Unit 1 Introduction

UNIT 1: INTRODUCTION TO ECONOMICS
Unit 1: Introduction to Economics

Part 1: What is Economics?
Chapter 1
ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

What We Will Learn
1. What is economics?
2. What are the assumptions of human behaviour?
3. What is the main economic problem that societies face?

What is Economics?
 Economics is the study of human behaviour and choice:
‒ 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?
 Opportunities and choices are limited by scarce resources:

‒ We have limited money.
‒ We have limited time.
‒ We have limited materials.

What is Economics?
 We consider three perspectives:
1. Consumers
2. Managers
3. Government Policymakers

Assumptions about Human Behaviour
 We making three main assumptions about human behaviour:
1. People are rational

‒ People make decisions they believe will make them happy or better off.
‒ People will act in their own self-interest.
‒ We will return to this assumption in Unit 6.
2. People respond to incentives

‒ When a particular option becomes more attractive, people will be more likely
to select it.
3. People use Cost-Benefit Analysis

‒ People compare the Marginal Benefit (MB) and Marginal Cost (MC) of each
option before making a decision.
‒ Only options with a positive Net Benefit will be selected.
The Economic Problem
 All societies face a basic economic problem:
Societies have Limited Resources,

but People have Unlimited Wants.
 When we devote resources to one type of activity, those same

resources cannot be used for a different type of activity.
 Societies face trade-offs.

 Our 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?


Part 2: Economic Systems
Chapter 1

What We Have Learned
3. Who will receive the goods and services produced?

What We Will Learn
1. What are the types of economic systems?
2. What is the Efficiency vs. Equity trade-off?

Types of Economic Systems
1. Market Economy
2. Centrally-Planned Economy
3. Mixed Economy

A Market Economy
 In a market economy, the answers to all three of our main
economic questions are determined solely by the private sector –
that is, made up of individuals and businesses that operate for a
profit. The public sector – the government, does not try to
influence the market outcome.
 Firms decide what to produce and how much to charge.

Consumers decide how much to buy.
 Market economies are characterized by an absence of state

intervention.
A Market Economy
 The classical liberal philosophers explained the basics of the market

economy system and promoted its use.
 Today, we often use the term neo-liberal or neo-classical to

describe economists who advocate for a free-market economy.

A Market Economy
Advantages Disadvantages
 Resources are usually allocated  They underproduce some types
efficiently with respect to production. of goods that are beneficial to
individuals and to society as a
whole.
 Market economies foster innovation
and entrepreneurship.
 They can generate substantial
levels of inequality – resources
 People are free to choose, and the are often not allocated efficiently
government does not have to with respect to consumption.
choose for them.

Socialism and the 19th and 20th Centuries
 Market-driven inequality in 19th century led to the creation of the
socialism philosophy.
 Socialism emphasizes community ownership of business:

‒ Co-operatives
‒ State-Owned Enterprises (SOEs)

A Centrally-Planned Economy
 If all (or most) businesses in the economy are state-owned
enterprises, we call it a communist economic system.
 In a centrally-planned economy, the government decides what is

produced and directs resources to meet these targets.
 20th Century communist economies were centrally-planned, but not

all centrally-planned economies were communist!
 The government may also decide how output is distributed to

consumers, for example through rationing.

A Centrally-Planned Economy
Advantages Disadvantages
 Rationing reduces inequality.  Production is usually not efficient.
 Can allocate societal resources  It is difficult for the government to

more efficiently than a free market choose the right targets and
in times of national emergency. allocate resources.
 Lack of innovation.
 Underperforms market economies

in overall production.

A Mixed Economy
 A mixed economy combines elements of both market economies
and central-planning.
 In mixed economies most types of goods are provided by the

private sector – by businesses owned by individuals. However,
the government may influence or regulate some aspects of the
market.
 The public sector – the government – also provides some types

of goods and services directly, such as through state owned
enterprises.
A Mixed Economy
 The extent to which the government provides goods and services
in a mixed economy varies from country to country.
 Since the 1980s, neo-liberal economists have successfully argued

for governments in Western Europe and North America to adopt a
policy of deregulation and sell some state-owned enterprises.

A Mixed Economy
 Mixed economies attempt to obtain the advantages of both free
markets and central-planning while avoiding the disadvantages of
either type.
 But, in practice we will face trade-offs which mean we cannot fully

capture all the benefits or avoid all the consequences of each type.
 Most economists and policymakers agree that a mixed economy is

best, but they disagree on how much or how little the government
should be involved. In democracies, citizens can decide through
voting.
Efficiency vs. Equity
 Market economies are more efficient than centrally-planned
economies.
‒ Productive efficiency: goods and services are produced at the lowest possible
cost.
‒ Allocative efficiency: a society’s resources are used to produce a mix of goods
and services that consumers actually want to buy.
 Markets function well because of voluntary exchange.
 Equity refers to a “fair” distribution of resources. What exactly

is considered fair though is open to interpretation. Unfortunately,
Government attempts to improve equity will usually reduce efficiency.
ECON 2ZZ3 “Intermediate Microeconomics II” explores this topic further.


Part 3: How Economists Work
Chapter 1

What We Will Learn
1. How do economists work?
2. What are Microeconomics and Macroeconomics?

How Economists Work
 To study how economic decisions are made and the outcomes
these decisions produce, economists develop theories, also called
models. We follow these five steps:
1. Decide on the assumptions to use in developing the model.

2. Formulate a testable hypothesis.
3. Use economic data to test the hypothesis.
4. Revise the model if it fails to explain the economic data well.
5. Retain the revised model to help answer similar economic
questions in the future.

Formulating Assumptions
 We start by making assumptions about how individuals will behave in
certain situations.
 Typically, we assume people are rational.
 Our assumptions will be used to predict behaviour and the outcomes of

decisions.
‒ Ex. If the price of paper towels goes down, we assume more people will buy them.
 To see if our assumptions are correct, we will proceed through the next
steps.

Testable Hypotheses
 Given the assumptions we have made, we can now make a
prediction about an observable and measurable outcome.
 A hypothesis is a statement about an economic variable that can

either be proved correct or incorrect. Usually, our hypothesis will
specify a causal relationship where a change in one variable
causes another variable to change.
‒ Ex. Lowering the price of paper towels will cause the quantity of paper
towels sold to increase.

Using Economic Data
 To test hypotheses, we collect data on how the economic variables
of interest are changing.
 If the variable changes in the way we hypothesized, then we

conclude our hypothesis was correct. If the variable does not
change in the way we hypothesized, then we will need to modify
our starting assumptions to generate different predictions that fit
our observations.
 We may need to revise our assumptions several times to develop

a model which accurately predicts what we observe in the real
world.

Positive vs. Normative Analysis
 Positive analysis concerns facts or logic. It is simply focused on
what “is” and what “could be”.
 Normative analysis makes value judgments about whether what

“is” or what “could be” is desirable or not.
 Many economists tend to focus on positive analysis, simply stating what

we observe to be happening in the real world, and what could happen
when a new decision is made. Business managers, government
policymakers, journalists, and others may interpret our findings in
different ways and argue for or against different decisions based on
whether they believe the predicted outcomes are desirable or not.
Microeconomics vs. Macroeconomics
 Microeconomics:
‒ Focuses on individual agents and markets.
‒ Considers the behaviour of individual consumers, workers, and firm managers.
‒ Examines production and efficiency for individual goods and services.
‒ Examines how the government can impact the market for specific goods and
services.
 Macroeconomics:  ECON 1BB3 “Introductory Macroeconomics”

‒ Focuses on the whole economy in aggregate, particularly economic growth, total
income, inflation, and unemployment.
‒ Considers the overall outcome of all household consumption decisions.
‒ Examines overall business activity and employment without differentiating by
sector or product.
‒ Examines the overall impact of government actions on the whole economy.

How to do economics
 All aspects of economics can be explained in one of three ways:
1. With words
2. With graphs
3. With equations


Part 4: Math Review
Chapter 1

What We Will Learn
Math Review!
1. Basic functions
2. Graphing
3. Solving Equations

Basic Functions and Graphs
 A function is an equation that 𝑦𝑦

tells us about the relationship
between two variables.
 We can display functions on a

graph with the values of one
variable (x) shown on the Origin: 𝑥𝑥 = 0, 𝑦𝑦 = 0
horizontal axis and the values
of the other variable (y) shown
on the vertical axis. 0 𝑥𝑥

𝑦𝑦
 Each point on the graph

represents a set of coordinates.
15 6,15
 We always write the 𝑥𝑥-coordinate 9 3,9

first.
0 3 6 𝑥𝑥

𝑦𝑦
 A linear function is a straight line.

15 6,15
 In economics we typically use
linear functions because: 9 3,9
1. They are easy to draw.
2. They often provide a good
approximation if the true
relationship is not linear. 0 3 6 𝑥𝑥

Basic Functions
𝑦𝑦
 A linear function:
𝑦𝑦 = 𝑚𝑚𝑚𝑚 + 𝑏𝑏
15 6,15
where: 9 3,9
𝑚𝑚 is the slope of the function
𝑏𝑏 is the y-axis intercept 𝑏𝑏
0 3 6 𝑥𝑥

Finding the Slope
𝑦𝑦2 − 𝑦𝑦1 𝑦𝑦 𝑚𝑚 > 0 → upward sloping
𝑚𝑚 =
𝑥𝑥2 − 𝑥𝑥1
15 6,15
15 − 9
𝑚𝑚 =
6−3 9 3,9
6
𝑚𝑚 = 𝑏𝑏
3
0 3 6 𝑥𝑥
𝑚𝑚 = 2
Finding the Slope
 To find the intercept, we can
use the slope plus one of the 𝑦𝑦
points:
𝑦𝑦2 − 𝑦𝑦1
𝑚𝑚 = 15 6,15
𝑥𝑥2 − 𝑥𝑥1
15 − 𝑏𝑏 9 3,9
2=
6−0
𝑏𝑏
15 − 𝑏𝑏
2= 0 3 6 𝑥𝑥
6
Finding the Slope
 Rearrange by using opposite 𝑦𝑦
operations:
15 − 𝑏𝑏
2= 15 6,15
6
15 − 𝑏𝑏 9 3,9
6 2= 6
6
𝑏𝑏
12 = 15 − 𝑏𝑏
0 3 6 𝑥𝑥

Finding the Slope
operations:
12 = 15 − 𝑏𝑏
15 6,15
12 − 15 = 15 − 𝑏𝑏 − 15
9 3,9
−3 = −𝑏𝑏
𝑏𝑏
0 3 6 𝑥𝑥

Finding the Slope
operations:
−3 = −𝑏𝑏
15 6,15
−1 −3 = −1 −𝑏𝑏
9 3,9
𝑏𝑏 = 3
3
𝑏𝑏
0 3 6 𝑥𝑥

An Upward Sloping Linear Function
 Therefore, this line can be 𝑦𝑦
presented as the linear function:
𝑦𝑦 = 2𝑥𝑥 + 3
15 6,15
 A 1 unit increase in 𝑥𝑥 corresponds 9 3,9

to a 2 unit increase in 𝑦𝑦.
3
 When 𝑥𝑥 = 0, 𝑦𝑦 = 3.
0 3 6 𝑥𝑥

A Downward Sloping Function
 We can consider the function: 𝑦𝑦 𝑚𝑚 < 0 → downward sloping
23
𝑦𝑦 = −3𝑥𝑥 + 23
 When 𝑥𝑥 = 0, 𝑦𝑦 = 23.
 A 1 unit increase in 𝑥𝑥 corresponds

to a 3 unit decrease in 𝑦𝑦.
0 𝑥𝑥

Intersection of Two Functions
 Suppose we have two functions: 𝑦𝑦
23
𝑦𝑦 = 2𝑥𝑥 + 3
𝑦𝑦 = −3𝑥𝑥 + 23
? ?,?
𝑦𝑦 = 𝑦𝑦
3
2𝑥𝑥 + 3 = −3𝑥𝑥 + 23
0 ? 𝑥𝑥

𝑦𝑦
2𝑥𝑥 + 3 = −3𝑥𝑥 + 23 23
2𝑥𝑥 + 3 + 3𝑥𝑥 = −3𝑥𝑥 + 23 + 3𝑥𝑥

? ?,?
2𝑥𝑥 + 3 + 3𝑥𝑥 = 23
5𝑥𝑥 + 3 = 23 3
0 ? 𝑥𝑥

𝑦𝑦
5𝑥𝑥 + 3 = 23 23
5𝑥𝑥 + 3 − 3 = 23 − 3
? ?,?
5𝑥𝑥 = 20
0 ? 𝑥𝑥

𝑦𝑦
5𝑥𝑥 = 20 23
5𝑥𝑥 20
=
5 5
? 4, ?
20
𝑥𝑥 =
5 3
𝑥𝑥 = 4 0 4 𝑥𝑥

 Since:
𝑦𝑦
𝑦𝑦 = 2𝑥𝑥 + 3
23
and
𝑦𝑦 = −3𝑥𝑥 + 23 ? 4, ?
we can use either equation to

solve. Both will give the same 3
answer if we have done our work
properly. 0 4 𝑥𝑥

 Since 𝑥𝑥 = 4, therefore:
𝑦𝑦
𝑦𝑦 = 2 4 + 3 23
𝑦𝑦 = 11
11 4,11
 Also:
𝑦𝑦 = −3 4 + 23 3
𝑦𝑦 = 11 0 4 𝑥𝑥

Non-Linear Functions
 Non-linear functions have a
slope that changes at every 𝑦𝑦
point.
 For any given point, we can find

the slope of the curve by
examining the slope of a
tangent line.
 We will not be calculating the

slopes of non-linear functions in
this course. 0 𝑥𝑥

Unit 1 Introduction

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UNIT 1: INTRODUCTION TO ECONOMICS

Unit 1: Introduction to Economics

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

2. What are the assumptions of human behaviour?

3. What is the main economic problem that societies face?

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Opportunities and choices are limited by scarce resources:

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

1. People are rational

2. People respond to incentives

3. People use Cost-Benefit Analysis

Societies have Limited Resources,

 When we devote resources to one type of activity, those same

 Societies face trade-offs.

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Our three main economic questions:

1. What goods and services will be produced?

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Our three main economic questions:

1. What goods and services will be produced?

2. How will the goods and services be produced?

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Our 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?

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

Unit 1: Introduction to Economics

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

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?

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

1. What are the types of economic systems?

2. What is the Efficiency vs. Equity trade-off?

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Firms decide what to produce and how much to charge.

 Market economies are characterized by an absence of state

 The classical liberal philosophers explained the basics of the market

 Today, we often use the term neo-liberal or neo-classical to

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Socialism emphasizes community ownership of business:

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 In a centrally-planned economy, the government decides what is

 20th Century communist economies were centrally-planned, but not

 The government may also decide how output is distributed to

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 Can allocate societal resources  It is difficult for the government to

 Underperforms market economies

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 In mixed economies most types of goods are provided by the

 The public sector – the government – also provides some types

 Since the 1980s, neo-liberal economists have successfully argued

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

 But, in practice we will face trade-offs which mean we cannot fully

 Most economists and policymakers agree that a mixed economy is

 Markets function well because of voluntary exchange.

 Equity refers to a “fair” distribution of resources. What exactly

ECON 1B03: Introductory Microeconomics © Dr. Colin Mang, 2023

Unit 1: Introduction to Economics