10.03.2011
What Is Economics?
Modern Economics
 Economics studies how individuals, firms, the government,
and other organizations make choices and how those
choices determine society's use of its resources.
 There are five core concepts:
 trade-offs
 incentives
 exchange
 information
 distribution
Trade-offs
Incentives
 All choices involve trade-offs:
 Incentives are the rewards and costs that stem from making
 What should you spend your weekly budget on—pizza, CDs,
choices.
movies, books, and so on?
 Prices reflect incentives: rewards and costs.
 More of one of these means you can spend less on another.
 All decision makers, consumers, businesses, and governments
 There is no such thing as a free lunch.
 Trade-offs stem from scarcity.
respond to incentives.
 You have limited money and time.
 Society has limited resources.
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10.03.2011
Exchange
Information
 Exchange is the trade of goods and services.
 Voluntary exchange in markets is how modern economies like the
 Making informed choices requires information.
United States determine which goods and services to produce to
satisfy the vast number of consumers.
 Voluntary exchange means both parties get something they want;
a worker wants income and a firm wants a certain job done, for
example.
 A market is any situation in which an exchange takes place.
 A market need not be a physical location.
 With competition, consumers have a choice of alternatives.
 The United States is a mixed economy where most exchanges take
place in a market but the government plays a critical role in other
aspects of the economy.
 Information is like any other good or service.
 There are firms and institutions that specialize in the purchase
and sale of information.
 The seller of a car lets you test drive it, but a seller of
information cannot let you see the information.
 In some markets information is so crucial it shapes the whole
market:
 Market for used cars
 Stock market and other security markets
 Insurance
Distribution
The Three Major Markets
 Markets determine who gets which goods according to the
 The product market: where final goods and services are
demand and supply of goods, labor, and capital.
 Some view the uneven distribution of wealth with unease.
 Government programs attempt to even out the distribution.
 The labor market: where workers sell labor and firms hire
 However, efforts to soften the distributional impact of markets
often blunt economic incentives.
exchanged
workers
 The capital market: where households, firms, and
government save and raise funds
 That is, there is a trade-off between equity and efficiency.
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The Three Major Markets
The Two Branches of Economics
 Microeconomics, the study of the small:
 Specific goods and services, industries, individuals, and firms
 Macroeconomics, the study of the large:
 How the overall economy behaves
Circular Flow
Revenue
Goods and
Services Sold
Consumption
Products Market
Firms
Goods and
Services Bought
Household
Inputs for
Production
Wages, Rent
and Profit
Capital, labor
and land market
Labor, Capital
and Land
Income
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