PAL3103 (The Economic

Thought of Biodiversity)

The Economic Way of Thinking

1
Origin of economics

 The word economy comes from the

Greek word for “one who manages a
household.”
 (Mankiw, 2004)

2
What is Economics?
 “A science that deals with the
ALLOCATION, or USE, of SCARCE
RESOURCES for the purpose of fulfilling
SOCIETY’S NEEDS & WANTS” –
Addison-Wesley
 Mankiw’s definition :
 …is the STUDY of HOW SOCIETY
MANAGES ITS SCARCE RESOURCES

3
What is Economics in General?
 Economics is the science of SCARCITY
and CHOICES
 SCARCITY results because our wants
are greater than our limited resources.
 Since we are unable to have everything
we desire, we must make CHOICES on
how we will use our resources.
 In ECONOMICS, we will study the
choices of individuals, firms, and
governments.

4
Cont..
 two concepts related:
 (1) RESOURCES are SCARCE

 (2)Society has UNLIMITED

NEEDS and WANTS

 Economics decides the “BEST”

way of providing one to the other

(CHOICES)

5
Cont..
 The economising problem is
underpinned by two fundamental facts:
(1) Unlimited or insatiable wants of
society for goods and services that
give UTILITY
 Utility is the economist’s term for
pleasure or satisfaction
(2) Economic resources are limited or
scarce
 Scarcity means that we have to make

6
CHOICES to MAXIMISE
SATISFACTION

7
Ten Principles of Economics (Mankiw, 2004)
 PRINCIPLE #1: PEOPLE
FACE TRADEOFFS
 PRINCIPLE #2: THE COST OF
SOMETHING IS WHAT YOU GIVE UP
TO GET IT
 PRINCIPLE #3: RATIONAL PEOPLE
THINK AT THE MARGIN
 PRINCIPLE #4: PEOPLE RESPOND
TO INCENTIVES
 PRINCIPLE #5: TRADE CAN
MAKE EVERYONE BETTER OFF
8
Cont..
 PRINCIPLE #6: MARKETS ARE USUALLY
A GOOD WAY TO ORGANIZE ECONOMIC
ACTIVITY
 PRINCIPLE #7: GOVERNMENTS
CAN SOMETIMES IMPROVE
MARKET OUTCOMES
 PRINCIPLE #8: A COUNTRY’S
STANDARD OF LIVING DEPENDS ON
ITS ABILITY TO PRODUCE GOODS AND
SERVICES

9
Cont..
 PRINCIPLE #9: PRICES RISE WHEN
THE GOVERNMENT PRINTS TOO
MUCH MONEY
 PRINCIPLE #10: SOCIETY FACES
A SHORT-RUN TRADEOFF
BETWEEN INFLATION AND
UNEMPLOYMENT

1
0
PRINCIPLE #1: PEOPLE FACE
TRADEOFFS
 To get one thing that we like, we usually
have to give up another thing that we like.
Making decisions requires trading off one goal
against another.
 When people are grouped into societies,
they face different kinds of tradeoffs.
 The classic tradeoff is between “guns and
butter.” The more we spend on national
defense to protect our shores from foreign
aggressors (guns), the less we can spend on
consumer goods to raise our
11
standard of living at home (butter).

12
Cont..
 Tradeoff between a clean environment and a
high level of income.
 Laws that require firms to reduce pollution
raise the cost of producing goods and
services. Because of the higher costs, these
firms end up earning smaller profits, paying
lower wages, charging higher prices, or
some combination of these three.
 Thus, while pollution regulations give us the
benefit of a cleaner environment and the
improved health that comes with it, they
have the cost of reducing the incomes of the

13
firms’ owners, workers, and customers.

14
Cont..
 Nonetheless, ACKNOWLEDGING
LIFE’S TRADEOFFS is important
because people are likely to make good
decisions only if they UNDERSTAND
THE OPTIONS that
they have available.

15
PRINCIPLE #2: THE COST OF SOMETHING IS
WHAT YOU GIVE UP TO GET IT
 Because people face TRADEOFFS,
making DECISIONS requires
COMPARING THE COSTS & BENEFITS of
ALTERNATIVE
courses of action.
 The OPPORTUNITY COST of an item
is what you give up to get that
item.
 When making any decision, decision
makers should be aware of the

16
opportunity costs that accompany each
possible action.

17
PRINCIPLE #3: RATIONAL PEOPLE
THINK AT THE MARGIN
 Economists use the term MARGINAL
CHANGES to describe small incremental
adjustments to an existing plan of action.
 Keep in mind that “MARGIN” means
“EDGE,” so marginal changes are
adjustments around the edges of what you
are doing.
 Individuals and firms can make better
decisions by thinking at the margin.
 A rational decision maker takes an action if
and only if the MARGINAL BENEFIT >
18
MARGINAL
COST

19
PRINCIPLE #4: PEOPLE RESPOND
TO INCENTIVES
 Because people make decisions by comparing
costs and benefits, their behavior MAY CHANGE
when the costs or benefits change. That is,
people respond to INCENTIVES.
 When the price of an apple rises, for instance,
people decide to eat more pears and fewer
apples, because the cost of buying an apple is
higher.
 At the same time, apple orchards decide to hire
more workers and harvest more apples,
because the benefit of selling an apple is also
20
higher.

21
Cont..
 Public POLICYMAKERS should never forget
about incentives, for many POLICIES change
the costs or benefits that people face and,
therefore, ALTER BEHAVIOUR.
 A tax on gasoline, for instance, encourages
people to drive smaller, more fuel-efficient
cars.
 It also encourages people to take public
transportation rather than drive and to live
closer to where they work.
 If the tax were large enough, people
would start driving electric cars.
22
PRINCIPLE #5: TRADE CAN MAKE
EVERYONE BETTER OFF
 Trade allows each person to
SPECIALIZE in the activities he or
she/country does best
 Countries benefit from the ability to
trade with one another.
 Trade allows countries to specialize in
what they do best and to enjoy a greater
variety of goods and services.

23
PRINCIPLE #6: MARKETS ARE USUALLY A GOOD WAY
TO ORGANIZE ECONOMIC ACTIVITY
 In a MARKET ECONOMY, the decisions of a
central planner are replaced by the decisions of
millions of firms and households.
 FIRMS decide WHOM TO HIRE and WHAT
TO MAKE
 HOUSEHOLDS decide WHICH FIRMS TO WORK
FOR and WHAT TO BUY with their incomes.
 These firms and households INTERACT in
the MARKET PLACE, where prices and self-
interest guide their decisions.

24
 INDUSTRY A

Land, labor, Land, labor, Land, labor,

Capital Capital Capital

Sales & Profit

Sales & Profit

Sales & Profit

Produce

Produce

Produce
CONSUMERS
Sales & Profit

Sales & Profit

Sales & Profit

Produce

Produce
Produce

Land, Land, Land, labor,

labor, labor, Capital
Capital Capital

19
Free Enterprise Economic System
 INDUSTRY B

19
Free Enterprise Economic System
MONETARY
SYSTEM
GOVERNMENT
LEGAL
SYSTEM
Land, labor, Land, labor, Land, labor, -monopoly reg’n
Capital Capital Capital -pollution control
-building regs

Sales & Profit

Sales & Profit

Sales & Profit

Produce

Produce

Produce
ECONOMIC
POLICY CONSUMERS
Sales & Profit

Sales & Profit

Sales & Profit

-fiscal
-monetary
Produce

Produce
Produce

ESSENTIAL
GOODS &
Land, labor, Land, labor, Land, labor,
SERVICES
Capital Capital Capital

TAXATION
GOVERNMENT
Mixed Economic System 20
 Government (Central Planning Authority)

Owns, Plans & Allocates Resources, & Controls Production

INDUSTRY A INDUSTRY B INDUSTRY C INDUSTRY D

Prices set by
Government

CONSUMERS

21
PRINCIPLE #7: GOVERNMENTS CAN SOMETIMES
IMPROVE MARKET OUTCOMES
 Although MARKETS are usually a
good way to organize economic
activity, this rule has some
important exceptions.
 There are two broad reasons for a
GOVERNMENT to intervene in the
economy: to promote EFFICIENCY
and to promote EQUITY
 That is, most POLICIES aim either to
enlarge the economic pie (EFFICIENCY)
or to change how the pie is divided
22
(EQUITY).

23
Cont…

 EFFICIENCY:
 the property of society getting the most it
can from its scarce resources

 EQUITY:
 the property of distributing economic
prosperity fairly among the members
of society

24
Cont..
 To say that the government can improve
on markets outcomes at times does not
mean that it always will.
 One GOAL of the study of ECONOMICS
is to help us to JUDGE when a
GOVERNMENT POLICY is justifiable to
promote efficiency or equity and when it
is not.

25
PRINCIPLE #8: A COUNTRY’S STANDARD
OF LIVING DEPENDS ON ITS ABILITY TO
PRODUCE GOODS AND SERVICES

 The differences in living standards

around the world are staggering.
 Citizens of high-income countries have
MORE TV sets, more cars, BETTER
nutrition, better health care, and
LONGER life expectancy than citizens of
low-income countries.
 What explains these large
differences in living standards
among countries and over time?
26
Cont..
 Almost all variation in living standards is
attributable to differences in countries’
PRODUCTIVITY
 Productivity = the amount of goods and
services produced from each hour of a worker’s
time.
 In nations where workers can produce a large
quantity of goods and services per unit of time,
most people enjoy a high standard of living; in
nations where workers are less productive, most
people must endure a more meagre existence
(lack of quality or quantity).

27
 Similarly, the GROWTH RATE OF A
NATION’S PRODUCTIVITY DETERMINES
THE GROWTH RATE OF ITS AVERAGE
INCOME.

28
Cont..
 The relationship between PRODUCTIVITY and
LIVING STANDARDS also has profound
implications for PUBLIC POLICY.
 When thinking about how any POLICY will
affect living standards, the key question is how
it will affect our ability to produce goods and
services.
 To BOOST LIVING STANDARDS, policymakers
need to RAISE PRODUCTIVITY by ensuring that
(1) WORKERS ARE WELL EDUCATED, have the
(2) TOOLS NEEDED TO PRODUCE GOODS &
SERVICES, and (3) HAVE ACCESS TO THE BEST

29
AVAILABLE TECHNOLOGY

30
PRINCIPLE #9: PRICES RISE WHEN THE
GOVERNMENT PRINTS TOO MUCH
MONEY
 When a government creates large
quantities of the nation’s money, the
VALUE of the money falls.
 Inflation:
 an increase in the overall level of prices
in the economy

31
PRINCIPLE #10: SOCIETY FACES A SHORT-RUN
TRADEOFF
BETWEEN INFLATION AND UNEMPLOYMENT

 If inflation is so easy to explain, why do

policymakers sometimes have trouble
ridding the economy of it?
 One reason is that reducing inflation is
often thought to cause a temporary rise
in unemployment.

32
Cont..
 When the government reduces the
quantity of money, for instance, it
reduces the amount that people spend.
 Lower spending, together with prices that
are stuck too high, reduces the quantity of
goods and services that firms sell.
 Lower sales, in turn, cause firms to lay
off workers.
 Thus, the reduction in the quantity of
money raises unemployment
temporarily until prices have fully
adjusted to the
33
change.

34
Conclusion
 All the economic way of thinking
can be grouped into 3 categories;
 (1) HOW PEOPLE MAKE DECISIONS
 (2) HOW PEOPLE INTERACT
 (3) HOW THE ECONOMY AS A
WHOLE WORKS

35
Summary
 (1)HOW PEOPLE MAKE DECISIONS
 #1: People Face Tradeoffs
 #2: The Cost of Something Is What You
Give Up to Get It
 #3: Rational People Think at the Margin
 #4: People Respond to Incentives

36
Cont..
 (2) HOW PEOPLE INTERACT
 #5: Trade Can Make Everyone Better Off
 #6: Markets Are Usually a Good
Way to Organize Economic
Activity
 #7: Governments Can Sometimes
Improve Market Outcomes

37
Cont..
 (3) HOW THE ECONOMY AS A
WHOLE WORKS
 #8: A Country’s 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-Run
Tradeoff between Inflation and
Unemployment

38