Memorial University – Grenfell Campus

ECON 1010 – Introduction to Microeconomics

Fall 2020
Lecture Notes – Chapter 02

NOTE: The followings are supplemental materials to the PowerPoint slides.

These materials were mostly (but not all) adapted from the 16th edition of
Microeconomics written by Christopher T.S. Ragan. Resources for studying
this chapter include the second chapter of the textbook, lecture notes,
PowerPoint slides, and the sample questions (if there is any).

Chapter 2: Economic Theories, Data, and Graphs

Objectives – This chapter distinguishes between positive and normative
statements; explains why and how economists use theories to help them
understand the economy; shows the interaction between economic theories and
empirical observation; identifies several types of economic data, including index
numbers, time-series and cross-sectional data, and scatter diagrams; and
recognizes the slope of a line on a graph relating two variables as the “marginal
response” of one variable to a change in the other.

Question: How would economists construct theories (Economic

Methodology)?
Answers:
Economists rely on the scientific method, which consists of;
 observe the world
 formulate hypotheses
 test by comparing actual outcomes to the hypothesized predictions
 accept, reject, modify hypotheses as indicated
 continue testing against the facts
 theory or model
 law or principle

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Deriving Theories
Theoretical economics: The process of deriving and applying economic
theories and principles (i.e., statements about economic behavior that enable
prediction of the probable effects of certain actions.)

Economic Theory:
An economic theory is a statement or set of related statements about cause
and effect, action and reaction.

Economic Model:
An economic model is a formal statement of an economic theory. Usually a
mathematical representation of a presumed relationship between two or
more variables.

In deriving economic theories, the following points should be considered:

Ockham’s Razor:
It states that in specifying economic theories irrelevant detail should be cut
away.

Ceteris Paribus (also known as “other things being equal”):

It is used to analyze the relationship between two variables while the values
of other variables are held constant.

Inductive Reasoning:
The process of observing regular patterns from raw data and drawing
generalizations from them.

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Pitfalls in economic theories:

Post Hoc Fallacy:

A common error made when thinking about causation: if A happened before
B then A did not necessarily cause B.

Example:
It always rains about an hour after you finish washing your car. Concluding that
washing your car caused it to rain is an example of
A) fallacy of composition
B) post hoc fallacy
C) fallacy of inductive reasoning
D) ceteris paribus conditions

Answer: B

Fallacy of Composition:
The fallacy of composition implies that what is true for a part is necessarily
true for the whole.

Example:
You see better if you stand up at a football game. But if everyone stands up, your
ability to see the game is no better than it was when you sat down to watch the
game. This is an example of the
A) fallacy of division
B) post hoc fallacy
C) ceteris paribus fallacy
D) fallacy of composition

Answer: D

Correlation vs. Causation:

Two variables are correlated if one variable changes when the other changes.
For example, there is a correlation between the height above sea level and
temperature.

Causation indicates a change in one variable will cause a change in the value
of another variable. In other words, one variable makes another variable to
happen. For example, lack of sufficient RAM in a mobile phone causes the
mobile phone to be frozen.

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Index Numbers
Purpose: Index numbers are used to compare changes in some variable
relative to a base period.

Example:
Suppose we want to create a price index for the price of a pasta dish across
several restaurants in a metropolitan area on the 1st day of September 2020.
The data are shown as follows:

Restaurant Price per pasta

A $ 8.25
B 7.99
C 10.12
D 8.75
E 9.85
F 11.40
G 9.14
H 12.60

i) Using Restaurant C as the “base restaurant,” construct the restaurant pasta price index
in the metropolitan area.

ii) At which restaurant is pasta the least expensive, and by what percentage is the price
lower than in Restaurant C?

iii) At which restaurant is pasta the most expensive, and by what percentage is the price
higher than in Restaurant C?

iv) Are the data listed above time-series or cross-sectional data?

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ANSWERS:
i)
Restaurant Price per pasta Price Index

A $ 8.25 81.52
B 7.99 78.95
C 10.12 100.00
D 8.75 86.46
E 9.85 97.33
F 11.40 112.65
G 9.14 90.32
H 12.60 124.51

ii) Restaurant B; 21.05 percent

iii) Restaurant H; 24.51 percent

iv) Cross-sectional data