Top Banner
CHAPTER 1 The Scope and Method of Economics 1 PART I INTRODUCTION TO ECONOMICS The Scope and Method of Economics Why Study Economics? To Learn a Way of Thinking To Understand Society To Understand Global Affairs To Be an Informed Voter The Scope of Economics Microeconomics and Macroeconomics The Diverse Fields of Economics The Method of Economics Theories and Models Economic Policy An Invitation Appendix: How to Read and Understand Graphs CHAPTER OUTLINE
36
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Page 1: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

1PART I INTRODUCTION TO ECONOMICS

The Scope andMethod of

EconomicsWhy Study Economics?To Learn a Way of ThinkingTo Understand SocietyTo Understand Global AffairsTo Be an Informed Voter

The Scope of EconomicsMicroeconomics and MacroeconomicsThe Diverse Fields of Economics

The Method of EconomicsTheories and ModelsEconomic Policy

An Invitation

Appendix: How to Read and Understand Graphs

CHAPTER OUTLINE

Page 2: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Scope And Method Of Economics

economics The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.

The purpose of this chapter and the next is to elaborate on this definition and to introduce the subject matter of economics.

key words: choose and scarce

Economics is a behavioral, or social, science. In large measure it is the study of how people make choices. The choices that people make, when added up, translate into societal choices.

Page 3: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Three fundamental concepts:

Opportunity cost

Marginalism, and

Efficient markets

To Learn A Way Of Thinking

Why Study Economics?

Page 4: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Nearly all economic decisions involve trade-offs. Opportunity cost is directly related with these trade-offs.

opportunity cost The best alternative that we forgo, or give up, when we make a choice or a decision.

Opportunity cost does not have to be measured in dollar terms. The value of an alternative activity is usually measured in both monetary and nonmonetary costs.

Opportunity costs arise because resources are scarce, that is, limited.

Why Study Economics?

Opportunity Cost

To Learn A Way Of Thinking

Page 5: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Question

Which of the following is NOT an opportunity cost of attending college?

A) the tuition you pay

B) the income you could have earned if you didn't attend college

C) the alternative uses of the time you spend studying

D) the cost of the food that you consume while you are attending college

Page 6: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Question

If you own a building and you decide to use that building to open a book store,

A) there is no opportunity cost of using this building for a book store because you own it.

B) there is an opportunity cost of using this building for a book store because it could have been used in other ways.

C) the only cost relevant to this decision is the price you paid for the building.

Page 7: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Why Study Economics?

marginalism The process of analyzing the additional or incremental costs or benefits arising from a choice or decision.

sunk costs Costs that cannot be avoided, regardless of what is done in the future, because they have already been incurred.

Ex: music business. To produce a typical CD, music labels spend around $300,000 on recording the music and music video, marketing materials etc.

Once the label has made the investment the $300,000 are a sunk cost. Afterwards, physically producing another copy of the CD costs say $2. So, the marginal cost of producing the 20001st copy is $2.

Marginalism and Sunk Costs

To Learn A Way Of Thinking

Page 8: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Question

If you can buy 9 DVDs for $126 or you could buy 10 DVDs for $130, then the marginal cost of the tenth DVD is:

A) $4.

B) $13.

C) $14.

D) $130.

Page 9: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Question

If you eat at a sushi restaurant that charges $20 for its all you can eat sushi special, then the marginal cost of your 10th piece of sushi is

A) zero.

B) $2.

C) $20.

D) $200.

Page 10: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Why Study Economics?

efficient market A market in which profit opportunities areeliminated almost instantaneously.

Ex: How should you react when a stockbroker calls with a hot tip on the stock market? With skepticism. Thousands of individuals each day are looking for hot tips in the market. If a particular tip about a stock is valid, there will be an immediate rush to buy the stock, which will quickly drive up its price.

There are clearly times when profit opportunities exist. Someone has to be first to get the news, and some people have quicker insights than others.

Efficient Markets—No Free Lunch

The study of economics teaches us a way of thinking and helps us make decisions.

To Learn A Way Of Thinking

Page 11: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Why Study Economics?

Industrial Revolution The period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities.

To Understand Society

Economic decisions shape the physical environment and influence the character of society. At no time has the impact of economic change on a society been more evident than during:

Page 12: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Why Study Economics?

To Understand Society

The study of economics is an essential part of the study of society.

It is not surprising that the discipline of economics began to shape during this period.

Adam Smith’s Wealth of Nations appeared in 1776. It was followed by the writings of David Ricardo, Karl Marx, Thomas Malthus, and many others.

Page 13: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Why Study Economics?

To Understand Global Affairs

An understanding of economics is essential to an understanding of global affairs.

iPod and the WorldAn iPod Has Global Value. Ask the (Many) Countries That Make It.

The New York Times

An iPod contains 451 parts. Final assembly is performed by several companies in southeast Asia. Toshiba made the most expensive component, the hard drive, at a cost of $73 per unit. But the largest fraction of the iPod’s price is the $163 in value added paid to Apple, various U.S. distributors, and domestic component makers. The true value of the iPod is its design and conception, not the parts that go into it.

Some claim that economic considerations dominate international relations.

Page 14: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Why Study Economics?

To Be An Informed Citizen

When we participate in the political process, we are voting on issues that require a basic understanding of economics.

A knowledge of economics is essential to be an informed citizen.

Examples: ??

Page 15: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

microeconomics The branch of economics that examines the functioning of individual industries and the behavior of individual decision-making units—that is, business firms and households.

Firms’ choices about what to produce and how much to charge and households’ choices about what and how much to to buy help to explain why the economy produces the goods and services it does.

The Scope of Economics

Microeconomics and Macroeconomics

macroeconomics The branch of economics that examines the economic behavior of aggregates—income, employment, output, and so on— on a national scale.

Page 16: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Scope of Economics

Microeconomics and Macroeconomics

Microeconomics is concerned with household income; macroeconomics deals with national income.

Microeconomics questions how many people will be hired (or fired) this year in a particular industry or in a certain geographic area and focuses on the factors that determine how much labor a firm or an industry will hire.Macroeconomics deals with aggregate employment and unemployment: how many jobs exist in the economy as a whole and how many people who are willing to work are not able to find work.

Microeconomics looks at the individual unit—the household, the firm, the industry. It sees and examines the “trees.” Macroeconomics looks at the whole, the aggregate. It sees and analyzes the “forest.”

Page 17: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Microeconomics and Macroeconomics

The Scope of Economics

TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

Divisionsof Economics Production Prices Income Employment

Microeconomics Production/output in individual industries and businesses How much steelHow much office spaceHow many cars

Price of individual goods and services 

Price of medical carePrice of gasolineFood pricesApartment rents

Distribution of income and wealth

Wages in the auto industryMinimum wageExecutive salariesPoverty

Employment by individual businesses and industries

Jobs in the steel industryNumber of employees in a firmNumber of accountants

Macroeconomics National production/output 

Total industrial outputGross domestic productGrowth of output

Aggregate price level 

Consumer pricesProducer pricesRate of inflation

National income

Total wages and salaries  Total corporate profits

Employment and unemployment in the economy

Total number of jobsUnemployment rate

Page 18: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Scope of Economics

TABLE 1.2 The Fields of Economics

Econometrics applies statistical techniques and data to economic problems in an effort to test hypotheses and theories.

Economic development

focuses on the problems of low-income countries. What can be done to promote development in these nations? Important concerns of development economists include population growth and control, provision for basic needs, and strategies for international trade.

Economic history traces the development of the modern economy. What economic and political events and scientific advances caused the Industrial Revolution? What explains the tremendous growth and progress of post—World War II Japan? What caused the Great Depression of the 1930s?

Behavioral economics

uses psychological theories relating to emotions and social context to help understand economic decision making and policy. Much of the work in behavioral economics focuses on the biases that individuals have that affects the decisions they make.

The Diverse Fields of Economics

Continued...

Page 19: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Scope of Economics

TABLE 1.2 The Fields of Economics

Environmental economics

studies the potential failure of the market system to account fully for the impacts of production and consumption on the environment and on natural resource depletion. Have alternative public policies and new economic institutions been effective in correcting these potential failures?

Finance examines the ways in which households and firms actually pay for, or finance, their purchases. It involves the study of capital markets (including the stock and bond markets), futures and options, capital budgeting, and asset valuation.

The history of economic thought

is grounded in philosophy and studies the development of economic ideas and theories over time, from Adam Smith in the eighteenth century to the works of economists such as Thomas Malthus, Karl Marx, and John Maynard Keynes. Because economic theory is constantly developing and changing, studying the history of ideas helps give meaning to modern theory and puts it in perspective.

Industrial organization

looks carefully at the structure and performance of industries and firms within an economy. How do businesses compete? Who gains and who loses?

The Diverse Fields of Economics

Continued...

Page 20: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Scope of Economics

TABLE 1.2 The Fields of Economics (continued)

International economics

studies trade flows among countries and international financial institutions. What are the advantages and disadvantages for a country that allows its citizens to buy and sell freely in world markets? Why is the dollar strong or weak?

Labor economics deals with the factors that determine wage rates, employment, and unemployment. How do people decide whether to work, how much to work, and at what kind of job? How have the roles of unions and management changed in recent years?

Law and economics analyzes the economic function of legal rules and institutions. How does the law change the behavior of individuals and businesses? Do different liability rules make accidents and injuries more or less likely? What are the economic costs of crime?

Public economics examines the role of government in the economy. What are the economic functions of government, and what should they be? How should the government finance the services that it provides? What kinds of government programs should confront the problems of poverty, unemployment, and pollution? What problems does government involvement create?

The Diverse Fields of Economics

Page 21: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

positive economics An approach to economics that seeks to understand behavior and the operation of systems without making judgments. It describeswhat exists and how it works.

Ex: What determines the wage rate for unskilled workers? What would happen if we abolished the corporate income tax?

normative economics An approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action. Also called policy economics.

Ex: Should the government subsidize or regulate the cost of higher education? Should we reduce or eliminate inheritance taxes?

Page 22: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

Positive economics is often divided into descriptive economics and economic theory.

descriptive economics The compilation of data that describe phenomena and facts.

Descriptive Economics and Economic Theory

economic theory A statement or set of related statements about cause and effect, action and reaction.

Economic theory attempts to generalize about data and interpret them. It can also arise from observation.

Page 23: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

model A formal statement of a theory, usually a mathematical statement of a presumed relationship between two or more variables.

variable A measure that can change from time to time or from observation to observation.Ex: Income is a variable- it has different values for different people and different values for the same person over time.

Theories and Models

Economic models are abstractions that strip away detail to expose only those aspects of behavior that are important to the question being asked.

The principle that irrelevant detail should be cut away is called Ockham’s razor.

Page 24: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

ceteris paribus, or all else equal A device used to analyze the relationship between two variables while the values of other variables are held unchanged.

Example: What is the impact of a change in gasoline price on driving behavior, ceteris paribus, or all else equal? If gasoline prices rise by 10%, how much less driving will there be assuming that population, income, public transportation etc. do not change?

All Else Equal: Ceteris Paribus

Theories and Models

Page 25: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

Sometimes words are sufficient to express the essence of a theory, but often it is necessary to be more specific about the nature of a relationship.

The most common method of expressing the quantitative relationship between two variables is graphing that relationship on a two-dimensional plane.

Quantitative relationships between variable can also be presented through equations.For ex, suppose that we discover that over time, households collectively spend, or consume, 90% of their income and save 10% of their income. Then, we could write:

C=0.9Y and S=0.1Y where C:consumption, S:saving, Y:income

Expressing Models in Words, Graphs, and Equations

Theories and Models

Page 26: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

Cautions and Pitfalls: In formulating theories and models, it is especially important to avoid two pitfalls:

The Post Hoc Fallacy

post hoc, ergo propter hoc Literally, “after this (in time), therefore because of this.” A common error made in thinkingabout causation: If Event A happens before Event B, it is not necessarily true that A caused B.

Theories and Models

The Fallacy of Composition

fallacy of composition The erroneous belief that what is true for a part is necessarily true for the whole.

For ex, theories that seem to work well when applied to individuals or households often break down when they are applied to the whole.

Page 27: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

empirical economics The collection and use of data to test economic theories.

Testing Theories and Models: Empirical Economics

Theories and Models

Page 28: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

Economic Policy

Criteria for judging economic outcomes:

1. Efficiency

2. Equity

3. Growth

4. Stability

Page 29: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

efficiency In economics, allocative efficiency. An efficient economy is one that produces what people want at the least possible cost.

The simplest example of an efficient change is a voluntary exchange. If you and your friend each want something that the other has and you agree to exchange, you are both better off.

When a company reorganizes its production or adopts a new technology that enables it to produce more of its product with fewer resources, without sacrificing quality, it has made an efficient change.

Efficiency

Economic Policy

Page 30: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

equity Fairness.

It is impossible to define equity universally, as each individual might have a different on what is fair.

Even so, public policy makers judge the fairness of economic outcomes all the time. Most social welfare programs are created in the name of equity.

Equity

Economic Policy

Page 31: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

economic growth An increase in the total output of an economy.

If output grows faster than the population, output per capita rises and standards of living increase.

Some policies discourage economic growth, and others encourage it. Tax laws, for example, can be designed to encourage the development and application of new production techniques. Building roads, highways, bridges and transport systems in developing countries may speed up the process of economic growth.

Growth

Economic Policy

Page 32: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

The Method of Economics

stability A condition in which national output is growing steadily, with low inflation and full employment of resources.

The causes of instability and the ways in which governments have attempted to stabilize the economy are the subject matter of macroeconomics.

Stability

Economic Policy

Page 33: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Questions

1) The reason that opportunity costs arise is that

A) an economy relies on money to facilitate exchange of goods and services.

B) resources are scarce.

C) there are no alternative decisions that could be made.

D) people have limited wants.

Page 34: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Questions

2) Sunk costs are

A) costs that cannot be avoided, because they have already been incurred.

B) the costs of what we give up when we make a choice or a decision.

C) the additional costs of producing an additional unit of a product.

D) the additional costs of consuming an additional unit of a product.

3) For each of the following, list whether the topic is microeconomic or macroeconomic in nature:

(a.) The price of gasoline.

(b.) The national unemployment rate.

(c.) The quantity of new cars sold each year.

(d.) The wage rate paid to steel workers.

(e.) The amount of national output in an economy.

Page 35: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Questions

4) An efficient market is a market

A) in which everyone always gets what they want.

B) in which profit opportunities are eliminated almost instantaneously.

C) in which profits are always very high and persistent.

D) in which opportunity costs are zero.

5) The statement "the unemployment rate is 5.1%" is an example of a

A) positive statement.

B) value judgement.

C) normative statement.

D) non-verifiable statement.

Page 36: Ch1

CH

AP

TE

R 1

T

he S

cope

and

Met

hod

of

Eco

nom

ics

Questions

6) The economy was expanding during all of the years that I was a student, but as soon as I graduated, the economy contracted. Therefore, the labor market was waiting until I started looking for a job to contract. This statement is an example of

A) ceteris paribus fallacy.

B) post hoc, ergo prompter hoc fallacy.

C) fallacy of composition.

D) fallacy of inductive reasoning.