1 of 36 Lecture 1 The Scope and Method of Economics Why Study Economics? To Learn a Way of Thinking...

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Lecture 1

The Scope and Method of Economics

Why 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

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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.

Economics is the study of how individuals and societies choose to use the scarceresources that nature and previous generations have provided. The key word in thisdefinition is choose. Economics is a behavioral, or social, science. In large measure it isthe study of how people make choices. The choices that people make, when added up,translate into societal choices.

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There are four main reasons to study economics:

• to learn a way of thinking,• to understand society,• to understand global affairs, and • to be an informed voter.

WHY STUDY ECONOMICS?

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Three fundamental concepts:Opportunity costMarginalism, andEfficient markets

TO LEARN A WAY OF THINKING


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

scarce Limited.


Opportunity Cost

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

sunk costs Costs that cannotbe avoided, regardless of what isdone in the future, because theyhave already been incurred.

Marginalism and Sunk Costs

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efficient market A marketin which profit opportunities areeliminated almost instantaneously.

Efficient Markets—No Free Lunch

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

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Industrial Revolution Theperiod in England during the lateeighteenth and early nineteenthcenturies 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

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

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TO UNDERSTAND GLOBAL AFFAIRS

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

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TO BE AN INFORMED VOTER

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 voter.

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

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.

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

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THE SCOPE OF ECONOMICS

THE DIVERSE FIELDS OF ECONOMICS

TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

DIVISION OF 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

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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.

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

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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.

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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.

THEORIES AND MODELS

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

Maps are useful abstract representations of reality.

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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.

All Else Equal: Ceteris Paribus

Using the device of ceteris paribus is one part of the process of abstraction. In formulatingeconomic theory, the concept helps us simplify reality to focus on the relationshipsthat interest us.

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

Expressing Models in Words, Graphs, and Equations

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Cautions and 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.

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The Fallacy of Composition

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

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empirical economics Thecollection and use of data to testeconomic theories.

Testing Theories and Models: Empirical Economics

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ECONOMIC POLICY

Criteria for judging economic outcomes:

1. Efficiency

2. Equity

3. Growth

4. Stability

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

Efficiency

equity Fairness.

Equity

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

Growth

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

Stability

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Review Terms and Concepts

ceteris paribus

descriptive economics

economic growth

economic theory

economics

efficiency

efficient market

empirical economics

equity

fallacy of composition

Industrial Revolution

macroeconomics

marginalism

microeconomics

model

normative economics

Ockham’s razor

opportunity cost

positive economics

post hoc, ergo propter hoc

scarce

stability

sunk costs

variable

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A graph is a two-dimensional representation of a set of numbers, or data.

HOW TO READ AND UNDERSTAND GRAPHS

Appendix

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Appendix

A time series graph shows how a single variable changes over time.

TIME SERIES GRAPH

FIGURE 1A.1 Total Disposable Personal Income in the United States: 1975–2005 (in billions of dollars)

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GRAPHING TWO VARIABLES ON A CARTESIANCOORDINATE SYSTEM

Appendix

The Cartesian coordinate system is the most common method of graphing two variables. This system is constructed by simply drawing two perpendicular lines: a horizontal line, or X-axis, and a vertical line, or Y-axis. The axes contain measurement scales that intersect at 0 (zero). This point is called the origin. FIGURE 1A.2 A Cartesian Coordinate System

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PLOTTING INCOME AND CONSUMPTION DATAFOR HOUSEHOLDS

Appendix

TABLE 1A.1 Total Disposable Personal Income in the UnitedStates, 1975–2005 (in billions of dollars)

YEAR TOTAL DISPOSABLEPERSONAL INCOME

YEAR TOTAL DISPOSABLEPERSONAL INCOME

19751976197719781979198019811982198319841985198619871988

1,181.41,299.9 1,436.01,614.8 1,808.2 2,019.8 2,247.9 2,406.82,586.02,887.63,086.53,262.53,459.53,752.4

19891990199119921993199419951996199719981999200020012002200320042005

4,016.34,293.64,474.84,754.64,935.35,165.45,422.65,677.75,968.26,355.66,627.47,120.27,393.27,827.78,159.98,646.98,945.6

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Appendix

This line slopes upward, indicating that there seems to be a positive relationship between income and spending.

Points A and B, above the 45° line, show that consumption can be greater than income.

TABLE 1A.2 Consumption Expendituresand Income, 2003

AVERAGEINCOME

BEFORE TAXES

AVERAGECONSUMPTIONEXPENDITURES

Bottom fifth 2nd fifth3rd fifth4th fifthTop fifth

$ 8,20121,47837,54261,132

127,146

$ 18,49226,72936,21350,46881,731

FIGURE 1A.3 Household Consumptionand Income

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Appendix

The slope of the line indicates whether the relationship between the variables is positive or negative.

The slope of the line is computed as follows:

Y

X

Y Y

X X

2 1

2 1

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Appendix

A downward-sloping line describes a negative relationship between X and Y.

An upward-sloping line describes a positive relationship between X and Y.

FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope

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Appendix

FIGURE 1A.5 Changing Slopes Along Curves

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Appendix

FIGURE 1A.6 National Income and Consumption

1 of 36 Lecture 1 The Scope and Method of Economics Why Study Economics? To Learn a Way of Thinking...

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