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Introducing the Economic Way of

Thinking• Key Concepts• Summary

©2005 South-Western College Publishing

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What will you learn in this chapter?

You will be acquainted with the foundation of the economic way of thinking

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What are the 3 building blocks in the economic

way of thinking?• scarcity & choice• model building• pitfalls of economic reasoning

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What is theeconomic problem?

Providing for people’s wants and needs in a

world of scarcity

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What is meant by scarcity?

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

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What does scarcity force us to do?

It forces us to make choices

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What are resources?The basic categories of inputs used to produce goods and services

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What are the three categories of resources?

LandLaborCapital

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What is aland resource?

A shorthand expression for any natural resource provided by nature

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What is labor?The mental and physical capacity of workers to produce goods and services

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What is capital?The physical plants, machinery, and equipment used to produce other goods

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What isfinancial capital?The money used to purchase capital

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What is entrepreneurship?

The creative ability of individuals to seek profits by combining resources to produce innovative products.

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LandLandLaborLabor

CapitalCapital

Entrepreneurship organizesresources to produce goodsand services

Entrepreneurship organizesresources to produce goodsand services

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What is economics?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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What is macroeconomics?

The branch of economics that studies decision-making for the economy as a whole

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What is microeconomics?

The branch of economics that studies decision-making by a single individual, household, firm, industry, or level of government

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What is the purpose of an economic model?To forecast or predict the results of various changes in variables

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What is thescientific method?• Problem identification• Model development• Testing a theory

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Identify the problemIdentify the problem

Develop a model basedon simplified assumptionsDevelop a model based

on simplified assumptions

Collect data andtest the model

Collect data andtest the model

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What are the two common pitfalls in understanding how

the economy works?• failing to understand the ceteris paribus assumption

• confusing association with causation

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What assumption is always made when testing a model?

ceteris paribus

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What isceteris paribus?

A Latin phrase that means that while certain variables can change, “all other things remain unchanged”

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What is the difference between association

and causation?We cannot always assume that when one event follows another, the first caused the second

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Why do some economists disagree?

The answer lies in understanding the difference between positive and normative economics

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What ispositive economics?

An analysis limited to statements that are verifiable

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What isnormative economics?

An analysis based on value judgement

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Key Concepts

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• What are the three building blocks in the economic way of thinking?

• 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?

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• What is the scientific method?• What are the two common pitfalls in

understanding how the economy works?• Why do some economists disagree?• What assumption is always made when testi

ng 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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Summary

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Scarcity is the fundamental economic problem that human wants exceed the availability to time, goods, and resources. Individuals and society therefore can never have everything they desire.

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Resources are factors of production classified as land, labor, and capital.

Entrepreneurship is a special type of labor. An entrepreneur combines resources to produce innovative products.

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Economics is the study of how individuals and society choose to allocate scarce resources in order to satisfy unlimited wants. Faced with unlimited wants and scarce resources, we must make choices among alternatives.

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Unlimitedwants

Scarcity

Society Chooses

Resources

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Macroeconomics applies an economy wide perspective that focuses on such issues as inflation, unemployment, and the growth rate of the economy.

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Microeconomics examines individual decision-making units within an economy.

Microeconomics studies such topics as a consumer’s response to changes in the price of coffee and the reasons for changes in the market price of personal computers.

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Models are simplified descriptions of reality used to understand and predict economic events. An economic model can be stated verbally or in a table, graph, or equation. If the evidence is not consistent with the model, the model is rejected.

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Identifythe

problem

Developa model basedon assumptions

Collect dataand test

the model

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Ceteris paribus holds “all other factors unchanged” that might affect a particular relationship. If this assumption is violated, a model cannot be tested. Another reasoning pitfall is to think association means causation.

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Positive economics uses testable statements. Often a positive argument is expressed as an “if-the” statement.

Normative economics is based on value judgments or opinions and uses words such as good, bad, ought to, and ought not to.

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END