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Chapter 1
Introducing the economic way of
thinking

Key concepts

What is the economic problem?

What is meant by scarcity?
What are resources?
What are the three categories of
resources?
What is entrepreneurship?
What is economics?
What is macroeconomics?
What is microeconomics?

Key concepts (cont.)

What is the scientific method?
What assumption is always made
when testing a model?
What is ceteris paribus?
What is the purpose of model
building?
What is positive economics?
What is normative economics?
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The problem of scarcity

Scarcity is the condition in which wants
are forever greater than the available
supply of time, goods and resources.

The result of scarcity

Scarcity forces us to make choices
individuals, groups, governments and
societies never have as much of all the
goods and services as they would like to
have.
Individuals: more clothes, new car,
better house
Governments: more education
facilities, more roads, defence etc.
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The economic problem

The problem of scarcity can also be
called the economic problem how to
achieve the most wants given the
resources at our disposal.

Resources
Resources are the basic categories of
inputs used to produce goods and
services.
Resources can also be called the factors
of production.

Three categories of resources

Land
Labour
Capital

Resources: land
Any natural resource provided by nature
used in the process of production
For example: forests, minerals, wildlife,
oil, rivers, lakes, oceans
May be renewable or non-renewable

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Resources: labour
The mental and physical capacity of
workers to produce goods and services
For example: farmers, nurses, lawyers
Entrepreneurship is a special type of
labour the creative ability of
individuals to manage the combination
of resources to produce products.

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Entrepreneurship
Organises and manages the resources
needed to produce goods and services

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Resources: capital
Capital is the physical plant, machinery
and equipment used to produce other
goods. That is, human-made goods that
do not directly satisfy human wants, for
example:
Earlier: axe, bow and arrow
Now: buildings, production
equipment, software, factories.
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A note about financial capital

Economists do not include money in
their definition of capital money
simply gives a measure to the value of
assets.

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What is economics?
Economics is the study of how society
chooses to allocate its scarce resources
to the production of goods and services
in order to satisfy unlimited wants.

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Two branches of economics

Microeconomics is the branch of
economics that studies decision-making
by a single individual, household, firm,
industry or level of government.
Macroeconomics is the branch of
economics that studies decision-making
for the economy as a whole.

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The methodology of economics

Economists (like other scientists) use
scientific method.
Scientific method is a step-by-step
procedure for solving problems.
1 Identify the problem.
2 Develop a model.
3 Test the model.
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Example: petrol consumption

Identify the
problem.

Petrol consumption has fallen.

Why?

Develop a
model.

Select relevant variables price of

petrol, price of cars, fuel economy.
Express them verbally, graphically
or mathematically.

Test the
model.

Gather data which tells us how well

the model estimates or predicts
relationships.

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The steps in the modelbuilding process

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More about models

A model is a simplified view of reality
(like a map).
It sets out (verbally, graphically or
mathematically) the relationship
between variables; between cause and
effect.
A valid model is useful because it
enables economists to forecast or
predict the results of various changes
in variables.
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Handle models with care!

There are two potential problems to be
aware of:
The ceteris paribus assumption
Possible confusion of association and
causation.

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Ceteris paribus
Ceteris paribus is a Latin phrase which
means other things remaining
unchanged.
For example, an economic model (the
law of demand) suggests that
consumption of a drink should fall if its
price increases. But is the model wrong
if people actually drink more in hot
weather?
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Association vs causation
We cannot always assume that when
one event follows another, the first
caused the second.
For example, assume exports from
Indonesia rose last month. Two events
might be associated:
The hole in the ozone layer grew last month.
Currency movements reduced the cost to
Australians of buying Indonesian goods.

But are they both possible causes?

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Why do economists disagree?

Economists agree on many things.
As in other professions, disagreements
occur.
One explanation for disagreements is
the difference between positive and
normative economics.

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What is positive economics?

An analysis limited to statements that
are verifiable.
Positive statements are testable they
can be proven true or false.
Examples
Airbags save lives.
Smoking is harmful to your health.

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What is normative economics?

An analysis based on value judgements.
Normative statements cannot be proven
by facts to be true or false.
They express opinions good, bad,
ought to, should.
Examples:
Every teenager who wants a job
should have one.
The government should allocate more
money to education.
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Chapter 1(appendix)
Applying graphs to economics

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Key concepts

Why use graphs in economics?

What is a direct relationship?
What is an inverse relationship?
What is an independent relationship
between two variables?
How do we measure the slope of a line?
How do graphs show three-variable
relationships?
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Why use graphs in

economics?
Graphs are one of the simplest ways to
present and understand relationships
between economic variables.
Graphs provide us with simple (twodimensional) economic models.
Graphs help economists to understand
the relationships that exist between
variables.
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What is a direct relationship?

A direct relationship is a positive
association between two variables.
When one variable increases, the other
also increases.
When one variable decreases, the other
also decreases.
Note the line on the next slide has a
positive slope.
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A direct relationship

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What is an inverse
relationship?
An inverse relationship is a negative
association between two variables.
When one variable increases, the other
decreases.
When one variable decreases, the other
increases.
Note the line on the next slide has a
negative slope.
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An inverse relationship

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What is an independent
relationship?
An independent relationship is a zero
association between two variables.
When one variable changes, the other
remains unchanged.

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An independent relationship

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The slope of a straight line

The ratio of change in the variable on
the vertical axis (the rise or fall) to
change in the variable on the horizontal
axis (the run).
Slope

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= rise/run
= vertical axis/horizontal axis
= Y/X

The slope of a curve

A straight-line relationship is a linear
relationship.
The slope of a curve changes from one
point on the curve to another.
To determine the slope of a curve at any
point, draw a tangent to the line at that
point, and measure the slope of the
tangent.
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The slope of a curve

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A three-variable relationship
How can a model drawn in two
dimensions show the impact of changes
in a third variable?
We must distinguish between
movements and shifts.
Movements along a graph show
changes in one of the variables on the
graphs axes.
Shifts show changes in other
variables.
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A three-variable relationship

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Graphs in economics
Graphs help us to understand
relationships and to see economic
concepts at work.
You should learn to draw, describe and
interpret them.

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