1. what is economics ch01

7/31/2019 1. What is Economics Ch01

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WHAT IS

ECONOMICS? 1Part


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Objectives

After studying this chapter, you will be able to:

Define economics and distinguish betweenmicroeconomics and macroeconomics

Explain the three big questions of microeconomics

Explain the three big questions of macroeconomics

Explain the ideas that define the economic way of

thinking Explain how economists go about their work as social

scientists


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Choice, Change, Challenge, and Opportunity

Economics, the science of choice, has much to say aboutthe change, challenge, and opportunity that we face today.

Technological change, terrorism, and recession provide a

landscape that is rich with problems to be tackled andchoices to be understood.

Your economics course helps you to understand thepowerful forces that shape and change our world.


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Definition of Economics

Scarcity

All economic questions arise because we are unable tosatisfy all our wantsbecause we face scarcity.

Economics is the social science that studies the choicesthat individuals, businesses, governments, and societiesmake as they cope with scarcity.


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Definition of Economics

Microeconomics

Microeconomics is the study of choices made byindividuals and businesses, and the influence ofgovernment on those choices.

Macroeconomics

Macroeconomics is the study of the effects on thenational and global economy of the choices that

individuals, businesses, and governments make.


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Three Big Microeconomic Questions

Microeconomics seeks to understand what determines:

What goods and services are produced

How goods and services are produced

For whom goods and services are produced

Goods and services are the objects that people valueand produce to satisfy wants.


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What Goods and Services

are Produced?

Figure 1.1 shows themajor items produced inthe U.S. economy today.

It emphasizes thedominant place of servicesin our economy.


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Figure 1.2 shows thetrends in what the U.S.economy has producedover the past 60 years.

It shows the decline ofagriculture, mining,construction, andmanufacturing, and theexpansion of services.


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The facts about what weproduce raise the deeperquestion: What determines

the quantities of realtorservices, new homes, DVDplayers, and corn that weproduce?

Microeconomics providessome answers to thesequestions.


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How are Goods and Services Produced?

Factors of production are the resources that businessesuse to produce goods and services.

They are grouped into four categories:

Land

Labor

Capital

Entrepreneurship


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The gifts of nature that we use to produce goods and

services are land.

The work time and effort that people devote to producinggoods and services is labor.

The qualityof labor depends on human capital, which is

the knowledge and skill that people obtain from education,on-the-job training, and work experience.


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The tools, instruments, machines, buildings, and otherconstructions that are used to produce goods and servicesare capital.

The human resource that organizes land, labor, andcapital is entrepreneurship.


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Figure 1.3 shows ameasure of the growth ofhuman capital in the

United States over the lastcenturythe percentageof the population that hascompleted different levels

of education.


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The facts about how weproduce raise the deeperquestion: What determines

the quantities of capital,labor, and other resourcesthat get used to producegoods and services?

Microeconomics providessome answers to thisquestion.


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For Whom are Goods and Services Produced?

Who gets the goods and services depends on the incomes

that people earn. Land earns rent.

Labor earns wages.

Capital earns interest. Entrepreneurship earns profit.


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Figure 1.4 shows thedistribution of income in

the United States.

The richest 20 percentearn almost 50 percent oftotal income while the

poorest 20 percent earnonly 4 percent of totalincome.


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The facts about for whomraise the deeper question:

What determines earnings

and the distribution ofincome that in turndetermine who gets thegoods and servicesproduced?

Microeconomics providessome answers to thisquestion.


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Three Big Macroeconomic Questions

Macroeconomics focuses on three big questions:

What determines the standard of living?

What determines the cost of living?

Why does our economy fluctuate?


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What Determines the Standard of Living?

The standard of living is the level of consumption that

people enjoy on the average and is measured by averageincome per person.


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Figure 1.5shows incomeper person per day in anumber of countries andregions.

The United States has oneof the highest standards ofliving, and the nations ofAfrica have the lowest.



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Macroeconomics seeks toexplain differences in thestandard of living across

countries.Macroeconomics alsoseeks to explain the rate atwhich the standard of

living changes.



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What Determines the Cost of Living?

The cost of living is the amount of money it takes to buythe goods and services that a typical family consumes.

The cost of living in the United States is the number ofdollars it takes to buy the goods and services that a typicalfamily consumes.


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Table 1.1 shows the priceof a Big Mac in ten

countries.

The number of money unitsvaries a lot, but the cost issimilar in each country.

What matters is the rate atwhich prices change.

Country Currency Price

U.K Pound 1.90

U.S. Dollar 2.50Brazil Real 2.95

S. Africa Rand 9.00

China Yuan 9.90

France Franc 18.50

Russia Ruble 39.50

Japan Yen 294

Chile Peso 1,260

Italy Lira 4,500


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A rising cost of living is called inflation.

A falling cost of living is called deflation.Inflation brings a shrinking value of the dollar and deflationbrings a rising value of the dollar.

Macroeconomics seeks to explain the forces that

determine the cost of living and the inflation (or deflation)rate.


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Why Does Our Economy Fluctuate?

The business cycle is the periodic but irregular up-and-

down movement in production and jobs in an economy.During 2001, the U.S. economy entered a mildrecessionproduction and jobs shrank.

During the 1990s, the U.S. economy enjoyed a prolonged

expansionproduction and jobs increased.

Figure 1.6 on the next slide illustrates the phases andturning points of a business cycle.


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Why Does Our Economy Fluctuate?

Economists remain unsure about the sources of economicfluctuations and about the actions that might be taken tosmooth the economy.

But in your study of macroeconomics, you will learn whateconomists have discovered about economic fluctuations.


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The Economic Way of Thinking

Choices and Tradeoffs

The economic way of thinkingplaces scarcityand itsimplication, choice, at center stage.

You can think about every choice as a tradeoffanexchangegiving up one thing to get something else.

The classic tradeoff is guns versus butter.

Guns and butter stand foranytwo objects of value.


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Microeconomic Tradeoffs

How?Tradeoffsarise when businesses choose amongalternative production technologies.

For Whom?Tradeoffsarise when choices change thedistribution of buying power across individuals.Government redistribution of income from the rich to thepoor creates the big tradeoffthe tradeoff between

equality and efficiency.


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Macroeconomic Tradeoffs

Standard of Living Tradeoffsarise when we choosebetween current consumption and activities that increase

our standard of living.

Activities such as saving and investing, education, andresearch increase future production and consumptionpossibilities, which increases the standard of living.


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Macroeconomic Tradeoffs

An Output-Inflation Tradeoffarises when policymakerschoose how much inflation to endure in order to maintain a

high level of production.

An output-inflation tradeoff arises because a policyaction that lowers inflation also lowers output and a policyaction that boosts output increases inflation.


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Opportunity Cost

Thinking about a choice as a tradeoff emphasizes cost asan opportunity forgone.

The highest-valued alternative that we give up to getsomething is the opportunity cost of the activity chosen.


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Margins and Incentives

People make choices at themargin, which means thatthey evaluate the consequences of making incremental

changesin the use of their resources.

The benefit from pursuing an incremental increase in anactivity is its marginal benefit.

The opportunity cost of pursuing an incremental increasein an activity is its marginal cost.


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Margins and Incentives

Marginal benefit and marginal cost act as an incentiveaninducement to take a particular action.

For any activity, if marginal benefit exceeds marginal cost,people have an incentive to do more of that activity

If marginal cost exceeds marginal benefit, people have anincentive to do less of that activity.

Economists seek to predict choices by looking at changesin incentives.


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Economics: A Social Science

Social Science

Economics is a social science.

Economists distinguish between two types of statements:

What ispositivestatements

What ought to benormativestatements

A positive statement can be tested by checking it againstfacts

A normative statement cannot be tested.


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Social science

The task of economic science is to discover positivestatements that are consistent with what we observe in theworld and that enable us to understand how the economic

world works.

This task is large and breaks into three steps:

Observation and measurement

Model buildingTesting models


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Observation and Measurement

Economists observe and measure economic activity,keeping track of such things as:

Quantities of resourcesWages and work hours

Prices and quantities of goods and services produced

Taxes and government spending

Quantities of goods and services bought from and soldto other countries


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Model Building

Aneconomic model is a description of some aspect ofthe economic world that includes only those features ofthe world that are needed for the purpose at hand.


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Testing Models

An economic theory is a generalization that summarizeswhat we think we understand about the economic choicesthat people make and the performance of industries and

entire economies.

A theory is a bridge between a model and reality. It is aproposition about which model works.


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Obstacles and Pitfalls in Economics

Economists cannot easily do experiments and mosteconomic behavior has many simultaneous causes.

To isolate the effect of interest, economists use the logicaldevice called ceteris paribusor other things being equal.

Economists try to isolate cause-and-effect relationships bychanging only one variable at a time, holding all other

relevant factors unchanged.


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Obstacles and Pitfalls in Economics

Two common fallacies that economists try to avoid are:

The fallacy of composition, which is the false statement

that what is true for the parts is true for the whole or whatis true for the whole is true for the parts.

The post hoc fallacyfrom the Latin term post hoc, ergopropter hocmeans after this, therefore because of this,

which is the error of reasoning that a first event causes asecond event because the first occurs beforethe second.


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Agreement and Disagreement

Economists are often accused of contradicting each other.

In contrast to the popular image, economists find much

common ground on a wide range of issues.Page 14 of the textbook lists twelve economic propositionsthat at least 70 percent of all economists polled agreed on.


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WHAT IS

ECONOMICS? 1CHAPTER

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1. what is economics ch01

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