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Introduction to Economics

Lecture Notes

1. Economics Defined - Economics is the study of the allocation of SCARCE resources

to meet unlimited human wants.

a. Microeconomics - is concerned with decision-making by individual economic

agents such as firms and consumers.

b. Macroeconomics - is concerned with the aggregate performance of the entire

economic system.

c. Empirical economics - relies upon facts to present a description of economic

activity.

d. Economic theory - relies upon principles to analyze behavior of economic

agents.

e. Inductive logic - creates principles from observation.

f. Deductive logic - hypothesis is formulated and tested.

2. Usefulness of economics - economics provides an objective mode of analysis, with

rigorous models that are predictive of human behavior.

3. Assumptions in Economics - economic models of human behavior are built upon

assumptions; or simplifications that permit rigorous analysis of real world events,
without irrelevant complications.

a. model building - models are abstractions from reality - the best model is the
one that best describes reality and is the simplest.

b. simplifications:

1. ceteris paribus - means all other things equal.

2. problems with abstractions, based on assumptions. Too often the

models built are inconsistent with observed reality - therefore they are
faulty and require modification. When a model is so complex that it cannot

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 be easily communicated or its implications understood - it is less useful.

4. Goals and their Relations - Positive economics is concerned with what is; Normative
economics is concerned with what should be. Economic goals are value statements.

a. Most societies have one or more of the following goals:

1. Economic efficiency,

2. Economic growth,

3. Economic freedom,

4. Economic security,

5. Equitable distribution of income,

6. Full employment,

7. Price level stability, and

8. Reasonable balance of trade.

5. Goals are subject to:

a. interpretation - precise meanings and measurements will often become the

subject of different points of view, often caused by politics.

b. complementary - goals that are complementary are consistent and can often
be accomplished together.

c. conflicting - where one goal precludes or is inconsistent with another.

d. priorities - rank ordering from most important to least important; again

involving value judgments.

6. The Formulation of Public and Private Policy - Policy is the creation of guidelines,
regulations or law designed to affect the accomplishment of specific economic goals.

a. Steps in formulating policy:

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 1. stating goals - must be measurable with specific stated objective to be
accomplished.

2. options - identify the various actions that will accomplish the stated
goals & select one, and

3. evaluation - gather and analyze evidence to determine whether policy

was effective in accomplishing goal, if not re-examine options and select
option most likely to be effective.

7. Objective Thinking:

a. bias - most people bring many misconceptions and biases to economics.

Because of political beliefs and other value system components rational,
objective thinking concerning various issues requires the shedding of these
preconceptions and biases.

b. fallacy of composition - is simply the mistaken belief that what is true for the
individual, must be true for the group.

c. cause and effect - post hoc, ergo propter hoc - after this, because of this
fallacy.

1. correlation - statistical association of two or more variables.

2. causation - where one variable actually causes another. Granger

causality states that the thing that causes another must occur first, that the
explainer must add to the correlation, and must be sensible.

d. cost-benefit or economic perspective - marginal decision making - if benefits

of an action will reap more benefits than costs it is rational to do that thing.

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 2. National Income Accounting

Lecture Notes

1. Gross Domestic Product - (GDP) the total value of all goods and services produced
within the borders of the United States (or country under analysis).

2. Gross National Product - (GNP) the total value of all goods and services produced
by Americans regardless of whether in the United States or overseas.

3. National Income Accounts are the aggregate data used to measure the well-being of
an economy.

a. The mechanics of these various accounts are:

Gross Domestic Product

- Depreciation =

Net Domestic Product

+ Net American Income Earned Abroad

- Indirect Business Taxes =

National Income

- Social Security Contributions

- Corporate Income Taxes
- Undistributed Corporate Profits
+ Transfer Payments =

Personal Income

- Personal Taxes =

Disposable Income

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4. Expenditures Approach vs. Incomes Approach

a. Factor payments + Nonincome charges - GNP/GDP adjustments = GDP

is the incomes approach

b. Y = C + Ig + G + Xn
is the expenditures approach (where Y = GDP)

5. Social Welfare & GDP - GDP and GNP are nothing more than measures of total
output (or income). More information is necessary before conclusions can be drawn
concerning social welfare. There are problems with both measures, among these are:

a. Nonmarket transactions such as household-provided services or barter are

not included in GDP.

b. Leisure is an economic good but time away from work is not counted,
however, movie tickets, skis, and other commodities used in leisure time are.

c. Product quality - no pretense is made in GDP to account for product or service

quality.

d. Composition & Distribution of Output - no attempt is made in GDP data to

account for the composition or distribution of income or output. We must look at
sectors to determine composition and other information for distribution.

e. Per capita income - is GDP divided by population, very rough guide to

individual income, but still mostly fails to account for distribution.

f. Environmental problems - damage done to the environment in production or

consumption is not counted in GDP data unless market transactions occur to
clean-up the damage.

g. Underground economy - estimates place the amount of underground

economic activities may be as much a one-third of total U.S. output. Criminal
activities, tax evasion, and other such activities are the underground economy.

6. Price Indices - are the way we attempt to measure inflation. Price indices are far
from perfect measures and are based on surveys of prices of a specific market basket
of goods.

a. Market-basket surveys - The market basket of goods and services are

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 selected periodically in an attempt to approximate what the average family of four
purchases at that time.

b. CPI (U) is for urban consumers & CPI (W) is for urban wage earners. GDP
Deflator is based on a broader market basket and may be more useful in
measuring inflation.

1. Standard of living - is eroded if there is inflation and no equal increase

in wages.

2. COLA - are escalator clauses that tie earnings or other payments to the
rate of inflation, but only proportionally.

3. Other indices - American Chamber of Commerce Research

Association in Indianapolis does a cross sectional survey, there are
wholesale price indices and several others designed for specific purposes.

c. Inflation/Deflation - throughout most of U.S. economic history we have

experienced deflation - which is a general decline in all prices. Inflation is
primarily a post-World War II event and is defined to be a general increase in all
prices.

d. Nominal versus Real measures - economists use the term nominal to

describe money value or prices (not adjusted for inflation); real is used to
describe data which are adjusted for inflation.

7. Measuring the price level

a. CPI = (current year market basket/ base year market basket) X 100
the index number for the base year will be 100.00 (or 1 X 100)

b. Inflating is the adjustment of prices to a higher level, for years when the index
is less than 100.

c. Deflating is the adjustment of prices to a lower level, for years when the index
is more than 100.

1. to change nominal into real the following equation is used:

Nominal value/(price index/100)

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d. Changing base years - a price index base year can be changed to create a
consistent series (remembering market baskets also change, hence the process
has a fault). The process is a simple one. If you wish to convert a 1982 base
year index to be consistent with a 1987 base year, then you use the index
number for 1982 in the 1987 series and divide all other observations for the 1982
series using the 1982 value in 1987 index series.