Unit 1: Introduction to Economics – Foundations and Models

Unit 1: Introduction to Economics

What is Economics?

Economics is the study of human behaviour and choice, focusing on how individuals and societies allocate scarce resources to satisfy unlimited wants. The discipline seeks to answer fundamental questions about the decisions people make, the factors influencing those decisions, and the consequences for both individuals and society.

• Key Questions:

  • What choices do people make?

  • What factors influence those choices?

  • What are the consequences of those choices for the person making them?

  • What are the consequences of those choices for others?

• Scarce Resources: Opportunities and choices are limited by scarce resources, such as money, time, and materials.

Perspectives in Economics

Economics considers the perspectives of three main groups:

• Consumers

• Managers

• Government Policymakers

Assumptions about Human Behaviour

Economists make three core assumptions about human behaviour:

1. People are rational: Individuals make decisions they believe will make them happier or better off, typically acting in their own self-interest.

2. People respond to incentives: When an option becomes more attractive, people are more likely to choose it.

3. People use cost-benefit analysis: Individuals compare the Marginal Benefit (MB) and Marginal Cost (MC) of each option before making a decision. Equation: $MB \geq MC$ (A rational choice is made when marginal benefit is at least as great as marginal cost.)

The Economic Problem

All societies face the fundamental economic problem: Limited Resources vs. Unlimited Wants. This leads to the necessity of making choices and facing trade-offs.

• When resources are devoted to one activity, they cannot be used for another.

• Societies must make decisions about how to allocate resources efficiently.

Three Main Economic Questions

1. What goods and services will be produced?

2. How will the goods and services be produced?

3. Who will receive the goods and services produced?

Three Economic Models

Societies use different models to answer the economic questions:

• Market Economy

• Centrally-Planned Economy

• Mixed Economy

Comparison of Economic Models

Model	Advantages	Disadvantages
Market Economy	Resources are usually allocated efficiently with respect to production. Fosters innovation and entrepreneurship. People are free to choose; government does not choose for them.	Underproduces some beneficial goods (e.g., public goods). Can generate substantial inequality; resources may not be allocated efficiently with respect to consumption.
Centrally-Planned Economy	Rationing reduces inequality. Can allocate resources efficiently in times of national emergency.	Production is usually not efficient. Difficult for government to choose the right targets and allocate resources. Lack of innovation. Underperforms market economies in overall production.
Mixed Economy	Combines elements of both market and centrally-planned economies. Most goods are provided by the private sector (businesses owned by individuals), but the public sector (government) provides some goods and services directly. Aims to capture the advantages of both systems while minimizing disadvantages.

Additional info: In practice, mixed economies face trade-offs and cannot fully capture all benefits or avoid all disadvantages of either system. The degree of government involvement is often debated and decided democratically.

How Economists Work

Economists use models (theories) to study economic decisions and outcomes. The scientific method in economics involves:

1. Deciding on assumptions for the model.

2. Formulating a testable hypothesis.

3. Using economic data to test the hypothesis.

4. Revising the model if it fails to explain the data well.

5. Retaining the revised model for future questions.

Positive vs. Normative Analysis

• Positive Analysis: Concerns facts or logic; focuses on what "is" and what "could be" without value judgments.

• Normative Analysis: Involves value judgments about whether outcomes are desirable or not.

Economists often focus on positive analysis, while policymakers and others may use normative analysis to argue for or against decisions.

Microeconomics vs. Macroeconomics

• Microeconomics: Studies individual agents and markets, such as consumers, workers, and firms. Examines production, efficiency, and the impact of government on specific markets.

• Macroeconomics: Focuses on the economy as a whole, including aggregate growth, total income, inflation, and unemployment. Examines overall outcomes without differentiating by sector or product.

How to Do Economics

Economic concepts can be explained in three main ways:

1. With words (verbal explanation)

2. With graphs (visual representation)

3. With equations (mathematical models)