ECW1101 Week 1 Lecture - L

Reading
Business and Economics
Chapter 1: Ten lessons from economics
ECW1101
Introductory Microeconomics
Chapter 2: Thinking like an economist

Your note taking from each chapter should focus on making sure you have an
understanding of the weekly learning objectives.
Week 1: What is Economics?

1. Ten Lessons from Economics
2. Thinking like an economist
ECW1101 - Semester 1 2015
Learning objectives
On completing week 1 you will be able to:
differentiate between microeconomics and
macroeconomics (Ch-1)
identify the relationship between scarcity, choice and
opportunity cost (Ch-1)
explain how people make decisions (Ch-1)
demonstrate how the relationship between economic
variables can be illustrated using diagrams (Ch-2)
use and interpret the production possibility frontier
(Ch-2)
distinguish between positive and normative
statements (Ch-2)
Chapter 1
TEN LESSONS FROM ECONOMICS
In this part of lecture, we will discover

answers for following questions:
Economy
What is Economics? What does it have to do

with scarce of resource? How do we
differentiate between Microeconomics and
Macro economics?
What is trade-off? What is opportunity cost?
Why do we need those in real life?
What is marginal thinking? How does it differ
from total? How do people respond to
incentive?
What do we mean by the word

economy ?
Oikonomos (Greek)
One who manages a household
Economy
Water scarcity and its consequences
A household and an economy face many similar

decisions:
Many countries
across Asia face intense
water scarcity and water
pollution. The challenge
facing the nations is
therefore the efficient
management of this
scarce resource to
maximize the possible
benefits across various
uses, such agriculture,
fishing, water
transportation.
Who will work?

What goods and how many of them should be
produced?
What resources should be used?
At what price should the goods be sold?
Both household and economy allocates scarce

resources among various members based on
their abilities, efforts and desires.
Economics
Economics
Society and scarce resources

Scarcity means that society has limited
resources and therefore cannot
produce all the goods and services that
people want.
Economics is the study of how society
manages its scarce resources.
Central Planning vs. Market Forces.
Microeconomics focuses on the

individual parts of the economy.
How households and firms make decisions
and how they interact in specific markets.
Macroeconomics looks at the

economy as a whole
Economy-wide phenomena, including
inflation, unemployment and economic
growth (we refer to GDP).
Self-test: Is it a Macro
issue or a Micro issue?
10
Self-test: Is it a Macro
issue or a Micro issue?
Microsoft acquires Nokia
its mainly firm level
decision and has
nothing to do with
whole economy.
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12
Ten lessons from economics
How people make decisions (Micro issue we will

focus this topic in todays lecture).
There are 10 principles/ lessons of Economics,

which fall under 3 major categories:
Lesson 1: People face trade-offs.

Lesson 2: The cost of something is what
you give up to get it.
Lesson 3: Rational people think at the
margin.
Lesson 4: People respond to incentives.
How people make decisions (Micro issue)

How people interact with each other
(Micro issue).
How the economy as a whole works
(Marco issue).
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How the economy as a whole works (Marco

issues).
How people interact with each other (Micro issue).
Lesson 5: Trade can make everyone better

off (Week 2).
Lesson 6: Markets are usually a good way
to organize economic activity (Week 3).
Lesson 7: Governments can sometimes
improve market outcomes (Week 5
onward).
8. A countrys standard of living depends on its

ability to produce goods and services.
9. Prices rise when the government prints too
much money.
10. Society faces a short-term trade-off between
inflation and unemployment.
These issues will be discussed in Introductory

Macroeconomics.
15
Lesson 1: People face trade-offs
16
There is no such
thing as a free
lunch!
To get one thing,
we usually have
to give up another
thing.
Guns vs Butter is the classic tradeoff between household and

military production
17
Clothing purchases mean holiday

opportunities diminish
18
Efficiency vs. Equity
Efficiency vs. Equity
Efficiency means society

gets the most that it can
from its scarce
resources.
Equity means the
benefits of those
resources are
distributed fairly among
the members of society.
Tax is paid by wealthy people and then

distributed to those less fortunate
it may improve equality
but lower the return to
hard work
therefore reduce
efficiency, reduce the
level of output produced
by our resources
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20
On Saturday night, Mei can:
How does Mei decide

what to give up?
Sleep
watch a movie on
television
study accounting
go to a
party
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Lesson 2: The cost of something is what

you give up to get it
22
Self practice: What is the opportunity cost to

Mei of going to the party?
Decisions require comparing costs and

benefits of alternatives.
The opportunity cost of an item is what is
the next best alternative that you give up to
obtain that item.
http://www.youtube.com/watch?v=fKQGWoSA_C
o
Mei should choose the option which has

lowest opportunity cost
http://www.youtube.com/watch?v=goTfE0Tnolk
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Lesson 3: Rational people think at

the margin

the margin
Marginal changes are small incremental

adjustments to an existing plan of action.
Example: It costs RM24,000 to hire, fuel

and crew a plane with 120 seats to Bali
and back.
People make decisions by comparing costs

and benefits at the margin.
Interpretation of marginal thinking:
If the firm hires one more worker, how many
additional output could it produce,
Or, if the firm sells one additional unit, how
much additional profit it could make.
25

the margin
26
Lesson 4: People respond to incentives

Since decision making is influenced by cost-benefit
comparison, marginal changes in costs or benefits
motivate people to respond people respond to
incentives.
Incentive
The additional cost of each passenger

(food, airport fees, etc) is RM80.
You set the price of a ticket at RM350 and
sell 100 tickets: Total revenue is RM35,000
Total cost:
RM24,000 +(RM80 X 100) = RM32,000.
Just before take off a new potential
passenger offers you RM150 to join the flight
Something that induces a person to act differently
Higher price
Buyers - consume less
Sellers - produce more
Public policy
Should you accept the offer?

Change costs or benefits

Change peoples behavior
27

Example:
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Example : Baby bonus issue
Boxing Day sales set to hit an all-time record this year

http://www.dailytelegraph.com.au/newslocal/news/boxing-daysales-set-to-hit-an-alltime-record-this-year/story-fngr8gwi1226789909928
The Australian governments baby bonus was

introduced on 1 July 2004 parents of children born on
or after that date would receive a payment of $3000.
This created an incentive for parents whose baby was
due at the end of June 2004 to delay the birth of their
child (by scheduling planned caesareans and
inducements a little later) so that they would qualify
for the payment.
Indeed, the births data show that an estimated 1167
births were shifted from June to July that year.
29
30

Example : Seat belt law
Hundreds of students queue up to get a free pizza at Domino's

(http://www.dailymail.co.uk/news/article-1316734/Hundredsstudents-queue-free-Dominos-pizza.html#ixzz36bkUgHvF)
Seat belt laws increase the use of seat belts,

increasing the probability of surviving a crash.
However before the law people chose not to use
seat belts because it was consistent with their
individual optimal risk choice.
With the seat belt law these people can achieve
their old optimal risk by driving more
adventurously.
This leads to an increase in the number of car
accidents. The net effect for society is ambiguous.
Self-test: Which lesson does best explain

the following incidence?
Lesson 1 & 4
Jessica needs to decide whether to quit her fulltime

RM1500/month job for attending MBA program. She expects to
earn RM5000/month upon completion of her degree.
Lesson 2 & 3
Oil price hikes during 2005-2008, as a result, more people starts

using fuel economy car.
Lesson 4
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ECW1101 - semester 1 2015
32
Recap
Business and Economics
Week 1: What is Economics?
Economics is dealing with scarce resource.
2. Thinking like an economist
Economics is divided into two subfields:

microeconomics and macroeconomics.
Trade-offs are inevitable and measured as
opportunity costs.
Rational people compare marginal costs and
marginal benefits and respond to incentives.
33
ECW1101 - Lecture Week 1
34
In this part of lecture, we will discover

answers for following questions:
Learning objectives
On completing week 1 you will be able to:
What is Economic model? How do

economists develop a model? What is the
role of assumption?
What is circular flow diagram?
What is Production Possibilities Frontier?
differentiate between microeconomics and

macroeconomics (Ch-1)
identify the relationship between scarcity, choice and
opportunity cost (Ch-1)
explain how people make decisions (Ch-1)
demonstrate how the relationship between economic
variables can be illustrated using diagrams (Ch-2)
use and interpret the production possibility frontier
(Ch-2)
distinguish between positive and normative
statements (Ch-2)
35
36
Economic models
The role of assumptions
Economic models: Simplified versions of reality

used to analyze real-world economic situations.
Assumptions are employed to make

the world easier to understand
To develop a model economists generally follow

following steps:
The art in scientific thinking is

deciding which assumptions to make.
Decide on the assumptions to be used in developing the

model.
Formulate a testable hypothesis.
Use economic data to test the hypothesis.
Revise the model if it fails to explain the economic data.
Retain the revised model to help answer similar economic
questions in the future
Economists use different assumptions

to answer different questions
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40
The circular flow
Economic models
The circularflow diagram

shows how
inputs,
outputs and
dollars flow
through
markets
among
households
and firms in
an economy
Two of the most

basic economic
models are
circular-flow
diagram
production
possibilities
frontier
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Second model: The PPF

The production possibilities frontier (PPF) is a
graph showing the combinations of output that
an economy can possibly produce given
Construction of PPF
the available factors of production; and.

the available production technology.
In other words, given the level of inputs, the

production possibilities frontier shows the level
of potential outputs for a person/ group/
country.
43
Fred and John each works 48 hours a

week
Hours of work
to wash a car
Fred
What is their possible

output?
Hours of work
to install a
computer
No. of car wash if No. of computer

only wash car
installed if only
install computer
?
?
?
?
Fred
John
Total Production
John
45
Quantity
Car wash
What is their possible

output?
Total Production
6
Fred
John
44
36
Freds PPF
Slope = 2 car per
computer
(which is Freds
opportunity cost of
computer
installation)
It is a straight line
because Freds
technology involves a
constant opportunity
cost
Quantity
12
10
8
No. of car wash if No. of computer

only wash car
installed if only
install computer
12
6
24
8
14
No. of
car
wash if
only
wash
car
No. of
comput
er
installe
d if only
install
comput
er
6
Fred
12
John
24
Total
Product
ion
36
14
1
47
46
6
Computer
installation
48
Quantity
Car wash
Slope = 3 car per

computer
(which is Johns
opportunity cost of
computer
installation)
24
21
18
No. of
car
wash if
only
wash
car
No. of
comput
er
installe
d if only
install
comput
er
Fred
12
John
24
Total
Product
ion
36
14
Quantity
Car wash
Johns PPF
36
Quantity
Computer
installation
No. of
comput
er
installe
d if only
install
comput
er
6
Fred
12
John
24
Total
Product
ion
36
14
Johns opp. cost = 3 car per

computer
Quantity
Computer
14
installation
50
Technological Change: A shift in the

PPF
51
Technological Change: A shift in the

PPF
52
Positive versus normative analysis

Positive statements try to describe the
world as it is
A technological advance in the computer

industry
Enables the economy to produce more computers
for any given number of cars.
The production possibilities frontier shifts outward.
If the economy moves from point A to point E,
then the production of both cars and computers
increases.
No. of
car
wash if
only
wash
car
49
The PPF of an economy which produces only

cars and computers (simplified assumption)
PPF bowed
out
Opportunity
cost of
computer
installation
increases
24
Note Johns technology

also has a constant
opportunity cost (But a
different rate to Freds)
8
Joint PPF
Freds opp. cost = 2 car per
computer
53
called descriptive analysis

Can be proven true or false
Normative statements try to describe how

the world should be
called prescriptive analysis
Opinions or value judgements
54
Self-test: Positive versus normative

analysis
Self-test: Positive versus normative

analysis
Positive or normative statements?
Positive or normative statements?
An increase in the minimum wage will cause a

decrease in employment among the least skilled.
An increase in the minimum wage will cause a

decrease in employment among the least skilled.
POSITIVE
The income gains from a higher minimum wage are

worth more than any slight reductions in
employment.
The income gains from a higher minimum wage are

worth more than any slight reductions in
employment.
NORMATIVE
55
Summary
56
Next part of lecture
Economists analyze problems objectively

employing appropriate assumptions and
simplified models
Interdependence and the gains from

trade
Chapter 3
Circular-flow diagram and Production

Possibilities frontier; and their
interpretation.
Two goods
(Car wash and
computer
installation)
Two people
(Fred and John)
What should each

produce?
Why should they
trade?
Positive statements are about how the

world is while normative statements are
about how the world ought to be.
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10

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Reading

Business and Economics

Chapter 1: Ten lessons from economics

Chapter 2: Thinking like an economist

Week 1: What is Economics?

TEN LESSONS FROM ECONOMICS

In this part of lecture, we will discover

What is Economics? What does it have to do

ECW1101 - Semester 1 2015

What do we mean by the word

ECW1101 - Semester 1 2015

Water scarcity and its consequences

A household and an economy face many similar

Who will work?

Both household and economy allocates scarce

ECW1101 - Semester 1 2015

Society and scarce resources

Microeconomics focuses on the

Macroeconomics looks at the

ECW1101 - Semester 1 2015

ECW1101 - Semester 1 2015

ECW1101 - Semester 1 2015

Ten lessons from economics

How people make decisions (Micro issue we will

There are 10 principles/ lessons of Economics,

Lesson 1: People face trade-offs.

How people make decisions (Micro issue)

Ten lessons from economics

ECW1101 - Semester 1 2015

Ten lessons from economics

Ten lessons from economics

How the economy as a whole works (Marco

How people interact with each other (Micro issue).

Lesson 5: Trade can make everyone better

8. A countrys standard of living depends on its

These issues will be discussed in Introductory

Lesson 1: People face trade-offs

ECW1101 - Semester 1 2015

Lesson 1: People face trade-offs

Guns vs Butter is the classic tradeoff between household and

ECW1101 - Semester 1 2015

Clothing purchases mean holiday

ECW1101 - Semester 1 2015

Lesson 1: People face trade-offs

Lesson 1: People face trade-offs

Efficiency vs. Equity

Efficiency vs. Equity

Efficiency means society

Tax is paid by wealthy people and then

ECW1101 - Semester 1 2015

Lesson 1: People face trade-offs

On Saturday night, Mei can:

How does Mei decide

ECW1101 - Semester 1 2015

Lesson 2: The cost of something is what

ECW1101 - Semester 1 2015

Self practice: What is the opportunity cost to

Decisions require comparing costs and

Mei should choose the option which has

ECW1101 - Semester 1 2015

Lesson 3: Rational people think at

Lesson 3: Rational people think at

Marginal changes are small incremental