Introduction to Economics

Microeconomics vs. Macroeconomics

Economics is divided into two main branches: microeconomics and macroeconomics. Understanding their differences is fundamental for economic analysis.

• Microeconomics: Studies individual units such as households, firms, and markets. Topics include consumer behavior, production decisions, and price determination in specific markets.

• Macroeconomics: Examines the economy as a whole, focusing on aggregate indicators like GDP, unemployment, inflation, and economic growth.

• Examples: Analyzing the impact of a tax on the car market (micro); studying national unemployment rates (macro).

Economic Methodology

The Scientific Method in Economics

Economists use the scientific method to develop theories and test hypotheses about economic behavior.

• Steps:

  1. Identify the question and define relevant variables.

  2. Specify assumptions (e.g., ceteris paribus—"all else equal").

  3. Formulate a hypothesis.

  4. Test the hypothesis with data.

  5. Accept, reject, or revise the hypothesis.

• Ceteris Paribus: The assumption that all other variables are held constant to isolate the effect of one variable.

Types of Economic Analysis

Positive vs. Normative Economics

Economic analysis can be classified as positive (objective) or normative (subjective).

• Positive Economics: Describes and explains economic phenomena without value judgments. Example: "An increase in the minimum wage will lead to higher unemployment among teenagers."

• Normative Economics: Involves value judgments about what ought to be. Example: "The government should increase the minimum wage."

• Limitations: The conventional view that positive economics is entirely objective is debated, as assumptions and interpretations can introduce bias.

Logical Fallacies in Economic Reasoning

Common Fallacies

• Fallacy of Association as Causation: Assuming that because two events occur together, one causes the other. Example: Ice cream sales and drowning rates both rise in summer, but one does not cause the other.

• Fallacy of Composition: Assuming what is true for an individual is true for the group. Example: If one person stands at a concert, they see better; if everyone stands, no one sees better.

Production Possibilities Frontier (PPF)

PPF Model and Opportunity Cost

The Production Possibilities Frontier (PPF) illustrates the maximum combinations of two goods that can be produced with available resources and technology.

• Efficient Points: On the PPF; resources are fully utilized.

• Inefficient Points: Inside the PPF; resources are underutilized.

• Unattainable Points: Outside the PPF; not possible with current resources.

• Opportunity Cost: The value of the next best alternative foregone. Calculated as:

• Law of Increasing Opportunity Costs: As production of one good increases, the opportunity cost of producing additional units rises.

• Shifts in the PPF: Caused by changes in resources, technology, or economic growth.

Comparative and Absolute Advantage

Specialization and Trade

• Absolute Advantage: The ability to produce more of a good with the same resources than another producer.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

• Gains from Trade: Specialization according to comparative advantage allows for increased total output and mutual benefit.

Market Forces: Demand and Supply

The Law of Demand

• Law of Demand: As the price of a good falls, the quantity demanded rises, ceteris paribus, and vice versa.

• Demand Curve: Downward sloping, reflecting the inverse relationship between price and quantity demanded.

Determinants of Demand

• Factors that Shift Demand:

  • Income (normal vs. inferior goods)

  • Prices of related goods (substitutes and complements)

  • Tastes and preferences

  • Expectations about future prices

  • Number of buyers

The Law of Supply

• Law of Supply: As the price of a good rises, the quantity supplied increases, ceteris paribus, and vice versa.

• Supply Curve: Upward sloping, reflecting the direct relationship between price and quantity supplied.

Determinants of Supply

• Factors that Shift Supply:

  • Input prices

  • Technology

  • Expectations about future prices

  • Number of sellers

  • Taxes and subsidies

Market Equilibrium

Equilibrium Price and Quantity

• Equilibrium: The price at which quantity demanded equals quantity supplied.

• Graphical Illustration: The intersection of the demand and supply curves.

• Disequilibrium: Prices above equilibrium create surpluses; prices below create shortages. Market forces push prices toward equilibrium.

Shifts in Demand and Supply

• Demand Increase: Shifts demand curve right; raises equilibrium price and quantity.

• Supply Increase: Shifts supply curve right; lowers equilibrium price, raises quantity.

• Graphical Analysis: Draw new curves to show effects of shifts on equilibrium.

Government Intervention: Price Ceilings

Price Ceilings and Market Outcomes

• Price Ceiling: A legal maximum price set below equilibrium (e.g., rent control).

• Effects:

  • Creates shortages (quantity demanded exceeds quantity supplied).

  • Leads to non-price rationing (e.g., waiting lines, favoritism).

  • May cause black markets.

• Numerical Example: If equilibrium rent is $1000 but a ceiling is set at $800, the quantity of apartments demanded exceeds the quantity supplied, resulting in a shortage.

Summary Table: Key Concepts

Additional info: These notes synthesize core concepts from McEachern Chapters 1, 2, and 4, as well as standard introductory macroeconomics material. For practice, refer to in-class worksheets and assignments.