1 The Economic Problem

1.1 Scarcity: The Nature of the Problem

Economics is the study of how scarce resources are

allocated across competing uses (Ruffin/Gregory, 1987).
Economics is the (behavioral/social) science of how
scare resources are (best) used.
Scarcity is the imbalance between limited resources &
unlimited desired uses for them. A resource is scarce
(free) when its uses exceed (fall below) supply.
Although we can change economic outcomes, we cannot
have all of everything we want: something must be
foregone/choices must be made.
The consequence of scarcity is choice; the consequence
of choice is (opportunity) cost.

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1.2 Economic Systems

An economic system is one defined by who makes

choices (allocates/organizes) scare resources
(ownership).
Market economics are based on the principles of 1)
individual self-governance & private property & 2)
allocational efficiency: property is (resources are) owned
privately (by households) & exchanged freely & more
efficiently in markets.
Owners of inputs/outputs (through optimization) make
buy/sell (exchange) decisions & prices adjust (invisible
hand) to reflect (signal) relative scarcities (value):
prices rise (fall) for goods/services whose demand is
above (below) its supply.
In socialist economies, property is owned & distributed
by the state.

1.3 Micro- v Macro-economics

Micro- (macro-) economics studies

economic activity at the individual
(aggregate) level.
Microeconomics studies the behavior of
consumers & producers & how markets
where they interact are organized.
Microeconomics models the economy
without money. Macroeconomics includes
money as affecting real economic
behavior.

1.3 Micro- v Macro-economics

Macroeconomics studies of the aggregate

effects of the decisions of individuals, firms
& governments in the economy.
Macroeconomics aggregates all product
(output)/factor (input) markets into one
called the economy.
Key aggregate macroeconomic effects or
variables are interest rates, inflation,
unemployment & GDP (total output of the
economy).

1.4 Positive v Normative Analysis

Positive (or descriptive or objective)

analysis describes the world as it is or
could be.
Normative (or prescriptive or subjective)
analysis describes the world as it should
be.
If a good is scarce, cost must be incurred.
Policies require goals which are by nature
subjective & often conflicting.

1.4 Positive v Normative Analysis (cont)

Government should raise taxes on tobacco

companies to help pay for rising health care
costs.
Higher government deficits will affect
interest rates adversely.
The income gains from a higher minimum
wage are worth higher unemployment.
An increase in the minimum wage should
cause an increase in unemployment.
Taxes on smoking will reduce smoking.
Education, employment, medical care &
housing are basic human/economic rights.

1.5 The Scientific Method & Rational

Economic Behavior

The scientific method asserts cause &

effect (ie interdependence).
OHTAR
Abstraction means simplification, where
scientists describe effects (dependent
variables) as the result of several logical
causes (independent variables). A model
is an abstraction.

1.5 The Scientific Method & Rational

Economic Behavior (cont)

Francis Bacon (b. 1561 d. 1626)

1.5 The Scientific Method & Rational

Economic Behavior (cont)

Paul the Apostle: Test all things; hold

fast to that which is good (true).
1Thes5.21 (circa 55ad)

1.5 The Scientific Method & Rational

Economic Behavior (cont)
Peter the Apostle: Be prepared at all
time to give reason (a logical
explanation) for the hope (faith in
Jesus Christ) that lies within you.
1Pt3.15 (circa 55ad)

1.5 The Scientific Method & Rational

Economic Behavior (cont)

Ceteris paribus isolates one independent variable

@ a time, that is, only that variable is analysed @
different values whereas all other possible causes
are fixed @ a given value.
By understanding the forces that drive outcomes,
scientists can make forecasts/ prescribe policies
to address them. (Policies require goals which
are often conflicting).
The economic law of maximization under
constraints (income/technology; prices/
information) @ the margin describes rational
decision-making: maximizing (expected)
benefits/minimizing (expected) costs

1.5 The Scientific Method & Rational

Economic Behavior (cont)

Consumers maximize (optimize) their satisfaction

(utility) - constrained by their scarce resources - by
equating marginal (not total) benefits (utility) to
marginal costs across goods.
Businesses maximize profits when they use scarce
resources efficiently to produce goods, also by
equating marginal benefits (revenue) to marginal costs
across production lines.
Governments seek to maximize general welfare of
society, where the objective is rarely the efficient use of
scarce resources (concentrate benefits/disperse cost).

1.6 Math review