Introductory notes Yevgeniy M. Orel, C.Sc.(Econ.), Docent, Faculty of Economic Science, NaUKMA Fundamentals of Economic Theory

Thursday, July 23, Course outline [1] Trimester 4 (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

Thursday, July 23, Course outline [2] Trimester 5 (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

Thursday, July 23, What we do: Trimester 4 (88 hrs.): –Lectures – 26 hrs –Seminars – 22 hrs –2 interim tests –Self-study – 38 hrs –Consultations – 2 hrs –Office hours – ~ –Final test Trimester 5 (74 hrs.): –Lectures – 26 hrs –Seminars – 16 hrs –2 interim tests –Self-study – 30 hrs –Consultations – 2 hrs –Office hours – ~ –Final examination

Thursday, July 23, What we get: Trimester 4: –Number of credits 1.5 Trimester 5: –Number of credits 1.5

Thursday, July 23, 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

Thursday, July 23, My contact info: Yevgeniy M. Orel, C.Sc.(Econ.), Docent, Faculty of Economic Science, NaUKMA Office: Tel.: (380-44) , intercom. 432 Cell-phone: Alt.

Lecture 1. The nature and method of economic theory. Essence of the economizing problem Topic 1a. Yevgeniy M. Orel, C.Sc.(Econ.), Docent, Faculty of Economic Science, NaUKMA Fundamentals of Economic Theory

Thursday, July 23, Topic 1a The nature and method of economic theory

Thursday, July 23, Outline of the presentation (Topic 1a The nature and method of economic theory) The nature, methods and methodology of economic theory Positive and normative economics Micro- and macro-economics The goals of economic policy

Thursday, July 23, 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

Thursday, July 23, What economics IS NOT about: Mathematics (see D.Hands article) Housekeeping, Law, Music, Family planning, Marriage and divorce Many other things HOWEVER…

Thursday, July 23, Applications of economics: Businessmens decisions Consumers decisions Policy-makers decisions Voters decisions

Thursday, July 23, Genesis of economics Xenophon ca 431-ca 352 Greek historian, coined the term economy

Thursday, July 23, Genesis of economics [2] Aristotle – BC – per him, economy means organization of slave-owners business.

Thursday, July 23, 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.

Thursday, July 23, Antoine de Montcretiens, 1576–1621 Treatise on Political Economy (1615) Thus he coined the term political economy

Thursday, July 23, Political economy approach In the course of production, people enter into economic (production) relations Each level of production relations fit respective socioeconomic superstructure

Thursday, July 23, 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

Thursday, July 23, Economic (production) relations [2] Means of labor cover the tools and instruments a human being applies to the objects of labor. They include: –Mechanical means of labor (machines, equipment, etc.) –Material conditions of labor (buildings, canals, pipelines, etc.)

Thursday, July 23, 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.

Thursday, July 23, Economic (production) relations [4] In the course of production, distribution, exchange and consumption, human beings enter into production (economic) relations. Production relations comprises a nature (subject-matter) of political economy. Unity and contradiction of productive forces and production relations.

Thursday, July 23, Karl Marx, His main work : Das Kapital

Thursday, July 23, Socioeconomic superstructure Comprises sociopolitical relations, establishments, political system, judicial bodies, etc. Economic relations (economic basis) influence upon one another.

Thursday, July 23, 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

Thursday, July 23, Basic provisions Human needs are infinite Resources to satisfy human needs are finite Alternative use of resources Human behavior is a factor

Thursday, July 23, Two levels of science: What is? Positive science What should be? Normative science

Thursday, July 23, 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)

Thursday, July 23, 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?

Thursday, July 23, 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.

Thursday, July 23, 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? )

Thursday, July 23, More on the positive versus the normative Period of time is not a criterion Positive statements are value-free (?!) Normative statements are value-based (!?)

Thursday, July 23, 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

Thursday, July 23, 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)

Thursday, July 23, Systems of values result from theories in ethics (a review?): Utilitarianism Liberalism Communitarianism

Thursday, July 23, Perspectives: Utilitarianism – outcomes Liberalism – starting points Communitarianism – character

Thursday, July 23, 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.

Thursday, July 23, 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?

Thursday, July 23, A repeat slide: Utilitarianism Liberalism Communitarianism x

Thursday, July 23, Liberalism: people 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. ).

Thursday, July 23, 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?

Thursday, July 23, A repeat slide: Utilitarianism Liberalism Communitarianism x x

Thursday, July 23, Communitarianism: Good 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?)

Thursday, July 23, 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?

Thursday, July 23, A repeat slide: Utilitarianism Liberalism Communitarianism x x x

Thursday, July 23, 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

Thursday, July 23, Two levels of science: Positive science based on data Normative science based on values

Thursday, July 23, Similarly: Two levels of economics: What, how, and for whom IS produced? Positive economics What, how, and for whom SHOULD BE produced? Normative economics

Thursday, July 23, In god we trust, from others we request data. Alan Maynard Professor University of York UK

Thursday, July 23, Relatively easy to figure out: What is and (separately) What should be

Thursday, July 23, Usually difficult to figure out: Transition between the two: what is what should be ?

Thursday, July 23, 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

Thursday, July 23, 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 achieve a higher labor productivity resulting in better living standards?

Thursday, July 23, Micro & Macro [1] MICROECONOMICS is the study of markets and that of their participants behavior. MACROECNOMICS is the study of the entire economic system at the level of aggregated units.

Thursday, July 23, Micro & Macro [2] Trees versus forest

Thursday, July 23, The goals of economic policy EFFICIENCY EQUITY STABILITY

Thursday, July 23, 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

Thursday, July 23, The goals of economic policy: EQUITY Economic freedom Fair distribution of income Economic security

Thursday, July 23, The goals of economic policy: STABILITY Macroeconomic stability: –Stable price level –Stable national currency unit –Maintaining foreign trade balance Economic growth

Thursday, July 23, Goals and means GOALS are set by policy-makers MEANS to achieve them are developed by economists

Lecture 1. Topic 1b Essence of the economizing problem Fundamentals of Economic Theory

Thursday, July 23, Outline of the presentation (Topic 1b 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

Thursday, July 23, Wants/needs and their classifications By urgency and significance: –Elementary needs, –Exquisite needs By nature: –Biological –Cultural –Social

Thursday, July 23, Maslows hierarchy

Thursday, July 23, Abraham Maslow

Thursday, July 23, What is economics concerned about? What to produce How to produce For whom to produce

Thursday, July 23, Economic resources Property resources : –Land –Capital Human resources: –Work force (labor force) –Entrepreneurial ability [others]

Thursday, July 23, 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

Thursday, July 23, 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

Thursday, July 23, Vilfredo Pareto

Thursday, July 23, Economic efficiency [2] Economic efficiency requires allocative, technical and (in some sources) distributive efficiency

Thursday, July 23, 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.

Thursday, July 23, 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.

Thursday, July 23, 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.

Thursday, July 23, 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.)

Thursday, July 23, Allocative and technical efficiency: a rule-of-thumb distinction Allocative efficiency means producing right things Productive efficiency means producing them in the right way

Thursday, July 23, 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

Thursday, July 23, Production possibilities of salo and computers with full employment and production efficiency in a hypothetic country U F Alternative opportunities Computers, thous. units Salo, thous. tons A030 B128 C224 D318 E410 50

Thursday, July 23,

Thursday, July 23, Opportunity costs OPPORTUNITY COST (альтернативна вартість, вартість найкращої з втрачених можливостей) – the largest quantity of the most desirable good we have to forgo in order to obtain a unit of particular good. An opportunity cost of any option is the best of forgone opportunities.

Thursday, July 23, 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.

Thursday, July 23, 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 (!?)

Thursday, July 23, Economic models Traditional Command economy Free-market economy Social market economy

Thursday, July 23, Different economic models differently resolve the problems of: What to produce How to produce To whom the produce is distributed

Thursday, July 23, 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.

Thursday, July 23, 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…

Thursday, July 23, Markets, more Types of markets: –Product market –Resource market –Labor market Participants in the markets: consumers, producers, entrepreneurs,

Thursday, July 23, Дякую за увагу! Thank you for attention!