Introduction to Economics

Lecture 1: Fundamentals and How

Do Markets Function?
Lecturer:
Dr. Phuong Nguyen
PhD, MSc, BA, FHEA
Outline

1. Course Overview
2. What Is Economics All About?
3. Ten Principles of Economics
4. Economists as Scientists
5. Economists as Policy Advisors
Course Overview
No. Topic
Introduction: Fundamentals and How Do Markets Function (Part 1)?
1.
Literature: Chapters 1, 2, 4 in Mankiw and Chapter 2, 3, 8 in The Economy 1.0
How Do Market Function (Part 2)?
2.
Literature: Chapters 5, 7, 9, 10 in Mankiw and Chapters 7, 12 in The Economy 1.0
How Do Markets Function (Part 3)?
3.
Literature: Chapters 13, 14, 15, 16 in Mankiw and Chapters 7, 8 in The Economy 1.0
Money and The Economic Cycle (Part 1)
4. Literature: Chapters 23, 25, 26, 29 in Mankiw and Chapters 13, 15, 16 in The
Economy 1.0
Money and The Economic Cycle (Part 2)
5. Literature: Chapters 30, 33, 34 in Mankiw and Chapters 13, 14, 15 in The Economy
1.0
International Economics
6.
Literature: Chapters 31, 32 in Mankiw and Chapter 18 in The Economy 1.0

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Course Overview
This module aims to provide students with an overview of subfields in
economics and introduce them to key economic fundamentals in order
to prepare them well for taking microeconomic and macroeconomic
modules.

Class attendance is compulsory. Students’ participation will be

checked at the beginning or conclusion of each session. Cellphones
are restricted in class.

The course combines lectures and reading assignments. Reading the

book by Mankiw is essential for students to develop their economic
vocabulary and economic and analytical skills.
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Course Overview
Evaluation: Final exam 100%

Principles of Economics by G. Mankiw. The latest is the 8th edition.

However, the 7th edition available at the library is also usable.

Course schedule, syllabus and learning materials are uploaded on e-

learning system.

Lecturer’s contact detail: TBA

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By the end of today’s lecture, you can answer
the following questions…
What kinds of questions does economics address?
What are the principles of economics?
What are economic models? What are Circular-Flow
diagram and Production Possibilities Frontier? How do
economists use them?
What are the roles of economists?
What is the difference between microeconomics and
macroeconomics? Between positive and normative?
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 What Is Economics All About?
Scarcity: the limited nature of society’s resources
Economics: the study of how society manages its scarce resources,
e.g.
how people decide what to buy,
how much to work, save, and spend
how firms decide how much to produce,
how many workers to hire
how society decides how to divide its resources between national
defense, consumer goods, protecting the environment, and other
needs

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 Ten Principles of
Economics

HOW PEOPLE
MAKE DECISIONS

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HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs
All decisions involve tradeoffs. Examples:
Going to a party the night before your midterm leaves less time for
studying.
Having more money to buy stuff requires working longer hours, which
leaves less time for leisure.

Society faces an important tradeoff:

efficiency vs. equality
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s
members
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HOW PEOPLE MAKE DECISIONS
Principle #2: The Cost of Something Is What You
Give Up to Get It
Making decisions requires comparing the costs and
benefits of alternative choices. The opportunity cost of
any item is whatever must be given up to obtain it.
It is the relevant cost for decision making.
Example: the opportunity cost of seeing a movie is not
just the price of the ticket, but the value of the time you
spend in the theater.
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HOW PEOPLE MAKE DECISIONS
Principle #3: Rational People Think at the Margin

Rational people
systematically and purposefully do the best they can to
achieve their objectives.
make decisions by evaluating costs and benefits of
marginal changes – incremental adjustments to an existing
plan.
Example: when a manager considers whether to increase
output, she compares the cost of the needed labor and
materials to the extra revenue.
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HOW PEOPLE MAKE DECISIONS
Principle #4: People Respond to Incentives
Incentive: something that induces a person to act,
i.e. the prospect of a reward or punishment.
Rational people respond to incentives. Examples:
When gas prices rise, consumers buy more hybrid
cars and fewer gas guzzling SUVs.
When cigarette taxes increase, teen smoking falls.

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 ACTIVE LEARNING 1
Applying the principles
You are selling your 1996 Mustang. You have already spent
$1000 on repairs.
At the last minute, the transmission dies. You can pay $600 to
have it repaired, or sell the car “as is.”
In each of the following scenarios, should you have the
transmission repaired? Explain.
A. Blue book value is $6500 if transmission works, $5700 if it
doesn’t
B. Blue book value is $6000 if transmission works, $5500 if it
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doesn’t
 Ten Principles of
Economics

HOW PEOPLE
INTERACT

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HOW PEOPLE INTERACT
Principle #5: Trade Can Make Everyone Better Off

Rather than being self-sufficient, people can specialize

in producing one good or service and exchange it for
other goods.
Countries also benefit from trade & specialization:
Get a better price abroad for goods they produce
Buy other goods more cheaply from abroad than
could be produced at home
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HOW PEOPLE INTERACT
Principle #6: Markets Are Usually A Good Way to
Organize Economic Activity
Market: a group of buyers and sellers (need not be in a single
location)
A market economy allocates resources through the
decentralized decisions of many households and firms as they
interact in markets.
Famous insight by Adam Smith in The Wealth of Nations (1776):
Each of these households and firms acts as if “led by an
invisible hand” to promote general economic well-being.

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HOW PEOPLE INTERACT
Principle #6: Markets Are Usually A Good Way to
Organize Economic Activity
The invisible hand works through the price system:
The interaction of buyers and sellers determines prices.
Each price reflects the good’s value to buyers and the cost of
producing the good.
Prices guide self-interested households and firms to make
decisions that, in many cases, maximize society’s economic well-
being.

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HOW PEOPLE INTERACT
Principle #7: Governments Can Sometimes
Improve Market Outcomes
Important role for govt: enforce property rights (with police, courts)
People are less inclined to work, produce, invest, or purchase if large
risk of their property being stolen.
Market failure: when the market fails to allocate society’s resources
efficiently.
In such cases, public policy may promote efficiency.
Govt may alter market outcome to promote equity.
If the market’s distribution of economic well-being is not desirable,
tax or welfare policies can change how the economic “pie” is
18 divided.
 ACTIVE LEARNING 2
Discussion Questions
In each of the following situations, what is the government’s
role? Does the government’s intervention improve the
outcome?
a. Public schools for K-12
b. Public highways
c. Patent laws, which allow drug companies to charge high
prices for life-saving drugs

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Ten Principles of
Economics

HOW THE
ECONOMY
AS A WHOLE
WORKS
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HOW THE ECONOMY AS A WHOLE WORKS
Principle #8: A country’s standard of living depends
on its ability to produce goods & services.
Huge variation in living standards across countries and over
time.
The most important determinant of living standards:
productivity, the amount of goods and services produced per
unit of labor.
Productivity depends on the equipment, skills, and
technology available to workers.
Other factors (e.g., labor unions, competition from abroad)
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have far less impact on living standards.
HOW THE ECONOMY AS A WHOLE WORKS
Principle #9: Prices rise when the government
prints too much money.
Inflation: increases in the general level of prices.
In the long run, inflation is almost always caused by
excessive growth in the quantity of money, which causes
the value of money to fall.
The faster the govt creates money,
the greater the inflation rate.

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HOW THE ECONOMY AS A WHOLE WORKS
Principle #10: Society faces a short-run tradeoff
between inflation and unemployment
In the short-run (1 – 2 years), many economic
policies push inflation and unemployment in
opposite directions.
Other factors can make this tradeoff more or less
favorable, but the tradeoff is always present.

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 The Economist as Scientist
Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
In the first, economists employ the scientific method,
the dispassionate development and testing of theories
about how the world works.

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Assumptions & Models
Assumptions simplify the complex world, make it
easier to understand.
Example: To study international trade, assume two
countries and two goods. Unrealistic, but simple to
learn and
gives useful insights about the real world.
Model: a highly simplified representation of a more
complicated reality. Economists use models to study
economic issues.
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Some Familiar Models in Other Fields

A road map

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Some Familiar Models in Other Fields

A model of human
anatomy from high
school biology class

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 Our First Model:
The Circular-Flow Diagram
The Circular-Flow Diagram: a visual model of the economy,
shows how dollars flow through markets among households and
firms
Two types of “actors”:
households
firms
Two markets:
the market for goods and services
the market for “factors of production” (labor, land, capital
(buildings & machines used in production)
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FIGURE: The Circular-Flow Diagram
Households:
§ Own the factors of production,
sell/rent them to firms for income
§ Buy and consume goods & services
Firms Households
Firms:
§ Buy/hire factors of production,
use them to produce goods and
services
§ Sell goods & services
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FIGURE: The Circular-Flow Diagram
Revenue Markets for
Spending

G&S Goods &

G&S
sold Services
bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income
profit
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 Our Second Model:
The Production Possibilities Frontier
The Production Possibilities Frontier (PPF): a graph that
shows the combinations of two goods the economy can
possibly produce given the available resources and the
available technology.
Example:
Two goods: computers and wheat
One resource: labor (measured in hours)
Economy has 50,000 labor hours per month available for
production.
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 PPF Example
Producing one computer requires 100 hours labor.
Producing one ton of wheat requires 10 hours labor.
Employment of
Production
labor hours
Computers Wheat Computers Wheat
A 50,000 0 500 0
B 40,000 10,000 400 1,000
C 25,000 25,000 250 2,500
D 10,000 40,000 100 4,000
E 0 50,000 0 5,000
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PPF Example
Wheat
Production
Point on (tons)
graph Com- 6,000
Wheat
puters
5,000
E
A 500 0 D
4,000
B 400 1,000
C 250 2,500
3,000 C
2,000
D 100 4,000
1,000
B
E 0 5,000
0
A
0 100 200 300 400 500 600
Computers

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 ACTIVE LEARNING 3
Points off the PPF
A. On the graph, find the point that represents (100
computers, 3000 tons of wheat), label it F. Would it be
possible for the economy to produce this combination of
the two goods? Why or why not?
B. Next, find the point that represents (300 computers,
3500 tons of wheat), label it G. Would it be possible for
the economy to produce this combination of the two
goods?

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The PPF: What We Know So Far
Points on the PPF (like A – E)
possible
efficient: all resources are fully utilized
Points under the PPF (like F)
possible
not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)
Points above the PPF (like G)
not possible
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 The PPF and Opportunity Cost
Recall: The opportunity cost of an item is what must
be given up to obtain that item.
§ Moving along a PPF involves shifting resources (e.g.,
labor) from the production of one good to the other.
§ Society faces a tradeoff: Getting more of one good
requires sacrificing some of the other.
§ The slope of the PPF tells you the opportunity cost of one
good in terms of the other.

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 The PPF and Opportunity Cost
Wheat Opportunity cost of
(tons) product A in terms of
–1000 product B:
6,000
slope = 100 = –10
5,000
∆QB
4,000 Slope = (<0)
3,000
∆QA

2,000
where Q is the quantity
1,000 Here, the opportunity
0 cost of a computer is
0 100 200 300 400 500 600 10 tons of wheat.
Computers

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 ACTIVE LEARNING 4
PPF and Opportunity Cost
What is the opportunity cost of wheat in terms of computers?
Wheat
(tons)
6,000
5,000
4,000
3,000
2,000
1,000
0
0 100 200 300 400 500 600
Computers

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Economic Growth and the PPF
With additional Wheat
resources or an (tons) Economic
improvement in
6,000 growth shifts
technology, 5,000 the PPF
the economy can 4,000 outward.
produce more 3,000
computers, 2,000
more wheat, 1,000
or any combination in 0
between. 0 100 200 300 400 500 600
Computers

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The Shape of the PPF
The PPF could be a straight line, or bow-shaped
Depends on what happens to opportunity cost
as economy shifts resources from one industry
to the other.
If opp. cost remains constant,
PPF is a straight line.
(In the previous example, opp. cost of a computer was
always 10 tons of wheat.)
If opp. cost of a good rises as the economy produces more
of the good, PPF is bow-shaped.
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 Why the PPF Might Be Bow-Shaped

As the economy

Beer
shifts resources
from beer to
mountain bikes:
§ PPF becomes
steeper
§ Opp. cost of
Mountain
mountain bikes
Bikes
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 Why the PPF Might Be Bow-Shaped
At point A, slope of At A, opp. cost of
A

Beer
PPF is low, so the mtn bikes is low.
opportunity cost of
mountain bikes in
terms of beer is low.
In other words, we
do not have to give
up much beer to get Mountain
more bikes. Bikes
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 Why the PPF Might Be Bow-Shaped
At B, the slope of

Beer
At B, opp. cost
PPF is high, so the of mtn bikes
opportunity cost of is high.
mountain bikes in B
terms of beer is high.
In other words, to
produce one more
bike, we have to give Mountain
up much more beer. Bikes
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 Why the PPF Might Be Bow-Shaped
So, PPF is bow-shaped when different workers
have different skills, different opportunity costs of
producing one good in terms of the other.
The PPF would also be bow-shaped when there
is some other resource, or mix of resources with
varying opportunity costs
(E.g., different types of land suited for different
uses).

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Microeconomics and Macroeconomics
Microeconomics is the study of how households and
firms make decisions and how they interact in markets.
Macroeconomics is the study of economy-wide
phenomena, including inflation, unemployment, and
economic growth.
These two branches of economics are closely
intertwined, yet distinct – they address different
questions.

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 Quick Quiz
Which of the following statements relates to Microeconomics?

A. The current unemployment rate in Vietnam is pretty high.

B. Economic profit is the incentive for new firms to join in the market
for production.
C. Monetary and fiscal policies are the government tools for
manipulating the the economy.
D. Vietnam’s unemployment rate in 2010 was 10%.

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The Economist as Policy Advisor
As scientists, economists make positive statements,
which attempt to describe the world as it is.
As policy advisors, economists make normative
statements, which attempt to prescribe how the world
should be.
Positive statements can be confirmed or refuted, normative
statements cannot.

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 ACTIVE LEARNING 3
Identifying positive vs. normative
Which of these statements are “positive” and which are
“normative”? How can you tell the difference?
a. Prices rise when the government increases the
quantity of money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of burritos will cause an
increase in consumer demand for video rentals.
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 Practice Exercises

Refer to the ‘Lecture 1 Practice Exercises’ on E-learning

platform

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 References
Mankiw, G. (2017). Principles of Economics, 8th edition,
Cengage.

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 Thank You!

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