Approches_Eco_Anal_Cours_2013

Université Pierre Mendes France

APPROACHES OF ECONOMICS ANALYSIS

COURSE

© EAD –FACULTE D’ECONOMIE-UPMF-2012

APPROACHES OF ECONOMIC

ANALYSIS

(F11)

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Faculty of Economics - Undergraduate-1st Year

2012-2013 ACADEMIC YEAR

(Distance Learning)

Professor:

Faruk ÜLGEN

(If you are moved to write to me, please do.)

Faculté d’Economie de Grenoble

Université Pierre Mendès France – Grenoble 2

: 1221, Rue des Résidences BP 47 – 38040 Grenoble Cedex 09 – FRANCE

: (33) 0-476 82 54 58: (33) 0-476 82 59 95

http://www.upmf-grenoble.fr

: Ulgen.Faruk@upmf-grenoble.fr

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Some introductory remarks1

Scholars usually consider the economics as the study of the use of scarce resources to satisfy unlimited human wants. A society’s resources consist of natural endowments (land, minerals, human resources, machinery, buildings, etc. Such resources are called factors of production, used to produce the outputs that people desire. These outputs are called commodities and divided into goods and services. The act of creating, elaborating or transforming these goods and services is called production, and the act of using them to satisfy wants and needs is called consumption.

When resources are supposed to be scarce, societies face the problem of deciding what to produce and how much each person will consume. Societies differ in who makes the choices and how they are made, but the need to choose is common to all. Just as scarcity implies the need for choice, so choice implies the existence of cost. Scarcity implies that choices must be made, and making choices implies the existence of costs. Making choice 1 instead of choice 2 implies a comparison between them in terms of their relative costs. That does generate what economists call ‘the opportunity costs’.

In standard terms of the economic theory, the opportunity cost of using resources for a certain purpose is the benefit given up by not using them in an alternative way; that is, it is the cost measured in terms of other commodities that could have been obtained instead. That is an arbitrage between two (or more) goods and services. If, for example, resources that could have produced are used instead to produce one small hospital, the opportunity cost of a hospital is two indoor swimming pools; looked at the other way round, the opportunity cost of one indoor swimming pool is a half of a small hospital. So, economic agents have always to do some choice among various goods and services that one could (and would) produce.

1 The concepts used in this introduction will be more developed in the second part of this course (in the Concepts of economic analysis (F21)).

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Because resources are assumed to be limited, some combinations-those that would require more than the total available supply of resources for their production-cannot be attained. Possible combinations are given in the production possibility boundary or production possibility curve with a negative slope because: when all resources are being used, having more of one kind of good requires having less of the other kind. This illustrates three concepts: scarcity, choice, and opportunity cost.

-Scarcity is indicated by the unattainable combinations above the boundary;

-Choice is indicated by the need to choose among the alternative attainable points along the boundary;

-Opportunity cost is indicated by the negative slope of the boundary. When the production is less than the boundary’s possibilities, it is called suboptimal (or inefficient) because the economy does not use all of its production possibilities. When the production points on the boundary, it is called optimal or efficient.

Major issues studied by economists can be grouped under some main questions:

1. The microeconomic issues: the study of the allocation of resources and the distribution of income as they are affected by the working of the price system and government policies that seek to influence it. Two concepts are then studied:

* The choice of production

The allocation of scare sources among alternative uses, called resource allocation, determines the quantities of various goods that are produced. Producing a particular combination of goods is the choice of a particular allocation of resources among the industries producing the goods.

* The choice of consumption

The relationship between the production of commodities and the consumption enjoyed by citizens. This issue is related to the distribution of a nation’s total output among citizens.

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2. The macroeconomic issues: the study of the determination of economic aggregates such as total output, total employment, the price level, and the rate of economic growth.

* Unemployment and inflation

When an economy is in recession, unemployed workers would like to have jobs, the managers and owners would like to be able to operate their factories, raw materials are available, and the goods that could be produced by these resources are wanted by individuals, but for some reason resources remain unemployed. This means that the economy is operating within its production possibility boundary.

The world’s economies have often experienced bouts of prolonged and substantial changes in price levels .In recent decades the course of prices has almost always been upward. The 1970s and early 1980s saw accelerating inflation all around the world. Then inflation slowed while unemployment soared.

* The economic growth

The capacity to produce commodities to satisfy human wants grows rapidly in some countries, slowly in others, and actually declines in still others.

Economic growth shifts the boundary outward and makes it possible to produce more of all commodities. If any economy’s capacity to produce goods and services is growing, combinations that are unattainable today will become attainable tomorrow. Growth makes it possible to have more of all goods.

An economic system is a distinctive organized structure in order to resolve the basic economic problems. Such systems are complex and include producers of every sort -publicly and privately owned, as well as domestically owned and foreign-owned producers. They include consumers of every sort: young and old, rich and poor, working and nonworking. They include laws and institutions -such as those relating to property rights-rules, regulations, taxes, subsidies, and everything else that government use to influence what is produced, how it is produced, and who gets it. They also include customs of every conceivable kind, and the entire range of contemporary mores and values.

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In the History of Economic Thought, economists distinguished various types of economic systems. The distinction is usually founded on the differences of the coordination/cooperation of activities: an economy with a cooperation founded on some contractual relations among individuals (market relations) and the cooperation based on a centralized and hierarchical command and subordination system (centrally planned relations). The market economy is founded on the price mechanism and on the autonomous enterprises. Economic decisions are made without any central direction. Instead, they result from innumerable, independent decisions made by individual producers and consumers; such a system is known as a free-market economy or, more simply, a market economy. In such an economy, decisions relating to the basic economic issues are decentralized. They are nonetheless coordinated. The centralized economy is a command economy where enterprises produce following some targets given by their hierarchical superiors. In command systems, economic behaviour is determined by some central authority, which makes most of the necessary decisions on what to produce, how to produce it, and who gets it. Such economies are characterized by the centralization of decision making.

Economies also differ as to who owns their productive resources. In a private-ownership economy, the basic raw materials, the productive assets of the society, and the goods produced in the economy, are predominantly privately owned. In contrast, a public-ownership economy is one in which the productive assets are predominantly publicly owned.

There is a political as well as a technical debate about the superiority of one system over another. For instance, one can remark that there is no guarantee that free markets will handle, on their own, some urgent matters as controlling pollution and producing sustainable growth. The ongoing world-wide financial and economic crisis shows that the working of free markets is not always efficient. Mixed economies, with significant degrees of government intervention, are needed to correct these inefficiencies of markets and decentralized private decisions. Some basic problems of the functioning of the market economy as the imperfect and/or incomplete information and other asymmetry problems among individuals make that the State intervention and/or supervision over the individuals’ free behavior may be compulsory to guarantee the viability of modern societies.

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Furthermore, acceptance of the free market over central planning does not provide an excuse to ignore a country’s pressing social issues. Acceptance of the benefits of the free market still leaves plenty of scope to debate the kinds, amounts, and directions of government interventions into the workings of our market-based economy that will help to achieve socials goals. It follows that there is still room for disagreement about the degree of the mix of market and government determination in any modern mixed economy-room enough to accommodate such divergent views as could be expressed by conservative and social democratic parties in parliamentary regimes.

When we look in detail at any real economy, however, we discover that its economic behaviour is the result of some mixture of central control and market determination, with a certain amount of traditional behaviour as well. In practice, every economy is a mixed economy in the sense that it combines significant elements of all systems in determining economic behaviour. Furthermore, within any economy, the degree of the mix varies from sector to sector. For example, in some planned economies the command principle was used more often to determine behaviour in heavy goods industries, such as steel, than in agriculture. Farmers were often given substantial freedom to produce and sell what they wished in response to varying market prices.

Modern economies are usually based on market transactions between people who voluntarily decide whether or not to engage in them. They have the right to buy and sell what they wish, to accept or refuse an offered work, and to move to where they want when they want. Key institutions are private property and freedom of contract, both of which must be maintained by active government policies. The government creates laws of ownership and contract and then provides the courts to enforce these laws.

In the period from 1750 to 1850 the market economies in Europe and the U.S. became industrial economies. With industrialization, modern market economies have raised ordinary people out of poverty by raising productivity at rates that appear slow from year to year but that have dramatic effects on living standards when sustained over long periods of time. The material living standards of any society depend on how much it can produce. How much a society can produce depends both on how many of its citizens are at work producing things

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and on their productivity in their work. In spite of some short-terms ups and downs, the trend of total employment has been upward over most of modern economies throughout the creation of new jobs. These new jobs provided employment for a rising population and for the increasing proportion of that population who wished to work. There were also large off-setting movements in male and female participation in the labor of force.

In modern industrialized economies, incomes became progressively more equally distributed up through the 1960s. After that, the trend reversed. Following the data given by Lipsey et al. (1993), over the 1970s, 1980s, and 1990s the distribution of income has slowly become more unequal. This growing inequality in the distribution of income seems to a great extent to be due to the increasing need for, and hence higher earnings of, relatively well-educated workers. This in turn is associated with changes in many production processes that demand higher and higher levels of skill. Today many jobs cannot be taught at all unless the workers have many years of education, followed by months of on-the-job training. The last few decades have shown two important trends. First, average incomes have risen much less rapidly then in earlier decades. Second, the shift in income distribution from poorer-to better-educated workers means that many of those at the low end of the scale have actually suffered declines in their income compared to what their parents earned.

The growth in incomes over the centuries since market economies first arose has been accompanied by continual technological change. Our technologies are our ways of doing things. New ways of doing old things, and new things to do, are continually being invented and brought into use. The technological changes make labor more productive, and they are constantly changing the nature of our economy. Old jobs are destroyed and new jobs are created as the technological structure slowly evolves. From the second half of the 20th century, the most dramatic changes are associated with the decline of jobs in manufacturing and the rise in service industries. Therefore, many observers interpret this change as a deindustrialization phenomenon of economies. The strong growth in what are recorded as service jobs overstates the decline in the importance of the manufacturing of goods in our economy. This is because many of the jobs

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recorded as service jobs in fact are an integral part of the production of manufactured goods.

First, some of the growth has occurred because services that used to be produced within the manufacturing firms have now been decentralized to specialist firms. This often includes design and marketing. Indeed, one of the most significant of the new developments in production is the break-down of the old hierarchical organization of firms and the development of the production unit as a loosely knit grouping of organizations, each responsible for part of the total activities; some units are owned by the firms but many are on contract to it.

Second, as a result of the rapid growth of international trade, production and sales have required growing quantities of service inputs for such things as transportation, insurance, banking and marketing.

Third, as more and more products become high-tech, increasing amounts are spent on product design at one and customer liaison at the other end. These activities, which are all related to the production and sale of goods, are often recorded as service activities.

As households’ incomes have risen over the decades, households have spent a rising proportion of their incomes on consuming services rather then goods. Today, for example, eating out is common; for our grandparents, it was a luxury. This does not mean, however, that we spend more on food. The extra expenditure goes to pay for the services of those who prepare and serve in restaurants the same ingredients that our grandparents prepared for themselves at home. When we talk of each generation having more real income than previous generations, we must not think of just having more and more money to spend on the same set of products that our grandparents consumed. In fact, we consume very few of the products that were the mainstays of expenditure for our grandparents.

One of the most important aspects of the change that permeates market economies is the continual introduction of new products. Most of the numerous instruments and tools in a modern dentist’s office, doctor’s office, and hospital did not exist 50 years ago. Penicillin, bypass operations, movies, videocassettes and recorders, pocket calculators, computers, compact discs, and fast, safe travel by

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