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You are on page 1of 54

chapter, you will be able to

economics and macroeconomics, and explain the

questions of microeconomics.

2 Describe the work of economists as social scientists.

way of thinking.

1.1 DEFINITIONS AND QUESTIONS

human wants exceed the resources available to satisfy

them.

Scarcity

The condition that arises because the available

resources are insufficient to satisfy wants.

choose among the available alternatives.

face.

1.1 DEFINITIONS AND QUESTIONS

Incentive

An incentive is a reward or a penalty—a “carrot” or a

“stick”—that encourages or discourages an action.

Economics

The social science that studies the choices that we

make as we cope with scarcity and the incentives that

influence and reconcile our choices.

and macroeconomics.

1.1 DEFINITIONS AND QUESTIONS

Microeconomics

Microeconomics: The study of the choices that

individuals and businesses make, the way these

choices interact, and the influence that governments

exert on these choices.

Macroeconomics

Macroeconomics: The study of the aggregate (or

total) effects on the national economy and the global

economy of the choices that individuals, businesses,

and governments make.

1.1 DEFINITIONS AND QUESTIONS

Microeconomic Questions

What?

What goods and services get produced and in what

quantities?

How?

How are goods and services produced?

For Whom?

For whom are the various goods and services

produced?

1.2 ECONOMICS: A SOCIAL SCIENCE

world works. Economists distinguish between:

• Positive statements: What is

• Normative statements: What ought to be

The task of economic science:

To discover and catalog positive statements that are

consistent with what we observe in the world and that

enable us to understand how the economic world

works.

1.2 ECONOMICS: A SOCIAL SCIENCE

• Observing and measuring

• Model building

• Testing

Observing and Measuring

Items such as:

• Quantities of resources

• Wages and work hours

• Prices and quantities of goods and services

• Taxes and government spending

• Volume of international trade

1.2 ECONOMICS: A SOCIAL SCIENCE

Model Building

Economic model

A description of some aspect of the economic world that

includes only those features of the world that are

needed for the purpose at hand.

1.2 ECONOMICS: A SOCIAL SCIENCE

Testing

A model’s predictions might correspond to or conflict

with the data.

Economic theory

A generalization that summarizes what we understand

about the economic choices that people make and the

economic performance of industries and nations.

1.2 ECONOMICS: A SOCIAL SCIENCE

The central idea that economists use to unscramble

cause and effect is ceteris paribus.

Ceteris Paribus

Ceteris paribus means “other things being equal.”

But ceteris paribus can be a problem in economics when

testing a model.

1.2 ECONOMICS: A SOCIAL SCIENCE

• Natural experiments

• Statistical investigations

• Economic experiments

Natural Experiments

A situation that arises in the ordinary course of

economic life in which the one factor of interest is

different and other things are equal.

1.2 ECONOMICS: A SOCIAL SCIENCE

Statistical Investigations

Correlation

The tendency for the values of two variables to

move in a predictable and related way.

The error of reasoning that a first event causes a

second event because the first occurred before

the second.

1.2 ECONOMICS: A SOCIAL SCIENCE

Economic Experiments

Economic experiments put real subjects in a

decision-making situation and vary the influence of

interest to discover how the subjects respond to one

factor at a time. A relatively new approach.

1.3 THE ECONOMIC WAY OF THINKING

• Rational choice

• Cost

• Benefit

• Margin

• Incentives

1.3 THE ECONOMIC WAY OF THINKING

Rational Choice

Using the available resources to satisfy most effectively

the wants of the person making the choice.

Opportunity cost

The highest-valued alternative forgone.

Sunk Cost

A previously incurred and irreversible cost.

1.3 THE ECONOMIC WAY OF THINKING

Willing to Give Up

Benefit

The gain or pleasure that something brings.

On the Margin

Margin

A choice that is made by comparing all the relevant

alternatives systematically and incrementally.

1.3 THE ECONOMIC WAY OF THINKING

Marginal Cost

The cost of a one-unit increase in an activity

Marginal Benefit

What you gain when you get one more unit of something.

When we take those actions for which marginal benefit

exceeds or equals marginal cost.

1.3 THE ECONOMIC WAY OF THINKING

Responding to Incentives

In making our choices, we respond to incentives.

If the cost of something rises, we try to find a less costly

alternative.

If the benefit of something rises, we do more of that thing.

Example: most students believe that studying just before

an exam has a bigger benefit that studying a long time

before the exam. So study time increases as the exam

gets closer.

1.4 WHY ECONOMICS IS WORTH STUDYING

• Understanding

• Expanded career opportunities

Understanding

Economic ideas are all around you. You cannot ignore

them.

As you progress with you study of economics, you’ll gain a

deeper understanding of what is going on around you.

1.4 WHY ECONOMICS IS WORTH STUDYING

Most students of economics don’t become economists.

But knowledge of economics is vital in many fields such as

banking, finance, business, management, insurance, real

estate, law, government, journalism, health care and the

arts.

Economics graduates are not the highest-paid

professional, but they are close to the top.

1.4 WHY ECONOMICS IS WORTH STUDYING

earnings comparisons.

Graduates in disciplines

that teach problem

identifying, problem

solving, and strategic

brokering are top of the

earnings distribution:

• engineering

• computer science

• economics

1.4 WHY ECONOMICS IS WORTH STUDYING

The main cost of studying economics is forgone leisure

time.

Most students find that economics is difficult and that it

takes time to master.

The trick is practice, or learning by doing.

Benefits Versus Costs

Weigh up your benefits and costs!

APPENDIX CHECKLIST

appendix, you will be able to

a cross-section graph.

2 Interpret the graphs used in economic models.

variables.

APPENDIX: MAKING AND USING GRAPHS

Basic Idea

A graph enables us to visualize the relationship between

two variables.

To make a graph, set two lines perpendicular to each

other:

• The horizontal line is called the x-axis.

• The vertical line is called the y-axis.

• The common zero point is called the origin.

APPENDIX: MAKING AND USING GRAPHS

to make a graph

The horizontal axis

(x-axis) measures

temperature.

axis) measures ice

cream consumption.

APPENDIX: MAKING AND USING GRAPHS

the temperature is 40

degrees, ice cream

consumption is only 5

gallons a day.

the temperature is 80

degrees, ice cream

consumption jumps to 20

gallons a day.

APPENDIX: MAKING AND USING GRAPHS

Scatter diagram

A graph of the value of one variable against the value of

another variable.

Time-series graph

A graph that measures time on the x-axis and the

variable or variables in which we are interested on the

y-axis.

APPENDIX: MAKING AND USING GRAPHS

Trend

A general tendency for the value of a variable to rise or

fall.

Cross-section graph

A graph that shows the values of an economic variable

for different groups in a population at a point in time.

APPENDIX: MAKING AND USING GRAPHS

scatter diagram.

In 1996 (marked 96),

income per person was

$21,100 and

expenditure per person

was $20,100.

The data for the 1990s

show that as income

increases, expenditure

also increases.

APPENDIX: MAKING AND USING GRAPHS

another scatter diagram.

the price of an international

phone call was $1.24 a

minute, 11.4 billion minutes

of calls were made.

price falls, the number of

calls increases.

APPENDIX: MAKING AND USING GRAPHS

times-series graph.

the price of coffee was:

• High and low.

• Rising and falling.

• Changing quickly

and slowly.

APPENDIX: MAKING AND USING GRAPHS

cross-section graph.

percentage of people

who participate in

various sports

activities.

APPENDIX: MAKING AND USING GRAPHS

A relationship between two variables that move in the

same direction.

Linear relationship

A relationship that graphs as a straight line.

APPENDIX: MAKING AND USING GRAPHS

positive (direct) relationship.

At a speed of 40 MPH, you

travel 200 miles in 5 hours—

point A.

At a speed of 60 MPH, you

travel 300 miles in 5 hours—

point B.

As the speed increases, the

distance traveled in 5 hours

increases proportionately.

APPENDIX: MAKING AND USING GRAPHS

positive (direct) relationship.

As the distance sprinted

increases, recovery time

increases.

it takes more than twice as

long to recover—the curve

gets steeper.

APPENDIX: MAKING AND USING GRAPHS

positive (direct)

relationship.

As study time increases,

the number of problems

worked increases.

But study twice as long

and the number of

problems you work less

than double—the curve

gets less steep.

APPENDIX: MAKING AND USING GRAPHS

A relationship between two variables that move in

opposite directions.

APPENDIX: MAKING AND USING GRAPHS

negative (inverse)

relationship.

As the time playing tennis

increases, the time playing

squash decreases.

Because one more hour of

tennis means one hour less

of squash, the relationship

between these two

variables is described by a

straight line.

APPENDIX: MAKING AND USING GRAPHS

negative (inverse) relationship.

increases, the cost per mile of

the trip falls.

But there is a limit to how

much the cost per mile can

fall, so the curve becomes

less steep as journey length

increases.

APPENDIX: MAKING AND USING GRAPHS

negative (inverse) relationship.

As leisure time increases,

the number of problems

worked decreases.

But the tenth hour of leisure

(the first hour of work)

decreases the number of

problems worked most, so

the curve becomes steeper

as leisure time increases.

APPENDIX: MAKING AND USING GRAPHS

a maximum point.

As the rainfall increases:

the yield per acre rises.

A, the maximum yield.

the yield per acre falls.

APPENDIX: MAKING AND USING GRAPHS

minimum point.

As the speed increases:

1. The curve slopes

downward as the cost per

mile falls.

2. The curve is flat at point

B, the minimum cost per

mile.

3. The curve slopes upward

as the cost per mile rises.

APPENDIX: MAKING AND USING GRAPHS

variables that are unrelated.

increases, the student’s

grade in economics

remains at 75 percent.

APPENDIX: MAKING AND USING GRAPHS

variables that are unrelated.

As rainfall in California

increases, the output of

French vineyards remains

at 3 billion gallons.

APPENDIX: MAKING AND USING GRAPHS

Slope

The change in the value of the variable measured on

the y-axis divided by the change the value of the

variable measured on the x-axis.

Slope = ∆y ÷ ∆x.

APPENDIX: MAKING AND USING GRAPHS

a positive slope.

1. When ∆x is 4,

2. ∆y is 3.

APPENDIX: MAKING AND USING GRAPHS

a negative slope.

1. When ∆x is 4,

2. ∆y is –3.

APPENDIX: MAKING AND USING GRAPHS

slope of a curve at a point.

Slope of the curve at A

equals the slope of the red

line tangent to the curve at A.

1. When ∆x is 4,

2. ∆y is 3.

APPENDIX: MAKING AND USING GRAPHS

Variables

To graph a relationship that involves more than two

variables, we use the ceteris paribus assumption.

Ceteris Paribus

“other things remaining the same.”

Figure A1.8 shows the relationships between ice cream

consumed, the temperature, and the price of ice cream.

APPENDIX: MAKING AND USING GRAPHS

Figure A1.8(a) shows the relationship between price and

consumption, temperature remaining the same.

APPENDIX: MAKING AND USING GRAPHS

Figure A1.8(b) shows the relationship between temperature

and consumption, price remaining the same.

APPENDIX: MAKING AND USING GRAPHS

Figure A1.8(c) shows the relationship between price and

temperature, consumption remaining the same.

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