but sometimes its intervention make things worse ‐ no guarantee that government intervention makes the situation better ‐ occurrence of government failure

1.7 Economic Ways of Thinking (8) Trade-off between efficiency and equity – a compromise is necessary between the two objectives

(9) Trade-off between inflation and unemployment ‐ fundamental dilemma of national economic policy ‐ which objective should get more attention?

ECONOMICS

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