Introductory notes

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Introductory notes
Fundamentals of Economic Theory

• Yevgeniy M. Orel, C.Sc.(Econ.), Docent,
• Faculty of Economic Science, NaUKMA

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Course outline 1

• Part 1 (micro)
• Nature and method
• Demand and supply
• Marginal utility and marginal product
• Costs of production
• Market models
• Productive resources
• Market equilibrium

• Efficiency and equity
• Market failures
• Public and private choice
• Government and market
• Management
• Marketing
• Politico-economic context

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Course outline 2

• Part 2 (macro)
• GDP and other macro-indicators
• Aggregate expenditures
• AD/AS model
• Fiscal policy
• Budget deficit and national debt
• Money and banking

• Monetary policy
• Business cycles
• Unemployment and inflation
• Economic growth
• International economics
• Economic globalization and Ukraine

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What we do

• Trimester (108 hrs.)
• Lectures 26 hrs
• Seminars 12 hrs
• 2 interim tests
• Self-study 68 hrs
• Consultations 2 hrs
• Office hours (see ? special slide)
• Final test ?

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What we get

• Trimester 4
• Number of credits 2 ?

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What else we get, if anything at all

• Thinking like an economist? (likely)
• A recipe how to get rich? (hardly)
• Pleasure? (hope, yes)
• Frustration? (hope, not)
• Anything else? Qui vivra verra

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My contact info

• Yevgeniy M. Orel, C.Sc.(Econ.), Docent,
• Faculty of Economic Science, NaUKMA
• Office 6/207
• Tel. [phone], intercom. 432
• Cell-phone [phone]
• E-mail orele_at_ukma.kiev.ua
• Alt. E-mail orele2_at_gmail.com

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Office hours

• Tuesday 1400-1700
• Thursday 1400-1700

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Lecture 1.The economizing problem. Market
mechanism versus command economy. Demand and
supply.
Fundamentals of Economic Theory

• Yevgeniy M. Orel, C.Sc.(Econ.), Docent,
• Faculty of Economic Science, NaUKMA

10
Outline of the presentation

• The nature, methods and methodology of economic
  theory
• Positive and normative economics
• Micro- and macro-economics
• The goals of economic policy

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What economics IS about

• Production of goods (material goods, services)
  WHAT TO PRODUCE?
• Use of resources HOW TO PRODUCE?
• Distribution of goods FOR WHOM TO PRODUCE?
• Consumption of goods consumers decision
• Behavior, decision-making broader context

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What economics IS NOT about

• Mathematics (see ? D.Hands article)
• Housekeeping (!?),
• Law (!?),
• Music (!?),
• Family planning (!?),
• Marriage and divorce (!?),
• Many other things (!?),
• HOWEVER

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Applications of economics

• Businessmens decisions
• Consumers decisions
• Policy-makers decisions
• Voters decisions

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Genesis of economics

• Xenophon ca 431-ca 352 Greek historian, coined
  the term economy

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Genesis of economics 2

• Aristotle 384-322 BC per him, economy means
  organization of slave-owners business.

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Schools of economics

• Pre-modern Ancient schools of economics
  (Kautilya, Xenophon, Aristotle)
• Early Modern Scholasticism, Mercantilism,
  Physiocrats
• Modern Classical Economics, English historical
  school German historical school, Socialist
  Economics, Neoclassical economics, Lausanne
  school, Institutional economics
• 20th century Stockholm school, Keynesian
  economics, Austrian school, Chicago school.

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Mercantilism

• Mercantilism the first more-or-less clear-cut
  economic theory. The key principles
• The money and commodity circulation (especially
  foreign trade) is the key contributor to creation
  of added value or surplus product
• Wealth of nations is determined by availability
  of the precious metals.

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Antoine de Montcretiens, 15761621

• Treatise on Political Economy (1615)
• Thus he coined the term political economy.

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Political economy approach

• In the course of production, people enter into
  economic (production) relations
• Each level of production relations fits
  respective socioeconomic superstructure

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Economic (production) relations 1

• Production of goods labor is a deliberate and
  expedient action of human beings.
• Objects of labor
• Primary objects of labor given by nature
• Raw materials, i.e. objects earlier processed by
  human beings

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Economic (production) relations 2

• Means of labor consist of the tools and
  instruments a human being applies to the objects
  of labor. They include
• Mechanical and non-mechanical means of labor
  (machines, equipment, etc.)
• Material conditions of labor (buildings, canals,
  pipelines, etc.)

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Economic (production) relations 3

• Means of production include
• Objects of labor
• Means of labor.
• Means of production and labor power (work force)
  comprise productive forces of the society.

23
Economic (production) relations 4

• In the course of production, distribution,
  exchange and consumption, human beings enter into
  production (economic) relations.
• Production relations comprise a nature
  (subject-matter) of political economy.
• Unity and contradiction of productive forces and
  production relations.

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Karl Marx, 1818-1883His main work Das Kapital

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Socioeconomic superstructure

• Comprises sociopolitical relations,
  establishments, political system, judicial
  bodies, etc.
• Economic relations (economic basis) and
  socioeconomic infrastructure influence upon one
  another.

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What are we dealing with?

• Political economy versus analytical economy.

27
Subject-matter of economics (analytical economy)

• Economics is the science which studies human
  behavior as a relationship between ends and
  scarce means which have alternative uses.
• Lionel Robbins
• An Essay on the Nature
• and Significance of
• Economic Science,
• 1932

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Basic provisions

• Human needs are infinite
• Resources to satisfy human needs are finite
• Alternative use of resources
• Human behavior is a factor

29
Two levels of science

• What is? ? Positive science
• What should be? ? Normative science

30
Positive economics

• Positive economics studies WHAT IS, how the
  economy actually works.
• The aim of positive economics is to explain how
  decisions are made about production, consumption
  and the exchange of goods and to aid predictions
  about responses to changes in economic
  circumstances (F.Livesey / Dictionary of
  Economics)

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Positive economics 2

• Examples of statements and questions related to
  positive economics
• There is a market for CDs
• The price control tells on market forces
• In July 2005, unemployment rate amounted to 3
• Will inflation reach 20 next year?

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Normative economics 1

• Normative economics studies WHAT SHOULD BE.
• The aim of normative economics is to propose
  courses of action based on personal value
  judgments.

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Normative economics 2

• Examples of statements and questions related to
  normative economics
• There should be a free market for CDs
• The central government ought to interfere in
  pricing
• Unemployment rate is not to exceed 3
• How the national income should be distributed?
  (equally or fairly? ? )

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More on the positive versus the normative

• Period of time is not a criterion
• Positive statements are value-free (?!)
• Normative statements are value-based (!?)

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Distinction clear or vague?

• Positive economics is not always value-free,
  since
• economists can apply some procedures and reject
  others.
• E.g. Breaking down a set of elements into a
  certain number of categories or groups

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From facts to policy

• Empirical (descriptive) economics ? Economic
  Theory ? Economic Policies (prescriptive
  economics)
• The above is not a one-lane street
• Facts (empirical data) feed theory
• Theory explains facts
• Economic policies related to as policy
  economics or applied economics (C.McConnell,
  S.Brue)

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Systems of values result from theories in ethics
(a review?)

• Utilitarianism
• Liberalism
• Communitarianism

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Perspectives

• Utilitarianism outcomes
• Liberalism starting points
• Communitarianism character

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Utilitarianism (John Bentham)the greatest good
of the greatest number

• Subjective Individuals decide on their own
  well-being
• Objective experts create and apply an index of
  well-being.

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Utilitarianism cont.problems

• Utility may not even exist as a measurable thing
• (utilometer has never been invented)
• There is no 100-correct way to measure utility
• Is it fair to sacrifice some for others?

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A checking slide

• Utilitarianism
• Liberalism
• Communitarianism

x
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Liberalismpeople have the right to choose
their own life plan

• Libertarianism (libertarian liberalism) Negative
  rights, i.e. the rights to be left alone
  (laissez-faire?)
• Egalitarianism (egalitarian liberalism) Positive
  rights as a prerequisite for effective choice
  (universal public health and public education
  abortions, euthanasia, etc.).

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Liberalism cont.problems

• Difficult to know who is entitled to what rights
• Uncertain extent of possible redistribution
• If the rights conflict, what do we do?

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A checking slide

• Utilitarianism
• Liberalism
• Communitarianism

x
x
45
CommunitarianismGood character of individuals
to result in good society

• Relativism (relativist communitarianism) Each
  society to define good character for itself
• Universalism (universal communitarianism) One
  and the only true good character exists. (Does
  it?)

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Communitarianism cont.problems

• Boundaries of the community are hardly (if at
  all) definable
• Communities suppress dissent? How far do they go
  towards it?
• Conflicting visions of different universalists
  How to handle those conflicts?

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A checking slide

• Utilitarianism
• Liberalism
• Communitarianism

x
x
x
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Economists what are they?

• Economists tend to be subjective utilitarians,
  whether they know it or not.
• Marc J. Roberts
• Professor
• Harvard School of Public Health

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Two levels of science

• Positive science ? based on data
• Normative science ? based on values

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SimilarlyTwo levels of economics

• What, how, and for whom
• IS produced? ?
• ? Positive economics
• What, how, and for whom
• SHOULD BE produced? ?
• ? Normative economics

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Relatively easy to figure out

• What is
• and (separately)
• What should be

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Usually difficult to figure out

• Transition between the two

?
what is
what should be
53
In god we trust, from others we request data.
Alan Maynard Professor University of York UK
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Art of economics 1

• The art of economics forms relation of positive
  economics to normative economics
• The art of economics means applying the knowledge
  gained from positive economics to achieving the
  goals set by normative economics

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Art of economics 2

• Examples of statements and questions related to
  art of economics
• Market ensures efficiency, but does not provide
  for equity, so the government is to intervene.
• Given the way the economy works, how can we
  achieve a higher labor productivity resulting in
  better living standards?

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Micro Macro 1

• MICROECONOMICS is the study of markets and that
  of their participants behavior.
• MACROECONOMICS is the study of the entire
  economic system at the level of aggregated units.

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Micro Macro 2

• Trees versus forest

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The goals of economic policy

• EFFICIENCY
• EQUITY
• STABILITY

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The goals of economic policy EFFICIENCY

• Economic (allocative) efficiency
• Full employment of labor force
• Full utilization of available adequate resources
• Economic (technical) efficiency
• Economic (distributive) efficiency

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The goals of economic policy EQUITY

• Economic freedom
• Fair distribution of income
• Economic security

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The goals of economic policy STABILITY

• Macroeconomic stability
• Stable price level
• Stable national currency unit
• Maintaining foreign trade balance
• Economic growth

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Goals and means

• GOALS are set by policy-makers
• MEANS to achieve them are developed by economists

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Lecture 1, cont-d

• Sub-Topic
• Essence of the economizing problem

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Outline of the presentation (Sub-Topic Essence
of the economizing problem)

• Wants and their classifications
• Maslows hierarchy
• Economic resources
• Allocative and technical efficiency
• The production possibilities curve/frontier
• Opportunity costs
• Factors of economic growth
• Economic models

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Wants/needs and their classifications

• By urgency and significance
• Elementary needs,
• Exquisite needs
• By nature
• Biological
• Cultural
• Social

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Maslows hierarchy
67
Abraham Maslow1908-1970
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What is economics concerned about?

• What to produce
• How to produce
• For whom to produce

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Economic resources

• Property resources
• Land
• Capital
• Human resources
• Work force (labor force)
• Entrepreneurial ability
• others

70
Money capital and financial capital

• Money IS NOT an economic resource because it
  produces nothing
• Financial capital IS NOT an economic resource
  because it produces nothing
• Real capital IS an economic resource

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Economic efficiency 1

• Economic efficiency is the state of an economy
  in which no one can be made better off without
  someone being made worse off (Bannocks Dict-ry
  of Ec-cs)
• Pareto-optimality economic efficiency

72
Vilfredo Pareto1848-1923
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Economic efficiency 2

• Economic efficiency requires allocative,
  technical and (as mentioned in some sources)
  distributive efficiency

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Allocative and technical efficiency

• Allocative efficiency means that resources are
  used for production of goods and services desired
  by society.
• Technical/productive efficiency means that the
  goods are produced at the lowest cost.

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Allocative efficiency

• When inputs/outputs are put top their best uses
  in the economy so that no further gains in output
  of welfare are possible. (S.Witter T.Ensor)
• Nobody can be better-off without somebody getting
  worse-off.

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Technical (productive) efficiency

• When the firm produces the maximum possible
  sustained output from a given set of inputs.
  (S.Witter T.Ensor)
• Any given output produced employs minimal
  possible resources.

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Three main elements of efficiency (Pauly, 1970
Culyer, 1985)

• 1.  Do not waste resources
• 2.  Produce each output at least cost
  (Tech.-Effic.)
• 3.  Produce the types and amounts of output which
  people value most (Alloc-Effic.)

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Allocative and technical efficiencya
rule-of-thumb distinction

• Allocative efficiency means producing right
  things
• Productive (technical) efficiency means producing
  them in the right way

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The production possibilities curve/frontier

• Initial assumptions
• Full employment and maximal productive efficiency
• Resources available are constant both in quantity
  and in quality
• Technology is not subject to change
• Only two products can be made from the available
  resources

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Production possibilities of salo and computers
with full employment and production efficiency in
a hypothetic country U
F
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Opportunity costs

• OPPORTUNITY COST (????????????? ????????,
  ???????? ????????? ? ????????? ???????????) the
  largest quantity of the most desirable good we
  have to forgo in order to obtain a unit of a
  particular good. An opportunity cost of any
  option is the best of forgone opportunities.

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ECONOMIC GROWTH

• ECONOMIC GROWTH Ability of an economy to
  produce more and more products due to the
  technical progress and increase in the amount of
  resources.

84
Factors of economic growth

• Factors conducive to economic growth
•          Increase in the quantity and quality of
  resources (natural, investment, human)
•          Technical progress
•          Expanding foreign trade
• Factors hampering economic growth
•          Wars
•          Discrimination
•          Expanding foreign trade (!?)

85
Economic models

• Traditional
• Command economy
• Free-market economy
• Social market economy

86
Different economic models differently resolve the
problems of

• What to produce
• How to produce
• To whom the produce is distributed

87
Command economy model

• Huge resources are allocated inefficiently by a
  privileged bureaucracy, which negatively tells on
  individual consumption
• Due to poor distribution of resources, the system
  usually lacks incentives to work hard
• Bureaucracy develops into a self-serving elite
  that allocates resources to its followers, i.e.
  not necessarily on merit.

88
MARKET, definitions

• A group of buyers and sellers of a certain good
  (commodity or service)
• A place where they buyers and sellers get
  together
• A system, network, infrastructure, etc. conducive
  to market transactions
• Other definitions

89
Markets, more

• Types of markets
• Product market
• Resource market
• Labor market
• Participants in the markets consumers,
  producers, entrepreneurs, sellers, buyers, etc.

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Sub-Topic 1c

• Demand and supply

91
A saying

• Teach a parrot to say,
• Demand and supply!,
• and you have an economist!

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Outline of the presentation (Sub-Topic 1-c
Demand and Supply)

• Market, definition
• The law of demand. Demand shifters
• Demand and the quantity demanded
• The law of supply. Supply shifters
• Supply and the quantity supplied
• Market equilibrium
• Rationing function of prices
• Outcomes of changes in demand and supply

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Market, a repeat definition slide

• MARKET a group of sellers and buyers of a good
  (commodity) or service.
• MARKET a mechanism, institution, or a structure
  that brings together buyers and sellers of a
  certain good or service.

94
Demand, definitions of

• DEMAND (?????) a quantity of a product that
  buyers are able and willing to buy at different
  prices within a certain period of time, ceteris
  paribus.
• DEMAND The desire for a particular good or
  service supported by the possession of the
  necessary means of exchange to effect ownership.
  (Bannocks DoE)

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Conditions of demand

• Willingness to buy
• Ability to pay (availability of means or
  resources)
• Certain (limited) period of time
• Other conditions being constant, other things
  being equal, ceteris paribus

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Demand schedule (example of individual demand)
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Quantity demanded versus demand

• QUANTITY DEMANDED (???????? ??????) is determined
  by the price for a good.
• DEMAND is determined by the demand shifters.

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Demand shifters

• Demand shifters (determinants of demand1)
• 1.)    Buyers tastes and preferences
• 2.)    Number of buyers
• 3.)    Buyers income
• 4.)    Prices for related goods
• 5.)    Buyers expectations
• 1 ???. ???????????? ??????, ??????????
  ??????, ??????? ??????.

100
Related goods

• Related goods (?????? ?? ??????? ?????????????)
• 1.) substitute goods (beef-pork, butter-oleo)
• 2.) complementary goods (cars-gas,
  camcorders-chips)
• 3.) independent goods (beef-gas, oleo-camcorders)

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SUPPLY

• SUPPLY (??????????) a quantity of a product
  that suppliers are able and willing to supply at
  different prices within a certain period of time,
  ceteris paribus.

102
Conditions of supply

•         Willingness to sell (produce)
•         Ability to sell (produce)
•         Certain (limited) period of time
•         Other conditions not changed, other
  things equal, ceteris paribus

103
Supply schedule (example of individual supply)
104
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Quantity supplied versus supply

• QUANTITY SUPPLIED (???????? ??????????) is
  determined by the price for a good.
•  
• SUPPLY (??????????) is determined by supply
  shifters.

106
Supply shifters

• Supply shifters (determinants of supply1)
• 1.)    Prices for resources
• 2.)    Changes in technology
• 3.)    Taxes and subsidies
• 4.)    Prices for other goods
• 5.)    Suppliers expectations
• 6.)    Number of suppliers
• 1 ???. ???????????? ??????????, ??????????
  ??????????, ??????? ??????????.

107
LAW OF DEMAND

• The lower the price of a good, the more of it
  will be demanded, other things held constant.
• The higher the price of a good, the less of it
  will be demanded, other things held constant.

108
INCOME EFFECT

• The change in the demanded quantity of a product
  as a result of a change in its price, i.e. the
  impact of a change in price on the spending power
  of consumers. The change in price of a product
  results in a change in the real income of
  individual consumers, who can either afford to
  buy more units of the product, or have to buy
  less of it.
• Ukr. ????? ??????

109
SUBSTITUTION EFFECT

• The change in a consumers preferences resulting
  from changes in relative prices of goods, given
  the same real income and the same total utility.
• Ukr. ????? ?????????

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EQUILIBRIA

• EQUILIBRIUM PRICE (?????????? ????, ????
  ?????????) the price at which the market
  equilibrium is reached.
• EQUILIBRIUM PRICE the price toward which the
  invisible hand drives the market. (D.Collander)
•  EQUILIBRIUM QUANTITY (?????????? ?????????)
  the amount bought and sold at the equilibrium
  price. (D.Collander)

112
Topic 1d

• Elasticity of demand and supply

113
Outline of the presentation (Topic 1b)

• Price elasticity of demand and supply
• Determinants of price elasticity of demand
• Cross elasticity of demand
• Interdependent (substitute and complementary) and
  independent goods
• Cross elasticity of supply
• Normal goods
• Inferior goods
• Giffen goods

114
Price elasticity formula (repeat)

• -change in Q
• ________________ price elasticity
• change in P

115
Types of price elasticity of demand

• 1.)    Ed gt 1 elastic demand
• 2.)    Ed lt 1 inelastic demand
• 3.)    Ed 1 unit-elastic demand
• 4.)    Ed 0 perfectly inelastic demand
• 5.)    Ed ? perfectly elastic demand

116
Determinants of the price elasticity of demand

• 1.)    Substitute products availability,
  substitutability
• 2.)    Prices proportion in the consumers
  income
• 3.)    Luxury or necessity? Significance of the
  good for consumers
• 4.)    Time elapsed since the price change

117
PRICE ELASTICITY OF SUPPLY

• Price elasticity of supply the percentage
  change in quantity supplied divided by the
  percentage change in price
• Es ?Qs / ?P

118
Types of price elasticity of supply

• 1.)    Es gt 1 elastic supply
• 2.)    Es lt 1 inelastic supply
• 3.)    Es 1 unit-elastic suuply
• 4.)    Es 0 perfectly inelastic supply
• 5.)    Es ? perfectly elastic supply

119
Determinants of the price elasticity of supply

• 1.)    Time elapsed since the price change
• 2.)    Cost of the output expansion/contraction
• 3.)    Substitutability of resources
• 4.)    Shelf life and the cost of storage of the
  good

120
Cross-elasticity of supply

• Cross-elasticity of supply is the percentage
  change in the quantity demanded of one product
  divided by the percentage change in the price of
  another product.
• ECross-D ?Qd,X / ?PY
• Substitutable goods positive elasticity
• Complementary goods negative elasticity
• Independent goods nearly zero-elasticity

121
Income elasticity of demand

• Income elasticity of demand
• EIncome-D ?Q / ?I
• Normal goods (????????? ??????) Income
  elasticity of demand is positive
• Inferior goods (?????? ?????? ??????) Income
  elasticity of demand is negative

122
????? ?? ?????!Thank you for attention!