principles of microeconomics - attributed
TRANSCRIPT
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This document is attributed to Libby Rittenberg andTim Tregarthen
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AbouttheAuthors
LibbyRittenberg
LibbyRittenberghasbeenaProfessorofEconomicsatColoradoCollegein
ColoradoSpringssince1989.Sheteachesprinciplesofeconomics,
intermediatemacroeconomictheory,comparativeeconomicsystems,and
internationalpoliticaleconomy.ShereceivedherB.A.ineconomics-
mathematicsandSpanishfromSimmonsCollegeandherPh.D.in
economicsfromRutgersUniversity.
PriortojoiningthefacultyatColoradoCollege,
shetaughtatLafayetteCollegeandatthe
RutgersUniversityGraduateSchoolof
Management.SheservedasaFulbrightScholar
inIstanbul,Turkey,andasaresearch
economistatMathematica,Inc.inPrinceton,NewJersey.Dr.Rittenbergspecializesintheinternationallyorientedareasof
economics,withnumerousarticlesinjournalsandbooksoncomparative
anddevelopmenteconomics.Muchofherworkfocusesontransition
issuesandontheTurkisheconomy.
Shehasbeenveryinvolvedinstudyabroadeducationandhasdirected
programsincentralEuropeandTurkey.
TimTregarthen
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ThereisonewordthatcapturestheessenceofDr.TimothyTregarthen
inspiring.Timwasfirstdiagnosedwithmultiplesclerosis(MS)in1975.
Yet,hecontinuedaremarkableacademiccareerofteachingandresearch.
In1996,hepublishedthefirsteditionofhisprinciplesofeconomics
textbooktogreatacclaim,anditbecamewidelyusedincollegesaround
thecountry.Thatsameyear,MSmadehimwheelchair-bound.Thedisease
forcedhisretirementfromteachingattheUniversityofColoradoat
ColoradoSpringsin1998.Helosttheuseofhisarmsin2001andhasbeen
quadriplegiceversince.In2002,Timsdoctorexpectedhimtodie.
HewasplacedinthePikesPeakHospiceprogramandwastwicegivenhis
lastritesbyhispriest.UCCSChancellorShockley-Zalabaksays,Ireally
thoughtthatTimwoulddieinhospice.Thatswhatthedoctorstoldme,
andIreallybelievedthat.Irememberonedaytheycalledmeandtoldme
totrytocomeseehim.Theydidn'texpecthimtolivethroughthenight.
Notonlydidhelivethroughthenight,butheeventuallyrecoveredtothe
pointthathemovedfromhospicetoalong-termcarefacility.There,he
neverlethisdiseasegethimdown.Infact,heturnedbacktohisloveof
writingandteachingforinspiration.Heobtainedavoice-activated
computer,recruitedacoauthor,LibbyRittenbergofColoradoCollege,and
turnedhisattentiontorevisinghisprinciplesofeconomicsbook.Flat
WorldKnowledgeishonoredtopublishanew,firsteditionrelaunchof
thiswonderfulbook,andproudtobringTimsincredibletalentsasa
teacherbacktolifeforfuturegenerationsofstudentstolearnfrom.
Inadditiontocompletingtherewriteofhistextbook,Timrecently
completedanautobiographyaboutthethirty-twoyearshehashadMS,
titledSuffering,Faith,andWildflowers.Heisnearingcompletionofanovel,
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CoolLuck,basedonthelifeofafriend.Itisthestoryofayoungcouple
facingthehusbandsdiagnosisofALSLouGehrigsdisease.Remarkably,
in2007,hewasabletoreturntotheclassroomatUCCS,wherehehad
taughteconomicsfortwenty-sevenyears.InJanuaryof2009,Timmarried
DinoraMontenegro(nowDinoraTregarthen);thecouplelivesinSan
Gabriel,California.
PerhapsTimsapproachtolifeisbestsummedupbyanobservationby
UCCSEnglishProfessorThomasNaperierkowski:Oneoftheremarkable
thingsis,heck,Icanwakeupwithaheadacheandbeaprettygrouchy
character,butgivenhisphysicaltrials,whichhefaceseveryminuteofhis
lifethesedays,Iveneverseenhimgrouchy,Iveneverseenhimcranky.
Carryon,Tim.
Acknowledgments
Theauthorswouldliketothanktothefollowingindividualswhoreviewed
thetextandwhosecontributionswereinvaluableinshapingthefinal
product:
CarlosAguilar ElPasoCommunityCollege
JeffAnkrom WittenbergUniversity
LeeAshSkagitValleyCommunityCollege
RandallBennett GonzagaUniversity
JosephCalhoun FloridaStateUniversity
RichardCantrell WesternKentuckyUniversity
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GreggDavisFlatheadValleyCommunityCollege
KevinDunagan OaktonCommunityCollege
MonaElShazly ColumbiaCollege
JoseEsteban PalomarCollege
MauritaFawls PortlandCommunityCollege
FredFoldvary SantaClaraUniversity
RichardFowles UniversityofUtah
DorisGeide-Stevenson WeberStateUniversity
SarmilaGhoshUniversityofScranton,KaniaSchoolofManagement
DavidGordonIllinoisValleyCommunityCollege
ClintonGreene UniversityofMissouri-St.Louis
JamesHolcomb UniversityofTexasatElPaso
PhilHolleran MitchellCommunityCollege
YuHsingSoutheasternLouisianaUniversity
ThomasHyclak LehighUniversity
BruceJohnson CentreCollege
JamesKahiga GeorgiaPerimeterCollege
AndrewKohen JamesMadisonUniversity
MonacoKristenCaliforniaStateUniversityLongBeach
MarkMaier GlendaleCommunityCollege
DavidMcClough BowlingGreenStateUniversity
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AnnMcPherren HuntingtonUniversity
JohnMinNorthernVirginiaCommunityCollege
ShahriarMostashariCampbellUniversity,Lundy-FettermanSchoolofBusiness
FrancisMummery FullertonCollege
RobertMurphy BostonCollege
KathrynNantz FairfieldUniversity
PaulOkelloTarrantCountyCollege-SouthCampus
NicholasPeppes St.LouisCommunityCollege
RamooRatha DiabloValleyCollege
TeresaRiley YoungstownStateUniversity
MichaelRobinson MountHolyokeCollege
AnirbanSengupta TexasA&MUniversity
JohnSolow TheUniversityofIowa
JohnSomersPortlandCommunityCollege
CharlesStaelin SmithCollege
RichardStratton TheUniversityofAkron
KayE.Strong
BowlingGreenState
UniversityFirelands
DellaSue MaristCollege
JohnVahaly UniversityofLouisville
RobertWhaples WakeForestUniversity
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MarkWheelerWesternMichiganUniversity
LeslieWolfson ThePingrySchool
SourusheZandvakili UniversityofCincinnati
Wewouldliketoextendaspecialthankyoutothefollowinginstructors
whoclasstestedthetextintheircourses:
JohnathanMillman UniversityofMassachusettsBoston
JohnMin NorthernVirginiaCommunityCollege
KristenMonaco CaliforniaStateUniversityLongBeach
SteveSkinner WesternConnecticutStateUniversity
RichardStratton UniversityofAkron
Preface
GreekphilosopherHeraclitissaidover2500yearsagothatNothing
enduresbutchange.Forecastingisatrickybusiness,butthissentiment
strikesusasbeingassafeabetasonecanmake.Changerapidchange
underliesallourlives.Aswewerecompletingthistextbook,theworld
enteredaperiodofmarkedeconomicuncertaintythatledmanystudents,
andindeedpeoplefromallwalksoflife,totuneintoeconomiceventsas
neverbeforetotrytounderstandtheeconomicworldaroundthem.So,
whileweaseconomistshavethepublicsattention,weseeanopportunity
toshareeconomicsprinciplesandtheeconomicwayofthinkinginaway
thatemphasizestheirrelevancetotodaysworld.Weuseapplicationsfrom
sports,politics,campuslife,currentevents,andotherfamiliarsettingsto
illustratethelinksbetweentheoreticalprinciplesandcommon
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experiences.Becauseoftheincreasinglyglobalnatureofeconomicactivity,
wealsorecognizetheneedforaclearandconsistentinternationalfocus
throughoutaneconomicstext.Inaddition,wehavetriedtoprovidea
senseoftheintellectualexcitementofthefieldandanappreciationforthe
gainsithasmade,aswellasanawarenessofthechallengesthatlieahead.
Toensurestudentsrealizethateconomicsisaunifieddisciplineandnota
bewilderingarrayofseeminglyunrelatedtopics,wedevelopthe
presentationofmicroeconomicsandofmacroeconomicsaround
integratingthemes.
Theintegratingthemeformicroeconomicsisthemarginaldecisionrule,a
simpleapproachtochoicesthatmaximizethevalueofsomeobjective.
Followingitspresentationinanearlymicroeconomicschapter,the
marginaldecisionrulebecomesanintegratingdevicethroughoutthe
discussionofmicroeconomics.Insteadofahodgepodgeofrulesfor
differentmarketconditions,wegiveasinglerulethatcanbeapplied
withinanymarketsetting.
Theintegratingthemeformacroeconomicsisthemodelofaggregate
demandandaggregatesupply.Followingitspresentationinanearly
macroeconomicschapter,thismodelallowsustolookatbothshort-run
andlong-runconceptsandtoaddressavarietyofpolicyissuesand
debates.
Recognizingthatacourseineconomicsmayseemdauntingtosome
students,wehavetriedtomakethewritingclearandengaging.Clarity
comesinpartfromtheintuitivepresentationstyle,butwehavealso
integratedanumberofpedagogicalfeaturesthatwebelievemakelearning
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economicconceptsandprincipleseasierandmorefun.Thesefeaturesare
verystudent-focused.
Thechaptersthemselvesarewrittenusingamodularformat.In
particular,chaptersgenerallyconsistofthreemaincontentsectionsthat
breakdownaparticulartopicintomanageableparts.Eachcontentsection
containsnotonlyanexpositionofthematerialathandbutalsolearning
objectives,summaries,examples,andproblems.Eachchapteris
introducedwithastorytomotivatethematerialandeachchapterends
withawrap-upandadditionalproblems.Ourgoalistoencourageactive
learningbyincludingmanyexamplesandmanyproblemsofdifferent
types.
Atourofthefeaturesavailableforeachchaptermaygiveabettersenseof
whatwemean:
StartUpChapterintroductionssetthestageforeachchapterwithanexamplethatwehopewillmotivatereaderstostudythematerialthat
follows.Theseessays,ontopicssuchasthevalueofacollegedegreeinthe
labormarketorhowpolicymakersreactedtoaparticulareconomic
recession,lendthemselvestothetypeofanalysisexplainedinthechapter.
Weoftenrefertotheseexampleslaterinthetexttodemonstratethelink
betweentheoryandreality.
LearningObjectivesThesesuccinctstatementsareguidestothecontentofeachsection.Instructorscanusethemasasnapshotoftheimportant
pointsofthesection.Aftercompletingthesection,studentscanreturnto
thelearningobjectivestocheckiftheyhavemasteredthematerial.
HeadsUp!Thesenotesthroughoutthetextwarnofcommonerrorsandexplainhowtoavoidmakingthem.Afterourcombinedteaching
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experienceofmorethanfiftyyears,wehaveseenthesamemistakesmade
bymanystudents.Thisfeatureprovidesadditionalclarificationandshows
studentshowtonavigatepossiblytreacherouswaters.
KeyTakeawaysThesestatementsreviewthemainpointscoveredineachcontentsection.
KeyTermsDefinedwithinthetext,studentscanreviewthemincontext,aprocessthatenhanceslearning.
TryIt!questionsTheseproblems,whichappearattheendofeachcontentsectionandwhichareansweredcompletelyinthetext,give
studentstheopportunitytobeactivelearners.Theyaredesignedtogive
studentsaclearsignalastowhethertheyunderstandthematerialbefore
theygoontothenexttopic.
CasesinPointTheseessaysincludedattheendofeachcontentsectionillustratetheinfluenceofeconomicforcesonrealissuesandrealpeople.
Unlikeothertextsthatuseboxedfeaturestopresentinterestingnew
materialornewspaperarticles,wehavewritteneachcaseourselvesto
integratethemmoreclearlywiththerestofthetext.
SummaryInafewparagraphs,theinformationpresentedinthechapterispulledtogetherinawaythatallowsforaquickreviewofthematerial.
End-of-chapterconceptandnumericalproblemsThesearebountifulandareintendedtocheckunderstanding,topromotediscussionoftheissues
raisedinthechapter,andtoengagestudentsincriticalthinkingaboutthe
material.Includedarenotonlygeneralreviewquestionstotestbasic
understandingbutalsoexamplesdrawnfromthenewsandfromresultsof
economicsresearch.Somehavestudentsworkingwithreal-worlddata.
ChapterquizzesEachchapteralsoincludesonline,supplementarymultiplechoicequestionsthatprovidestudentswithfeedbackonboth
correctandincorrectresponses.Theseprovideyetanotherwayfor
studentstotestthemselvesonthematerial.
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AdditionalMaterialforInstructors
TheauthorshavebeenpersonallyinvolvedinthegenerationofahugeTest
Bankthatincludesmultiplechoice,true/false,andshortessaysquestions.
Thesequestionsarescoredintermsoflevelofdifficultyandinclude
multiplewaysoftestingthematerial.
TheSolutionsManual,withwhichtheauthorswerealsoinvolved,contains
answersforallconceptandnumericalproblemsfoundattheendofeach
textchapter.
ThePowerPointSlidesincludealltheexhibitscontainedinthetexttoallow
easeofuseinclass.
Wehopethatuserswillfindthistextanengagingandenjoyablewayof
becomingacquaintedwitheconomicsprinciplesandthatmasteryofthe
materialwillleadtolookingattheworldinadeeperandmoremeaningful
way.Wewelcomeallfeedback.
LibbyRittenberg
TimothyTregarthen
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Chapter1
Economics:TheStudyofChoice
StartUp:EconomicsintheNews
2008seemedtobetheyearofeconomicnews.Fromtheworstfinancial
crisissincetheGreatDepressiontothepossibilityofaglobalrecession,to
gyratinggasolineandfoodprices,andtoplunginghousingprices,
economicquestionsweretheprimaryfactorsinthepresidentialcampaign
of2008anddominatedthenewsgenerally.
Whatcausesthepricesofsomegoodtorisewhilethepricesofsomeother
goodsfall?Pricedeterminationisoneofthethingsthatwewillstudyin
thisbook.Wewillalsoconsiderfactorsthatleadaneconomytofallintoa
recessionandtheattemptstolimitit.
Whiletheinvestigationoftheseproblemssurelyfallswithintheprovince
ofeconomics,economicsencompassesafarbroaderrangeofissues.
Ultimately,economicsisthestudyofchoice.Becausechoicesrangeover
everyimaginableaspectofhumanexperience,sodoeseconomics.
Economistshaveinvestigatedthenatureoffamilylife,thearts,education,
crime,sports,jobcreationthelistisvirtuallyendlessbecausesomuchof
ourlivesinvolvesmakingchoices.
Howdoindividualsmakechoices:Wouldyoulikebettergrades?More
timetorelax?Moretimewatchingmovies?Gettingbettergradesprobably
requiresmoretimestudying,andperhapslessrelaxationand
entertainment.Notonlymustwemakechoicesasindividuals,wemust
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makechoicesasasociety.Dowewantacleanerenvironment?Faster
economicgrowth?Bothmaybedesirable,buteffortstocleanupthe
environmentmayconflictwithfastereconomicgrowth.Societymustmake
choices.
Economicsisdefinedlessbythesubjectseconomistsinvestigatethanby
thewayinwhicheconomistsinvestigatethem.Economistshaveawayof
lookingattheworldthatdiffersfromthewayscholarsinotherdisciplines
lookattheworld.Itistheeconomicwayofthinking;thischapter
introducesthatwayofthinking.
1.1DefiningEconomics
LEARNINGOBJECTIVES
1. Defineeconomics.2. Explaintheconceptsofscarcityandopportunitycostandhowthey
relatetothedefinitionofeconomics.
3. Understandthethreefundamentaleconomicquestions:Whatshouldbeproduced?Howshouldgoodsandservicesbeproduced?For
whomshouldgoodsandservicesbeproduced?
Economicsisasocialsciencethatexamineshowpeoplechooseamongthe
alternativesavailabletothem.Itissocialbecauseitinvolvespeopleand
theirbehavior.Itisasciencebecauseituses,asmuchaspossible,a
scientificapproachinitsinvestigationofchoices.
Scarcity,Choice,andCost
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Allchoicesmeanthatonealternativeisselectedoveranother.Selecting
amongalternativesinvolvesthreeideascentraltoeconomics:scarcity,
choice,andopportunitycost.
Scarcity
Ourresourcesarelimited.Atanyonetime,wehaveonlysomuchland,so
manyfactories,somuchoil,somanypeople.Butourwants,ourdesiresfor
thethingsthatwecanproducewiththoseresources,areunlimited.We
wouldalwayslikemoreandbetterhousing,moreandbettereducation
moreandbetterofpracticallyeverything.
Ifourresourceswerealsounlimited,wecouldsayyestoeachofour
wantsandtherewouldbenoeconomics.Becauseourresourcesare
limited,wecannotsayyestoeverything.Tosayyestoonethingrequires
thatwesaynotoanother.Whetherwelikeitornot,wemustmake
choices.
Ourunlimitedwantsarecontinuallycollidingwiththelimitsofour
resources,forcingustopicksomeactivitiesandtorejectothers.Scarcityis
theconditionofhavingtochooseamongalternatives.Ascarcegoodisone
forwhichthechoiceofonealternativerequiresthatanotherbegivenup.
Consideraparcelofland.Theparcelpresentsuswithseveralalternative
uses.Wecouldbuildahouseonit.Wecouldputagasstationonit.We
couldcreateasmallparkonit.Wecouldleavethelandundevelopedin
ordertobeabletomakeadecisionlaterastohowitshouldbeused.
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Supposewehavedecidedthelandshouldbeusedforhousing.Shoulditbe
alargeandexpensivehouseorseveralmodestones?Supposeitistobea
largeandexpensivehouse.Whoshouldliveinthehouse?IftheLeeslivein
it,theNguyenscannot.Therearealternativeusesofthelandbothinthe
senseofthetypeofuseandalsointhesenseofwhogetstouseit.Thefact
thatlandisscarcemeansthatsocietymustmakechoicesconcerningits
use.
Virtuallyeverythingisscarce.Considertheairwebreathe,whichis
availableinhugequantityatnochargetous.Coulditpossiblybescarce?
Thetestofwhetherairisscarceiswhetherithasalternativeuses.What
usescanwemakeoftheair?Webreatheit.Wepolluteitwhenwedrive
ourcars,heatourhouses,oroperateourfactories.Ineffect,oneuseofthe
airisasagarbagedump.Wecertainlyneedtheairtobreathe.Butjustas
certainly,wechoosetodumpgarbageinit.Thosetwousesareclearly
alternativestoeachother.Themoregarbagewedumpintheair,theless
desirableandhealthyitwillbetobreathe.Ifwedecidewewantto
breathecleanerair,wemustlimittheactivitiesthatgeneratepollution.Air
isascarcegoodbecauseithasalternativeuses.
Notallgoods,however,confrontuswithsuchchoices.Afreegoodisone
forwhichthechoiceofoneusedoesnotrequirethatwegiveupanother.
Oneexampleofafreegoodisgravity.Thefactthatgravityisholdingyou
totheearthdoesnotmeanthatyourneighborisforcedtodriftupinto
space!Onepersonsuseofgravityisnotanalternativetoanotherpersons
use.
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Therearenotmanyfreegoods.Outerspace,forexample,wasafreegood
whentheonlyusewemadeofitwastogazeatit.Butnow,ouruseof
spacehasreachedthepointwhereoneusecanbeanalternativeto
another.Conflictshavealreadyarisenovertheallocationoforbitalslots
forcommunicationssatellites.Thus,evenpartsofouterspacearescarce.
Spacewillsurelybecomemorescarceaswefindnewwaystouseit.
Scarcitycharacterizesvirtuallyeverything.Consequently,thescopeof
economicsiswideindeed.
ScarcityandtheFundamentalEconomicQuestions
Thechoicesweconfrontasaresultofscarcityraisethreesetsofissues.
Everyeconomymustanswerthefollowingquestions:
1. Whatshouldbeproduced?Usingtheeconomysscarceresourcestoproduceonethingrequiresgivingupanother.Producingbettereducation,
forexample,mayrequirecuttingbackonotherservices,suchashealth
care.Adecisiontopreserveawildernessarearequiresgivingupother
usesoftheland.Everysocietymustdecidewhatitwillproducewithits
scarceresources.
2. Howshouldgoodsandservicesbeproduced?Thereareallsortsofchoicestobemadeindetermininghowgoodsandservicesshouldbe
produced.Shouldafirmemployafewskilledoralotofunskilledworkers?
Shoulditproduceinitsowncountryorshouldituseforeignplants?
Shouldmanufacturingfirmsuseneworrecycledrawmaterialstomake
theirproducts?
3. Forwhomshouldgoodsandservicesbeproduced?Ifagoodorserviceisproduced,adecisionmustbemadeaboutwhowillgetit.Adecisionto
haveonepersonorgroupreceiveagoodorserviceusuallymeansitwill
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notbeavailabletosomeoneelse.Forexample,representativesofthe
poorestnationsonearthoftencomplainthatenergyconsumptionper
personintheUnitedStatesis17timesgreaterthanenergyconsumption
perpersonintheworlds62poorestcountries.Criticsarguethatthe
worldsenergyshouldbemoreevenlyallocated.Shouldit?Thatisafor
whomquestion.
Everyeconomymustdeterminewhatshouldbeproduced,howitshould
beproduced,andforwhomitshouldbeproduced.Weshallreturntothese
questionsagainandagain.
OpportunityCost
Itiswithinthecontextofscarcitythateconomistsdefinewhatisperhaps
themostimportantconceptinallofeconomics,theconceptofopportunity
cost.Opportunitycostisthevalueofthebestalternativeforgoneinmaking
anychoice.
Theopportunitycosttoyouofreadingtheremainderofthischapterwill
bethevalueofthebestotherusetowhichyoucouldhaveputyourtime.If
youchoosetospend$20onapottedplant,youhavesimultaneously
chosentogiveupthebenefitsofspendingthe$20onpizzasora
paperbackbookoranightatthemovies.Ifthebookisthemostvaluableof
thosealternatives,thentheopportunitycostoftheplantisthevalueofthe
enjoymentyouotherwiseexpectedtoreceivefromthebook.
Theconceptofopportunitycostmustnotbeconfusedwiththepurchase
priceofanitem.Considerthecostofacollegeoruniversityeducation.That
includesthevalueofthebestalternativeuseofmoneyspentfortuition,
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fees,andbooks.Butthemostimportantcostofacollegeeducationisthe
valueoftheforgonealternativeusesoftimespentstudyingandattending
classinsteadofusingthetimeinsomeotherendeavor.Studentssacrifice
thattimeinhopesofevengreaterearningsinthefutureorbecausethey
placeavalueontheopportunitytolearn.Orconsiderthecostofgoingto
thedoctor.Partofthatcostisthevalueofthebestalternativeuseofthe
moneyrequiredtoseethedoctor.But,thecostalsoincludesthevalueof
thebestalternativeuseofthetimerequiredtoseethedoctor.The
essentialthingtoseeintheconceptofopportunitycostisfoundinthe
nameoftheconcept.Opportunitycostisthevalueofthebestopportunity
forgoneinaparticularchoice.Itisnotsimplytheamountspentonthat
choice.
Theconceptsofscarcity,choice,andopportunitycostareattheheartof
economics.Agoodisscarceifthechoiceofonealternativerequiresthat
anotherbegivenup.Theexistenceofalternativeusesforcesustomake
choices.Theopportunitycostofanychoiceisthevalueofthebest
alternativeforgoneinmakingit.
KEYTAKEAWAYS
Economicsisasocialsciencethatexamineshowpeoplechooseamongthealternativesavailabletothem.
Scarcityimpliesthatwemustgiveuponealternativeinselectinganother.Agoodthatisnotscarceisafreegood.
Thethreefundamentaleconomicquestionsare:Whatshouldbeproduced?Howshouldgoodsandservicesbeproduced?Forwhom
shouldgoodsandservicesbeproduced?
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Everychoicehasanopportunitycostandopportunitycostsaffectthechoicespeoplemake.Theopportunitycostofanychoiceisthevalue
ofthebestalternativethathadtobeforgoneinmakingthatchoice.
TRYIT!
Identifytheelementsofscarcity,choice,andopportunitycostineach
ofthefollowing:
1. TheEnvironmentalProtectionAgencyisconsideringanorderthata500-acreareaontheoutskirtsofalargecitybepreservedinits
naturalstate,becausetheareaishometoarodentthatisconsidered
anendangeredspecies.Developershadplannedtobuildahousing
developmentontheland.
2. Themanagerofanautomobileassemblyplantisconsideringwhethertoproducecarsorsportutilityvehicles(SUVs)nextmonth.Assume
thatthequantitiesoflaborandothermaterialsrequiredwouldbethe
sameforeithertypeofproduction.
3. Ayoungmanwhowenttoworkasanursesaideaftergraduatingfromhighschoolleaveshisjobtogotocollege,wherehewillobtain
trainingasaregisterednurse.
CaseinPoint:TheRisingCostofEnergyOilisanexhaustibleresource.Theoilweburntodaywillnotbeavailable
foruseinthefuture.Partoftheopportunitycostofourconsumptionofgoodssuchasgasolinethatareproducedfromoilincludesthevalue
peopleinthefuturemighthaveplacedonoilweusetoday.
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Itappearsthatthecostofouruseofoilmayberising.Wehavebeenusing
lightcrude,theoilfoundinthegroundindepositsthatcanbereadily
tapped.Aslightcrudebecomesmorescarce,theworldmayneedtoturnto
so-calledheavycrude,thecrudeoilthatisfoundinthesandysoilof
placessuchasCanadaandVenezuela.Thatoilexistsinsuchabundance
thatitpropelsVenezuelatothetopoftheworldlistofavailableoil.Saudi
Arabiamovestothesecondposition;Canadaisthird.
Thedifficultywiththeoilmixedinthesandisthatextractingitisfarmore
costlythanlightcrude,bothintermsoftheexpendituresrequiredandin
termsoftheenvironmentaldamagethatminingitcreates.Northern
Alberta,inCanada,boastsaFlorida-sizedareawhosesandysoilsarerich
incrudeoil.Someofthatoilis1,200feetunderground.Extractingit
requirespumpingsteamintotheoilysandandthenpumpingupthe
resultantoilysyrup.Thatsyrupisthenplacedintohuge,industrial-sized
washingmachinesthatseparatecrudeoil.Whatisleftoveristoxicandwill
beplacedinhugelakesthatarebeingcreatedbydiggingpitsintheground
200feetdeep.Theoilproducedfromthesesandshasbecomeimportant
AlbertaisthelargestforeignsupplierofoiltotheUnitedStates.
Sandsthatareclosertothesurfaceareremovedbybulldozersandgiant
cranes;theforestoveritisclearedaway.Theoilysandisthenhauledoffin
two-storydumptruckswhich,whenfilled,weighmorethanaBoeing747.
TotalSA,aFrenchcompany,isleadingtheracetodevelopCanadasoil.
JeanLuc-Guiziou,thepresidentofTotalSAsCanadianoperations,says
thattheextraordinarilycostlyprocessofextractingheavycrudeis
somethingtheworldisgoingtohavetogetusedto.Thelightcrude
undiscoveredtodayisgettingscarcerandscarcer,hetoldTheWallStreet
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Journal.Wehavetoaccepttherealityofgeoscience,whichisthatthenext
generationofoilresourceswillbeheavier.
Already,TotalSAhasclear-cutthousandsofacresofforestlandinorderto
gainaccesstotheoilysandbelow.Theprocessofextractingheavycrude
oilcoststhecompany$25abarrelcomparedtothe$6perbarrelcostof
extractingandrefininglightcrude.Extractingheavycrudegeneratesthree
timesasmuchgreenhousegasperbarrelasdoeslightcrude.By2015,Fort
McMurray,thesmall(population61,000)townthathasbecomethe
headquartersofNorthernAlbertascrudeoilboom,willemitmore
greenhousegasthantheentirecountryofDenmark(population5.4
million).CanadawillexceeditsgreenhousegasquotasetbytheKyoto
Accordsaninternationaltreatyaimedatlimitingglobalwarming
largelyasaresultofdevelopingitsheavycrudedeposits.
Nooneevenconsideredtheextractionofheavycrudewhenlightcrude
wascheap.Inthelate1990s,oilcostjust$12perbarrel,anddepositsof
heavycrudesuchasthoseinCanadaattractedlittleattention.Bymid-
2006,oilsoldformorethan$70perbarrel,andCanadasheavycrudewas
suddenlyahotcommodity.Itmovedfrombeingjustaninteresting
experimentinnorthernCanadatoreallythisisthefuturesourceofoil
supply,GregStringhamoftheCanadianAssociationofPetroleum
ProducerstoldAlJazeera.
Albertasenergyminister,GregMelchin,defendstheprovincesdecisionto
proceedwiththeexploitationofitsoilysand.Thereisacosttoit,butthe
benefitsaresubstantiallygreater,heinsists.
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Noteveryoneagrees.GeorgePoitras,amemberoftheMikisewCreetribe,
livesdownstreamfromtheoilsandsdevelopment.Youseealotofthe
landdugup,alotoftheborealforeststruckdownanditsupsetting,itfills
mewithrage,hesays.DianaGibsonoftheParklandInstitute,an
environmentaladvocacygroup,saysthatyoucanseetheenvironmental
damagegeneratedbytheextractionofoilsandsaroundFortMcMurray
fromthemoon.Whatwearegoingtobehavingisdestructionofvery,
veryvaluableecosystems,andpermanentpollution,shesays.
Sources:AlbertasHeavyOilBurden,AlJazeeraEnglish,March17,2008
(seeenglish.aljazeera.net);andRussellGold,AsPricesSurge,OilGiants
TurnSludgeintoGold,TheWallStreetJournalOnline,March27,2006,A1.
ANSWERSTOTRYIT!PROBLEMS
1. The500-acreareaisscarcebecauseithasalternativeuses:preservationinitsnaturalstateorasiteforhomes.Achoicemustbe
madebetweentheseuses.Theopportunitycostofpreservingthe
landinitsnaturalstateistheforgonevalueofthelandasahousing
development.Theopportunitycostofusingthelandasahousing
developmentistheforgonevalueofpreservingtheland.
2. Thescarceresourcesaretheplantandthelaborattheplant.ThemanagermustchoosebetweenproducingcarsandproducingSUVs.
Theopportunitycostofproducingcarsistheprofitthatcouldbe
earnedfromproducingSUVs;theopportunitycostofproducingSUVs
istheprofitthatcouldbeearnedfromproducingcars.
3. Themancandevotehistimetohiscurrentcareerortoaneducation;histimeisascarceresource.Hemustchoosebetweenthese
alternatives.Theopportunitycostofcontinuingasanursesaideis
theforgonebenefitheexpectsfromtrainingasaregisterednurse;the
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opportunitycostofgoingtocollegeistheforgoneincomehecould
haveearnedworkingfull-timeasanursesaide.
1.2TheFieldofEconomics
LEARNINGOBJECTIVES
1. Explainthedistinguishingcharacteristicsoftheeconomicwayofthinking.
2. Distinguishbetweenmicroeconomicsandmacroeconomics.Wehaveexaminedthebasicconceptsofscarcity,choice,andopportunity
costineconomics.Inthissection,wewilllookateconomicsasafieldof
study.Webeginwiththecharacteristicsthatdistinguisheconomicsfrom
othersocialsciences.
TheEconomicWayofThinking
Economistsstudychoicesthatscarcityrequiresustomake.Thisfactisnot
whatdistinguisheseconomicsfromothersocialsciences;allsocial
scientistsareinterestedinchoices.Ananthropologistmightstudythe
choicesofancientpeoples;apoliticalscientistmightstudythechoicesof
legislatures;apsychologistmightstudyhowpeoplechooseamate;a
sociologistmightstudythefactorsthathaveledtoariseinsingle-parent
households.Economistsstudysuchquestionsaswell.Whatisitaboutthe
studyofchoicesbyeconomiststhatmakeseconomicsdifferentfromthese
othersocialsciences?
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Threefeaturesdistinguishtheeconomicapproachtochoicefromthe
approachestakeninothersocialsciences:
1. Economistsgivespecialemphasistotheroleofopportunitycostsintheiranalysisofchoices.
2. Economistsassumethatindividualsmakechoicesthatseektomaximizethevalueofsomeobjective,andthattheydefinetheirobjectivesinterms
oftheirownself-interest.
3. Individualsmaximizebydecidingwhethertodoalittlemoreoralittlelessofsomething.Economistsarguethatindividualspayattentiontothe
consequencesofsmallchangesinthelevelsoftheactivitiestheypursue.
Theemphasiseconomistsplaceonopportunitycost,theideathatpeople
makechoicesthatmaximizethevalueofobjectivesthatservetheirself-
interest,andafocusontheeffectsofsmallchangesareideasofgreat
power.Theyconstitutethecoreofeconomicthinking.Thenextthree
sectionsexaminetheseideasingreaterdetail.
OpportunityCostsAreImportant
Ifdoingonethingrequiresgivingupanother,thentheexpectedbenefitsof
thealternativeswefacewillaffecttheoneswechoose.Economistsargue
thatanunderstandingofopportunitycostiscrucialtotheexaminationof
choices.
Asthesetofavailablealternativeschanges,weexpectthatthechoices
individualsmakewillchange.Arainydaycouldchangetheopportunity
costofreadingagoodbook;wemightexpectmorereadingtogetdonein
badthaningoodweather.Ahighincomecanmakeitverycostlytotakea
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dayoff;wemightexpecthighlypaidindividualstoworkmorehoursthan
thosewhoarenotpaidaswell.Ifindividualsaremaximizingtheirlevelof
satisfactionandfirmsaremaximizingprofits,thenachangeinthesetof
alternativestheyfacemayaffecttheirchoicesinapredictableway.
Theemphasisonopportunitycostsisanemphasisontheexaminationof
alternatives.Onebenefitoftheeconomicwayofthinkingisthatitpushes
ustothinkaboutthevalueofalternativesineachprobleminvolving
choice.
IndividualsMaximizeinPursuingSelf-Interest
Whatmotivatespeopleastheymakechoices?Perhapsmorethananything
else,itistheeconomistsanswertothisquestionthatdistinguishes
economicsfromotherfields.
Economistsassumethatindividualsmakechoicesthattheyexpectwill
createthemaximumvalueofsomeobjective,giventheconstraintstheyface.Furthermore,economistsassumethatpeoplesobjectiveswillbe
thosethatservetheirownself-interest.
Economistsassume,forexample,thattheownersofbusinessfirmsseekto
maximizeprofit.Giventheassumedgoalofprofitmaximization,
economistscanpredicthowfirmsinanindustrywillrespondtochangesin
themarketsinwhichtheyoperate.AslaborcostsintheUnitedStatesrise,forexample,economistsarenotsurprisedtoseefirmsmovingsomeof
theirmanufacturingoperationsoverseas.
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Similarly,economistsassumethatmaximizingbehaviorisatworkwhen
theyexaminethebehaviorofconsumers.Instudyingconsumers,
economistsassumethatindividualconsumersmakechoicesaimedat
maximizingtheirlevelofsatisfaction.Inthenextchapter,wewilllookat
theresultsoftheshiftfromskiingtosnowboarding;thatisashiftthat
reflectsthepursuitofself-interestbyconsumersandbymanufacturers.
Inassumingthatpeoplepursuetheirself-interest,economistsarenot
assumingpeopleareselfish.Peopleclearlygainsatisfactionbyhelping
others,assuggestedbythelargecharitablecontributionspeoplemake.
Pursuingonesownself-interestmeanspursuingthethingsthatgiveone
satisfaction.Itneednotimplygreedorselfishness.
ChoicesAreMadeattheMargin
Economistsarguethatmostchoicesaremadeatthemargin.
Themarginisthecurrentlevelofanactivity.Thinkofitastheedgefrom
whichachoiceistobemade.Achoiceatthemarginisadecisiontodoalittlemoreoralittlelessofsomething.
Assessingchoicesatthemargincanleadtoextremelyusefulinsights.
Consider,forexample,theproblemofcurtailingwaterconsumptionwhen
theamountofwateravailablefallsshortoftheamountpeoplenowuse.
Economistsarguethatonewaytoinducepeopletoconservewateristo
raiseitsprice.Acommonresponsetothisrecommendationisthatahigherpricewouldhavenoeffectonwaterconsumption,becausewaterisa
necessity.Manypeopleassertthatpricesdonotaffectwaterconsumption
becausepeopleneedwater.
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Butchoicesinwaterconsumption,likevirtuallyallchoices,aremadeatthe
margin.Individualsdonotmakechoicesaboutwhethertheyshouldor
shouldnotconsumewater.Rather,theydecidewhethertoconsumealittle
moreoralittlelesswater.HouseholdwaterconsumptionintheUnited
Statestotalsabout105gallonsperpersonperday.Thinkofthatstarting
pointastheedgefromwhichachoiceatthemargininwaterconsumption
ismade.Couldahigherpricecauseyoutouselesswaterbrushingyour
teeth,takeshortershowers,orwateryourlawnless?Couldahigherprice
causepeopletoreducetheiruse,say,to104gallonsperpersonperday?
To103?Whenweexaminethechoicetoconsumewateratthemargin,the
notionthatahigherpricewouldreduceconsumptionseemsmuchmore
plausible.Pricesaffectourconsumptionofwaterbecausechoicesinwater
consumption,likeotherchoices,aremadeatthemargin.
Theelementsofopportunitycost,maximization,andchoicesatthemargin
canbefoundineachoftwobroadareasofeconomicanalysis:
microeconomicsandmacroeconomics.Youreconomicscourse,for
example,maybedesignatedasamicroorasamacrocourse.Wewill
lookatthesetwoareasofeconomicthoughtinthenextsection.
MicroeconomicsandMacroeconomics
Thefieldofeconomicsistypicallydividedintotwobroadrealms:
microeconomicsandmacroeconomics.Itisimportanttoseethe
distinctionsbetweenthesebroadareasofstudy.
Microeconomicsisthebranchofeconomicsthatfocusesonthechoices
madebyindividualdecision-makingunitsintheeconomytypically
consumersandfirmsandtheimpactsthosechoiceshaveonindividual
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markets.Macroeconomicsisthebranchofeconomicsthatfocusesonthe
impactofchoicesonthetotal,oraggregate,levelofeconomicactivity.
Whydoticketstothebestconcertscostsomuch?Howdoesthethreatof
globalwarmingaffectrealestatepricesincoastalareas?Whydowomen
endupdoingmostofthehousework?Whydoseniorcitizensgetdiscounts
onpublictransitsystems?Thesequestionsaregenerallyregardedas
microeconomicbecausetheyfocusonindividualunitsormarketsinthe
economy.
Isthetotallevelofeconomicactivityrisingorfalling?Istherateof
inflationincreasingordecreasing?Whatishappeningtothe
unemploymentrate?Thesearequestionsthatdealwithaggregates,or
totals,intheeconomy;theyareproblemsofmacroeconomics.The
questionaboutthelevelofeconomicactivity,forexample,referstothe
totalvalueofallgoodsandservicesproducedintheeconomy.Inflationisa
measureoftherateofchangeintheaveragepricelevelfortheentire
economy;itisamacroeconomicproblem.Thetotallevelsofemployment
andunemploymentintheeconomyrepresenttheaggregateofalllabor
markets;unemploymentisalsoatopicofmacroeconomics.
Bothmicroeconomicsandmacroeconomicsgiveattentiontoindividual
markets.Butinmicroeconomicsthatattentionisanendinitself;in
macroeconomicsitisaimedatexplainingthemovementofmajor
economicaggregatestheleveloftotaloutput,thelevelofemployment,
andthepricelevel.
Wehavenowexaminedthecharacteristicsthatdefinetheeconomicwayof
thinkingandthetwobranchesofthiswayofthinking:microeconomics
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andmacroeconomics.Inthenextsection,wewillhavealookatwhatone
candowithtrainingineconomics.
PuttingEconomicstoWork
Economicsisonewayoflookingattheworld.Becausetheeconomicway
ofthinkinghasprovenquiteuseful,trainingineconomicscanbeputto
workinawiderangeoffields.One,ofcourse,isinworkasaneconomist.
Undergraduateworkineconomicscanbeappliedtoothercareersaswell.
CareersinEconomics
Economistsworkinthreetypesoforganizations.About58%ofeconomists
workforgovernmentagencies.[1]Theremainderworkforbusinessfirms
orincollegesanduniversities.
Economistsworkingforbusinessfirmsandgovernmentagencies
sometimesforecasteconomicactivitytoassisttheiremployersinplanning.
Theyalsoapplyeconomicanalysistotheactivitiesofthefirmsoragencies
forwhichtheyworkorconsult.Economistsemployedatcollegesand
universitiesteachandconductresearch.
Perusethewebsiteofyourcollegeoruniversityseconomicsdepartment.
Chancesarethedepartmentwilldiscussthewidevarietyofoccupations
thattheireconomicsmajorsenter.Unlikeengineeringandaccountingmajors,economicsandothersocialsciencemajorstendtobedistributed
overabroadrangeofoccupations.
ApplyingEconomicstoOtherFields
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Supposethatyouareconsideringsomethingotherthanacareerin
economics.Wouldchoosingtostudyeconomicshelpyou?
Theevidencesuggestsitmay.Suppose,forexample,thatyouare
consideringlawschool.Thestudyoflawrequireskeenanalyticalskills;
studyingeconomicssharpenssuchskills.Economistshavetraditionally
arguedthatundergraduateworkineconomicsservesasexcellent
preparationforlawschool.EconomistMichaelNieswiadomyofthe
UniversityofNorthTexascollecteddataonLawSchoolAdmittanceTest
(LSAT)scoresforundergraduatemajorslistedby2,200ormorestudents
takingthetestin2003.Table1.1"LSATScoresandUndergraduate
Majors"givesthescores,aswellastherankingforeachofthesemajors,in
2003andintwopreviousyearsinwhichtherankingswerecompiled.In
rankingsforallthreeyears,economicsmajorsrecordedthehighestscores.
Table 1.1 LSAT Scores and Undergraduate Majors
MajorfieldLSATaverage20032004
20032004Rank
19941995Rank
19911992Rank
Economics 156.6 1 1 1
Engineering 155.4 2 4 2
History 155.0 3 2 3
English 154.3 4 3 4
Finance 152.6 5 6 5
Politicalscience 152.1 6 9 9
Psychology 152.1 7 7 8
Accounting 151.1 8 8 6
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MajorfieldLSATaverage20032004
20032004Rank
19941995Rank
19911992Rank
Communications 150.5 9 10 10
Sociology 150.2 10 12 13
Bus.Administration 149.6 11 13 12
CriminalJustice 144.7 12 14 14
HerearetheaverageLSATscoresandrankingsforthe12undergraduate
majorswithmorethan2200studentstakingthetesttoenterlawschoolin
the20032004academicyear.
Source:MichaelNieswiadomy,LSATScoresofEconomicsMajors:2003
2004ClassUpdate,JournalofEconomicEducation,37(2)(Spring2006):
244247andMichaelNieswiadomy,LSATScoresofEconomics
MajorsJournalofEconomicEducation,29(4)(Fall1998):377379.
Didthestrongperformancebyeconomics,engineering,andhistorymajors
meanthattraininginthosefieldssharpensanalyticalskillstestedinthe
LSAT,orthatstudentswithgoodanalyticalskillsaremorelikelytomajor
inthem?Bothfactorswereprobablyatwork.Economicsclearlyattracts
studentswithgoodanalyticalskillsandstudyingeconomicshelps
developthoseskills.
Economicsmajorsshineinotherareasaswell.AccordingtotheBureauof
LaborStatisticsOccupationalOutlookHandbook,astrongbackgroundin
economictheory,mathematics,andstatisticsprovidesthebasisfor
competingforthebestjobopportunities,particularlyresearchassistant
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positions,inabroadrangeoffields.Manygraduateswithbachelors
degreeswillfindgoodjobsinindustryandbusinessasmanagementor
salestraineesorasadministrativeassistants.Becauseeconomistsare
concernedwithunderstandingandinterpretingfinancialmatters,among
othersubjects,theywillalsobeattractedtoandqualifiedforjobsas
financialmanagers,financialanalysts,underwriters,actuaries,securities
andfinancialservicessalesworkers,creditanalysts,loanandbudget
officers,andurbanandregionalplanners.
Table1.2"AverageYearlySalaryOffers,May2006andOccupational
Outlook20042014,SelectedMajors/Occupations"showsaverageyearly
salaryoffersforbachelordegreecandidatesforMay2006andtheoutlook
forrelatedoccupationsto2014.
Table1.2AverageYearlySalaryOffers,May2006andOccupational
Outlook20042014,SelectedMajors/Occupations
Undergraduatemajor
Average$
OfferMay,2006
Projected%Changein
TotalEmploymentinOccupation20042014
ComputerEngineering $54,200 10.1
Electrical/ElectronicEngineering 54,053 11.8
ComputerScience 50,892 25.6
Accounting 46,188 22.4
EconomicsandFinance 45,058 12.4
ManagementInformationSystems 44,755 25.9
LogisticsandMaterialsManagement 43,426 13.2
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Undergraduatemajor
Average$OfferMay,2006
Projected%ChangeinTotalEmploymentinOccupation20042014
BusinessAdministration 40,976 17.0
EnvironmentalSciences(includingforestryandconservationscience) 39,750 6.3
OtherBusinessMajors(e.g.,Marketing) 37,446 20.8
HumanResources(incl.LaborRelations) 36,256 15.9
GeologyandGeologicalSciences 35,034 8.3
Sociology 33,752 4.7
PoliticalScience/Government 33,151 7.3
LiberalArts&Sciences(generalstudies) 32,627 na
PublicRelations 32,623 21.7
SpecialEducation 31,817 23.3
ElementaryEducation 31,778 18.2
ForeignLanguages 31,364 na
Letters(incl.English) 31,204 20.4
OtherSocialSciences
(IncludingCriminalJusticeandHistory) 30,788 12.3
Psychology 30,308 9.9
Pre-elementaryEducation 27,550 22.4
SocialWork 25,865 19.6
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Undergraduatemajor
Average$OfferMay,2006
Projected%ChangeinTotalEmploymentinOccupation20042014
VisualandPerformingArts 21,726 15.2
Sources:NationalAssociationofCollegesandEmployers,SalarySurvey,
Spring2006http://naceweb.org;BureauofLaborStatistics,20062007
editionoftheOccupationalOutlookHandbook;OccupationalEmployment,
Training,andEarnings:EducationalLevelReport(May,2006)
URL:http://data.bls.gov/oep/noeted/empoptd.jsp(note:na=not
reported;thatis,nospecificoccupationwasreportedinBLSreport;Other
businessmajors,Othersocialsciences,Socialwork(includingSociology),andEnvironmentalSciencesareweightedaveragesofvariousdisciplines,
calculatedbyauthors.)
Oneschoiceofamajor,orminor,isnotlikelytobebasedsolelyon
considerationsofpotentialearningsortheprospectoflandingaspotin
lawschool.Youwillalsoconsideryourinterestsandabilitiesinmakinga
decisionaboutwhethertopursuefurtherstudyineconomics.And,of
course,youwillconsidertheexpectedbenefitsofalternativecoursesof
study.Whatisyouropportunitycostofpursuingstudyofeconomics?Does
studyingmoreeconomicsserveyourinterestsandwilldoingsomaximize
yoursatisfactionlevel?Theseconsiderationsmaybeonyourmindasyou
begintostudyeconomicsatthecollegelevelandobviouslystudentswill
makemanydifferentchoices.But,shouldyoudecidetopursueamajoror
minorineconomics,youshouldknowthatabackgroundinthisfieldis
likelytoserveyouwellinawiderangeofcareers.
KEYTAKEAWAYS
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Economistsfocusontheopportunitycostsofchoices,theyassumethatindividualsmakechoicesinawaythatmaximizesthevalueofan
objectivedefinedintermsoftheirownself-interest,andtheyassume
thatindividualsmakethosechoicesatthemargin. Economicsisdividedintotwobroadareas:microeconomicsand
macroeconomics.
Awiderangeofcareeropportunitiesisopentoeconomicsmajors.Empiricalevidencesuggeststhatstudentswhoenterthejobmarket
withamajorineconomicstendtoearnmorethandostudentsin
mostothermajors.Further,economicsmajorsdoparticularlywellon
theLSAT.
TRYIT!
TheDepartmentofAgricultureestimatedthattheexpendituresa
middle-income,husbandwifefamilyofthreewouldincurtoraiseone
additionalchildfrombirthin2005toage17wouldbe$250,530.In
whatwaydoesthisestimateillustratetheeconomicwayofthinking?
WouldtheDepartmentsestimatebeanexampleofmicroeconomic
orofmacroeconomicanalysis?Why?
CaseinPoint:TheFinancialPayoffto
StudyingEconomicsCollegeeconomicsprofessorshavelongarguedthatstudyingeconomicsis
goodpreparationforavarietyofcareers.Arecentstudysuggeststheyare
rightandthatstudyingeconomicsisevenlikelytomakestudentsmore
prosperous.Studentswhomajorineconomicsbutdidnotpursuegraduate
workarelikelytoearnmorethanstudentsinvirtuallyeveryothercollege
major.Studentswhomajorineconomicsandthengoontolawschoolor
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anMBAprogramarelikelytoearnmorethanstudentswhoapproach
thoseareasofstudyhavingmajoredinmostotherareas.
EconomistsDanA.Black,SethSanders,andLowellTaylorusedthe1993
NationalSurveyofCollegeGraduates,whichincludedmorethan86,000
college-educatedworkersbetweentheagesof25and55thataskedwhat
fieldtheyhadmajoredin.Theythencontrolledforvariablessuchas
gender,race,andethnicity.Theyfoundthatstudentswhohadnotdone
graduateworkandhadmajoredineconomicsearnedmorethanstudents
inanyothermajorexceptengineering.Specifically,economicsmajors
earnedabout13%morethanothersocialsciencesmajors,11%morethan
businessadministrationmajors,andaboutthesameasnaturalscienceand
accountingmajors.Theeconomicsmajorsintheirsurvey,likethosewho
majoredinothersocialsciencesandbusinessadministrationandunlike
thosewhomajoredinengineeringoraccounting,werespreadoutovera
widerangeofoccupationsbutwithmanyinmanagementpositions.
Basedonthesurveytheyused,over40%ofeconomicsmajorswentonto
earngraduatedegrees,manyinlawandbusiness.Economicsmajors
rankedfirstintermsofwages,ascomparedtootherlawschoolgraduates
withthe12mostcommonpre-lawmajors(includingsuchmajorsas
businessadministration,finance,English,history,psychology,andpolitical
science).MBAgraduateswhohadmajoredineconomicsearnedmorethan
thosewhohadmajoredinanyotherfieldexceptchemicalengineering.
Specifically,undergraduateeconomicsmajorswithMBAsearnedabout
15%morethanthosewhohadmajoredinotherdisciplinesrepresentedin
thesurvey,includingbusiness-relatedmajors.
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Itisremarkablethatallofthebusiness-relatedmajorsgeneratedsalaries
muchlowerthanthoseearnedbyeconomicsmajorswithanMBA.One
couldarguethatthisreflectsself-selection;thatstudentswhomajorin
economicsaresimplybrighter.But,studentswhomajorinphysicshave
highSATscores,yetthey,too,earnedwagesthatwereabout20%lower
thanMBAstudentswhohadmajoredineconomics.Thisfindinglends
somecredencetothenotionthatthemarketplacerewardstraininginthe
economicwayofthinking.
Source:DanA.Black,SethSanders,andLowellTaylor,TheEconomic
RewardforStudyingEconomics,EconomicInquiry,41(3),July2003,365
377.
ANSWERTOTRYIT!PROBLEM
Theinformationgivensuggestsoneelementoftheeconomicwayof
thinking:assessingthechoiceatthemargin.Theestimatereflectsthe
costofonemorechildforafamilythatalreadyhasone.Itisnotclear
fromtheinformationgivenhowclosetheestimateofcostcomesto
theeconomicconceptofopportunitycost.TheDepartmentof
Agriculturesestimateincludedsuchcostsashousing,food,
transportation,clothing,healthcare,childcare,andeducation.An
economistwouldaddthevalueofthebestalternativeuseofthe
additionaltimethatwillberequiredforthechild.Ifthecoupleis
lookingfarahead,itmaywanttoconsidertheopportunitycostof
sendingachildtocollege.And,ifitislookingveryfarahead,itmay
wanttoconsiderthefactthatnearlyhalfofallparentsovertheageof
50supportatleastonechildovertheageof21.Thisisaproblemin
microeconomicanalysis,becauseitfocusesonthechoicesof
individualhouseholds.
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[1]BureauofLaborStatisticsOccupationalOutlookathttp://www.bls.gov/oco/.
1.3TheEconomistsToolKit
LEARNINGOBJECTIVES
1. Explainhoweconomiststesthypotheses,developeconomictheories,andusemodelsintheiranalyses.
2. Explainhowtheall-other-thingsunchanged(ceterisparibus)problemandthefallacyoffalsecauseaffectthetestingofeconomic
hypothesesandhoweconomiststrytoovercometheseproblems.3. Distinguishbetweennormativeandpositivestatements.
Economicsdiffersfromothersocialsciencesbecauseofitsemphasison
opportunitycost,theassumptionofmaximizationintermsofonesown
self-interest,andtheanalysisofchoicesatthemargin.Butcertainlymuch
ofthebasicmethodologyofeconomicsandmanyofitsdifficultiesare
commontoeverysocialscienceindeed,toeveryscience.Thissectionexplorestheapplicationofthescientificmethodtoeconomics.
Researchersoftenexaminerelationshipsbetweenvariables.Avariableis
somethingwhosevaluecanchange.Bycontrast,aconstantissomething
whosevaluedoesnotchange.Thespeedatwhichacaristravelingisan
exampleofavariable.Thenumberofminutesinanhourisanexampleofa
constant.
Researchisgenerallyconductedwithinaframeworkcalled
thescientificmethod,asystematicsetofproceduresthroughwhich
knowledgeiscreated.Inthescientificmethod,hypothesesaresuggested
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andthentested.Ahypothesisisanassertionofarelationshipbetweentwo
ormorevariablesthatcouldbeproventobefalse.Astatementisnota
hypothesisifnoconceivabletestcouldshowittobefalse.Thestatement
Plantslikesunshineisnotahypothesis;thereisnowaytotestwhether
plantslikesunshineornot,soitisimpossibletoprovethestatementfalse.
ThestatementIncreasedsolarradiationincreasestherateofplant
growthisahypothesis;experimentscouldbedonetoshowthe
relationshipbetweensolarradiationandplantgrowth.Ifsolarradiation
wereshowntobeunrelatedtoplantgrowthortoretardplantgrowth,
thenthehypothesiswouldbedemonstratedtobefalse.
Ifatestrevealsthataparticularhypothesisisfalse,thenthehypothesisis
rejectedormodified.Inthecaseofthehypothesisaboutsolarradiation
andplantgrowth,wewouldprobablyfindthatmoresunlightincreases
plantgrowthoversomerangebutthattoomuchcanactuallyretardplant
growth.Suchresultswouldleadustomodifyourhypothesisaboutthe
relationshipbetweensolarradiationandplantgrowth.
Ifthetestsofahypothesisyieldresultsconsistentwithit,thenfurther
testsareconducted.Ahypothesisthathasnotbeenrejectedafter
widespreadtestingandthatwinsgeneralacceptanceiscommonlycalled
atheory.Atheorythathasbeensubjectedtoevenmoretestingandthat
haswonvirtuallyuniversalacceptancebecomesalaw.Wewillexamine
twoeconomiclawsinthenexttwochapters.
Evenahypothesisthathasachievedthestatusofalawcannotbeproven
true.Thereisalwaysapossibilitythatsomeonemayfindacasethat
invalidatesthehypothesis.Thatpossibilitymeansthatnothingin
economics,orinanyothersocialscience,orinanyscience,canever
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beproventrue.Wecanhavegreatconfidenceinaparticularproposition,
butitisalwaysamistaketoassertthatitisproven.
ModelsinEconomics
Allscientificthoughtinvolvessimplificationsofreality.Therealworldis
fartoocomplexforthehumanmindorthemostpowerfulcomputerto
consider.Scientistsusemodelsinstead.Amodelisasetofsimplifying
assumptionsaboutsomeaspectoftherealworld.Modelsarealwaysbased
onassumedconditionsthataresimplerthanthoseoftherealworld,
assumptionsthatarenecessarilyfalse.Amodeloftherealworld
cannotbetherealworld.
WewillencounteraneconomicmodelinChapter2"ConfrontingScarcity:
ChoicesinProduction".Forthatmodel,wewillassumethataneconomy
canproduceonlytwogoods.Thenwewillexplorethemodelofdemand
andsupply.Oneoftheassumptionswewillmakethereisthatallthegoods
producedbyfirmsinaparticularmarketareidentical.Ofcourse,real
economiesandrealmarketsarenotthatsimple.Realityisneverassimple
asamodel;onepointofamodelistosimplifytheworldtoimproveour
understandingofit.
Economistsoftenusegraphstorepresenteconomicmodels.Theappendix
tothischapterprovidesaquick,refreshercourse,ifyouthinkyouneed
one,onunderstanding,building,andusinggraphs.
Modelsineconomicsalsohelpustogeneratehypothesesaboutthereal
world.Inthenextsection,wewillexaminesomeoftheproblemswe
encounterintestingthosehypotheses.
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TestingHypothesesinEconomics
Hereisahypothesissuggestedbythemodelofdemandandsupply:an
increaseinthepriceofgasolinewillreducethequantityofgasoline
consumersdemand.Howmightwetestsuchahypothesis?
Economiststrytotesthypothesessuchasthisonebyobservingactual
behaviorandusingempirical(thatis,real-world)data.Theaverageretail
priceofgasolineintheUnitedStatesrosefromanaverageof$2.12per
gallononMay22,2005to$2.88pergallononMay22,2006.Thenumber
ofgallonsofgasolineconsumedbyU.S.motoristsrose0.3%duringthat
period.
Thesmallincreaseinthequantityofgasolineconsumedbymotoristsasits
priceroseisinconsistentwiththehypothesisthatanincreasedpricewill
leadtoanreductioninthequantitydemanded.Doesthatmeanthatwe
shoulddismisstheoriginalhypothesis?Onthecontrary,wemustbe
cautiousinassessingthisevidence.Severalproblemsexistininterpreting
anysetofeconomicdata.Oneproblemisthatseveralthingsmaybe
changingatonce;anotheristhattheinitialeventmaybeunrelatedtothe
eventthatfollows.Thenexttwosectionsexaminetheseproblemsindetail.
TheAll-Other-Things-UnchangedProblem
Thehypothesisthatanincreaseinthepriceofgasolineproducesa
reductioninthequantitydemandedbyconsumerscarrieswithitthe
assumptionthattherearenootherchangesthatmightalsoaffect
consumerdemand.Abetterstatementofthehypothesiswouldbe:An
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increaseinthepriceofgasolinewillreducethequantityconsumers
demand,ceterisparibus.CeterisparibusisaLatinphrasethatmeansall
otherthingsunchanged.
ButthingschangedbetweenMay2005andMay2006.Economicactivity
andincomesrosebothintheUnitedStatesandinmanyothercountries,
particularlyChina,andpeoplewithhigherincomesarelikelytobuymore
gasoline.Employmentroseaswell,andpeoplewithjobsusemoregasoline
astheydrivetowork.PopulationintheUnitedStatesgrewduringthe
period.Inshort,manythingshappenedduringtheperiod,allofwhich
tendedtoincreasethequantityofgasolinepeoplepurchased.
OurobservationofthegasolinemarketbetweenMay2005andMay2006
didnotofferaconclusivetestofthehypothesisthatanincreaseinthe
priceofgasolinewouldleadtoareductioninthequantitydemandedby
consumers.Otherthingschangedandaffectedgasolineconsumption.Such
problemsarelikelytoaffectanyanalysisofeconomicevents.Wecannot
asktheworldtostandstillwhileweconductexperimentsineconomic
phenomena.Economistsemployavarietyofstatisticalmethodstoallow
themtoisolatetheimpactofsingleeventssuchaspricechanges,butthey
canneverbecertainthattheyhaveaccuratelyisolatedtheimpactofa
singleeventinaworldinwhichvirtuallyeverythingischangingallthe
time.
Inlaboratorysciencessuchaschemistryandbiology,itisrelativelyeasyto
conductexperimentsinwhichonlyselectedthingschangeandallother
factorsareheldconstant.Theeconomistslaboratoryistherealworld;
thus,economistsdonotgenerallyhavetheluxuryofconductingcontrolled
experiments.
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TheFallacyofFalseCause
Hypothesesineconomicstypicallyspecifyarelationshipinwhichachange
inonevariablecausesanothertochange.Wecallthevariablethat
respondstothechangethedependentvariable;thevariablethatinducesa
changeiscalledtheindependentvariable.Sometimesthefactthattwo
variablesmovetogethercansuggestthefalseconclusionthatoneofthe
variableshasactedasanindependentvariablethathascausedthechange
weobserveinthedependentvariable.
Considerthefollowinghypothesis:Peoplewearingshortscausewarm
weather.Certainly,weobservethatmorepeoplewearshortswhenthe
weatheriswarm.Presumably,though,itisthewarmweatherthatcauses
peopletowearshortsratherthanthewearingofshortsthatcauseswarm
weather;itwouldbeincorrecttoinferfromthisthatpeoplecausewarm
weatherbywearingshorts.
Reachingtheincorrectconclusionthatoneeventcausesanotherbecause
thetwoeventstendtooccurtogetheriscalledthefallacyoffalsecause.
Theaccompanyingessayonbaldnessandheartdiseasesuggestsan
exampleofthisfallacy.
Becauseofthedangerofthefallacyoffalsecause,economistsusespecial
statisticalteststhataredesignedtodeterminewhetherchangesinone
thingactuallydocausechangesobservedinanother.Giventheinabilityto
performcontrolledexperiments,however,thesetestsdonotalwaysoffer
convincingevidencethatpersuadesalleconomiststhatonethingdoes,in
fact,causechangesinanother.
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InthecaseofgasolinepricesandconsumptionbetweenMay2005and
May2006,thereisgoodtheoreticalreasontobelievethepriceincrease
shouldleadtoareductioninthequantityconsumersdemand.And
economistshavetestedthehypothesisaboutpriceandthequantity
demandedquiteextensively.Theyhavedevelopedelaboratestatistical
testsaimedatrulingoutproblemsofthefallacyoffalsecause.Whilewe
cannotprovethatanincreaseinpricewill,ceterisparibus,leadtoa
reductioninthequantityconsumersdemand,wecanhaveconsiderable
confidenceintheproposition.
NormativeandPositiveStatements
Twokindsofassertionsineconomicscanbesubjectedtotesting.Wehave
alreadyexaminedone,thehypothesis.Anothertestableassertionisa
statementoffact,suchasItisrainingoutsideorMicrosoftisthelargest
producerofoperatingsystemsforpersonalcomputersintheworld.Like
hypotheses,suchassertionscanbedemonstratedtobefalse.Unlike
hypotheses,theycanalsobeshowntobecorrect.Astatementoffactora
hypothesisisapositivestatement.
Althoughpeopleoftendisagreeaboutpositivestatements,such
disagreementscanultimatelyberesolvedthroughinvestigation.Thereis
anothercategoryofassertions,however,forwhichinvestigationcannever
resolvedifferences.Anormativestatementisonethatmakesavalue
judgment.Suchajudgmentistheopinionofthespeaker;noonecan
provethatthestatementisorisnotcorrect.Herearesomeexamplesof
normativestatementsineconomics:Weoughttodomoretohelpthe
poor.PeopleintheUnitedStatesshouldsavemore.Corporateprofits
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aretoohigh.Thestatementsarebasedonthevaluesofthepersonwho
makesthem.Theycannotbeprovenfalse.
Becausepeoplehavedifferentvalues,normativestatementsoftenprovoke
disagreement.Aneconomistwhosevaluesleadhimorhertoconcludethat
weshouldprovidemorehelpforthepoorwilldisagreewithonewhose
valuesleadtoaconclusionthatweshouldnot.Becausenotestexistsfor
thesevalues,thesetwoeconomistswillcontinuetodisagree,unlessone
persuadestheothertoadoptadifferentsetofvalues.Manyofthe
disagreementsamongeconomistsarebasedonsuchdifferencesinvalues
andthereforeareunlikelytoberesolved.
KEYTAKEAWAYS
Economiststrytoemploythescientificmethodintheirresearch. Scientistscannotproveahypothesistobetrue;theycanonlyfailto
proveitfalse.
Economists,likeothersocialscientistsandscientists,usemodelstoassistthemintheiranalyses.
Twoproblemsinherentintestsofhypothesesineconomicsaretheall-other-things-unchangedproblemandthefallacyoffalsecause.
Positivestatementsarefactualandcanbetested.Normativestatementsarevaluejudgmentsthatcannotbetested.Manyofthe
disagreementsamongeconomistsstemfromdifferencesinvalues.
TRYIT!LookagainatthedatainTable1.1"LSATScoresandUndergraduate
Majors".Nowconsiderthehypothesis:Majoringineconomicswill
resultinahigherLSATscore.Arethedatagivenconsistentwiththis
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hypothesis?Dothedataprovethatthishypothesisiscorrect?What
fallacymightbeinvolvedinacceptingthehypothesis?
CaseinPoint:DoesBaldnessCauseHeart
Disease?Awebsitecalledembarrassingproblems.comreceivedthefollowingemail:
DearDr.Margaret,
Iseemtobegoingbald.Accordingtoyourwebsite,thismeansImmorelikelytohaveaheartattack.IfItakeadrugtopreventhairloss,
willitreducemyriskofaheartattack?
WhatdidDr.Margaretanswer?Mostimportantly,shedidnotrecommend
thatthequestionertakedrugstotreathisbaldness,becausedoctorsdonot
thinkthatthebaldnesscausestheheartdisease.Amorelikelyexplanation
fortheassociationbetweenbaldnessandheartdiseaseisthatboth
conditionsareaffectedbyanunderlyingfactor.Whilenotingthatmore
researchneedstobedone,onehypothesisthatDr.Margaretoffersisthat
highertestosteronelevelsmightbetriggeringboththehairlossandthe
heartdisease.Thegoodnewsforpeoplewithearlybalding(whichisreally
wheretheassociationwithincreasedriskofheartdiseasehasbeen
observed)isthattheyhaveasignalthatmightleadthemtobechecked
earlyonforheartdisease.
Source:http://www.embarrassingproblems.com/problems/problempage
230701.htm.
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ANSWERTOTRYIT!PROBLEM
Thedataareconsistentwiththehypothesis,butitisneverpossibleto
provethatahypothesisiscorrect.Acceptingthehypothesiscould
involvethefallacyoffalsecause;studentswhomajorineconomics
mayalreadyhavetheanalyticalskillsneededtodowellontheexam.
1.4ReviewandPractice
SummaryChoicesareforcedonusbyscarcity;economistsstudythechoicesthat
peoplemake.Scarcegoodsarethoseforwhichthechoiceofone
alternativerequiresgivingupanother.Theopportunitycostofanychoice
isthevalueofthebestalternativeforgoneinmakingthatchoice.
Somekeychoicesassessedbyeconomistsincludewhattoproduce,howto
produceit,andforwhomitshouldbeproduced.Economicsis
distinguishedfromotheracademicdisciplinesthatalsostudychoicesby
anemphasisonthecentralimportanceofopportunitycostsinevaluating
choices,theassumptionofmaximizingbehaviorthatservestheinterestsof
individualdecisionmakers,andafocusonevaluatingchoicesatthe
margin.
Economicanalysesmaybeaimedatexplainingindividualchoiceorchoices
inanindividualmarket;suchinvestigationsarelargelythefocusof
microeconomics.Theanalysisoftheimpactofthoseindividualchoiceson
suchaggregatesastotaloutput,thelevelofemployment,andtheprice
levelistheconcernofmacroeconomics.
Workingwithintheframeworkofthescientificmethod,economists
formulatehypothesesandthentestthem.Thesetestscanonlyrefutea
hypothesis;hypothesesinsciencecannotbeproved.Ahypothesisthathas
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beenwidelytestedoftencomestoberegardedasatheory;onethathas
wonvirtuallyuniversalacceptanceisalaw.Becauseofthecomplexityof
therealworld,economistsrelyonmodelsthatrestonaseriesof
simplifyingassumptions.Themodelsareusedtogeneratehypotheses
abouttheeconomythatcanbetestedusingreal-worlddata.
Statementsoffactandhypothesesarepositivestatements.Normative
statements,unlikepositivestatements,cannotbetestedandprovidea
sourceforpotentialdisagreement.
PROBLEMS
1. Whydoesthefactthatsomethingisscarcerequirethatwemakechoices?
2. Doesthefactthatsomethingisabundantmeanitisnotscarceintheeconomicsense?Whyorwhynot?
3. Insomecountries,suchasCubaandNorthKorea,thegovernmentmakesmostofthedecisionsaboutwhatwillbeproduced,howitwill
beproduced,andforwhom.Doesthefactthatthesechoicesare
madebythegovernmenteliminatescarcityinthesecountries?Why
orwhynot?
4. Explainwhatismeantbytheopportunitycostofachoice.5. Whatistheapproximatedollarcostofthetuitionandotherfees
associatedwiththeeconomicscourseyouaretaking?Doesthisdollar
costfullyreflecttheopportunitycosttoyouoftakingthecourse?
6. IntheCaseinPointessayTheRisingCostofEnergy,whatwouldbesomeofthethingsthatwouldbeincludedinanestimateofthe
opportunitycostofpreservingpartofnorthernAlbertaCanadaby
prohibitingheavycrudeoilextraction?Doyouthinkthatthe
increasedextractionrepresentsthebestuseoftheland?Whyorwhy
not?
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7.Indicatewhethereachofthefollowingisatopicofmicroeconomicsormacroeconomics:
1. Theimpactofhigheroilpricesontheproductionofsteel2. Theincreaseddemandinthelast15yearsforexoticdietary
supplements
3. ThesurgeinaggregateeconomicactivitythathitmuchofAsialateintheearly2000s
4. ThesharpincreasesinU.S.employmentandtotaloutputthatoccurredbetween2003and2007
5. Theimpactofpreservationofwildernessareasontheloggingindustryandonthepriceoflumber
8.Determinewhethereachofthefollowingraisesawhat,how,orforwhomissue.Arethestatementsnormativeor
positive?
1. Arequirementthataluminumusedincarsbemadefrom
recycledmaterialswillraisethepriceofautomobiles.
2. Thefederalgovernmentdoesnotspendenoughforchildren.3. Anincreaseinpoliceresourcesprovidedtotheinnercitywill
lowerthecrimerate.
4. Automationdestroysjobs.5. Effortstoimprovetheenvironmenttendtoreduce
productionandemployment.
6. Japanesefirmsshouldbemorewillingtohireadditionalworkerswhenproductionrisesandtolayoffworkerswhen
productionfalls.
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7. Accesstohealthcareshouldnotbelimitedbyincome.
9. Yourtimeisascarceresource.Whatifthequantityoftimewereincreased,sayto48hoursperday,andeveryonestilllivedasmanydaysasbefore.Wouldtimestillbescarce?
10.Mostcollegestudentsareunderage25.Givetwoexplanationsforthisonebasedonthebenefitspeopleofdifferentagesarelikelyto
receivefromhighereducationandonebasedontheopportunity
costsofacollegeeducationtostudentsofdifferentages.
11.Somemunicipalwatercompanieschargecustomersaflatfeeeachmonth,regardlessoftheamountofwatertheyconsume.Othersmeterwateruseandchargeaccordingtothequantityofwater
customersuse.Comparethewaythetwosystemsaffectthecostof
wateruseatthemargin.
12.Howmightyoutesteachofthefollowinghypotheses?Suggestsomeproblemsthatmightariseineachtestdueto
theceterisparibus(all-other-things-unchanged)problemandthefallacyoffalsecause.
1. Reducingthequantityofheroinavailablewillincreasetotalspendingonheroinandincreasethecrimerate.
2. Higherincomesmakepeoplehappier.3. Higherincomesmakepeoplelivelonger.
13.Manymodelsinphysicsandinchemistryassumetheexistenceofaperfectvacuum(thatis,aspaceentirelyemptyofmatter).Yetwe
knowthataperfectvacuumcannotexist.Aresuchmodelsvalid?Why
aremodelsbasedonassumptionsthatareessentiallyincorrect?
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14.Supposeyouwereaskedtotestthepropositionthatpublishingstudentsteacherevaluationscausesgradeinflation.Whatevidence
mightyouwanttoconsider?Howwouldtheinabilitytocarryout
controlledexperimentsmakeyouranalysismoredifficult?15.ReferringtotheCaseinPointBaldnessandHeartDisease,explain
thepossiblefallacyoffalsecauseinconcludingthatbaldnessmakesa
personmorelikelytohaveheartdisease.
16.In2005theFoodandDrugAdministrationorderedthatVioxxandotherpopulardrugsfortreatingthepainofarthritisbewithdrawn
fromthemarket.Theorderresultedfromafindingthatpeopletaking
thedrugshadanincreasedriskofcardiovascularproblems.Someresearcherscriticizedthegovernmentsaction,arguingthat
concludingthatthedrugscausedthecardiovascularproblems
representedanexampleofthefallacyoffalsecause.Canyouthinkof
anyreasonwhythismightbethecase?
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Chapter2ConfrontingScarcity:ChoicesinProduction
StartUp:TighteningSecurityattheWorlds
Airports
Doyouwantsaferairtravelornot?Whilethatquestionisseldomaskedso
bluntly,anypersonwhotravelsbyaircantellyouthatourcollective
answerhasbeenyes,andithasbeenaccompaniedbyincreasesin
securityanditsassociatedcostsatairportsallovertheworld.Why?In
short,9/11.TerroristshijackedfourU.S.commercialairlinerson
September11,2001,andthetragicresultsthatfollowedledtoasharp
tighteninginairportsecurity.
Inanefforttopreventsimilardisasters,airportsecurityofficialsscrutinize
luggageandpassengersmorecarefullythaneverbefore.Inthemonths
following9/11,delaysofasmuchasthreehourswerecommonasagents
triedtoassurethatnoweaponsorbombscouldbesmuggledontoanother
plane.
Whattoproduce?isafundamentaleconomicquestion.Everyeconomy
mustanswerthisquestion.Shoulditproducemoreeducation,better
healthcare,improvedtransportation,acleanerenvironment?Thereare
limitstowhatanationcanproduce;decidingtoproducemoreofonething
inevitablymeansproducinglessofsomethingelse.Individualsinmuchof
theworld,afterthetragedyof9/11,clearlywerewillingtogiveuptime,
andafairamountofindividualprivacy,inanefforttoobtaingreater
security.Nationsandindividualcitiesalsodevotedadditionalresourcesto
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policeandotherformsofprotectioninanefforttopreventtragediessuch
as9/11.Peopleallovertheworldchosetoproducelessofothergoodsin
ordertodevotemoreresourcestotheproductionofgreatersecurity.And,
asofearly2009,thechoicetodevotemoreresourcestosecurityhadpaid
off;therehadbeennosimilarhijackingsintheUnitedStates.
Inthischapterweuseourfirstmodel,theproductionpossibilitiesmodel,
toexaminethenatureofchoicestoproducemoreofsomegoodsandless
ofothers.Asitsnamesuggests,theproductionpossibilitiesmodelshows
thegoodsandservicesthataneconomyiscapableofproducingits
possibilitiesgiventhefactorsofproductionandthetechnologyithas
available.Themodelspecifieswhatitmeanstouseresourcesfullyand
efficientlyandsuggestssomeimportantimplicationsforinternational
trade.Wecanalsousethemodeltoillustrateeconomicgrowth,aprocess
thatexpandsthesetofproductionpossibilitiesavailabletoaneconomy.
Wethenturntoanexaminationofthetypeofeconomicsysteminwhich
choicesaremade.Aneconomicsystemisthesetofrulesthatdefinehowan
economysresourcesaretobeownedandhowdecisionsabouttheiruse
aretobemade.Wewillseethateconomicsystemsdifferintermsofhow
theyanswerthefundamentaleconomicquestions.Manyoftheworlds
economicsystems,includingthesystemsthatprevailinNorthAmerica,
Europe,andmuchofAsiaandCentralandSouthAmerica,relyon
individualsoperatinginamarketeconomytomakethosechoices.Other
economicsystems,includingthoseofCubaandNorthKoreatodayand
historicallythoseoftheformerSovietUnion,Sovietbloccountries,and
China,relyorreliedongovernmenttomakethesechoices.Different
economicsystemsresultindifferentsetsofchoicesandthusdifferent
outcomes;thefactthatmarketeconomiesgenerallyoutperformtheothers
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whenitcomestoprovidingmoreofthethingsthatpeoplewanthelpsto
explainthedramaticshiftfromgovernment-dominatedtowardmarket-
dominatedeconomicsystemsthathasoccurredthroughouttheworldin
thepast25years.Thechapterconcludeswithanexaminationoftheroleof
governmentinaneconomythatrelieschieflyonmarketstoallocategoods
andservices.
2.1FactorsofProduction
LEARNINGOBJECTIVES1. Definethethreefactorsofproductionlabor,capital,andnatural
resources.
2. Explaintheroleoftechnologyandentrepreneursintheutilizationoftheeconomysfactorsofproduction.
Choicesconcerningwhatgoodsandservicestoproducearechoicesabout
aneconomysuseofitsfactorsofproduction,theresourcesavailabletoitfortheproductionofgoodsandservices.Thevalue,orsatisfaction,that
peoplederivefromthegoodsandservicestheyconsumeandtheactivities
theypursueiscalledutility.Ultimately,then,aneconomysfactorsof
productioncreateutility;theyservetheinterestsofpeople.
Thefactorsofproductioninaneconomyareitslabor,capital,andnatural
resources.Laboristhehumaneffortthatcanbeappliedtotheproduction
ofgoodsandservices.Peoplewhoareemployedorwouldliketobeare
consideredpartofthelaboravailabletotheeconomy.Capitalisafactorof
productionthathasbeenproducedforuseintheproductionofother
goodsandservices.Officebuildings,machinery,andtoolsareexamplesof
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capital.Naturalresourcesaretheresourcesofnaturethatcanbeusedfor
theproductionofgoodsandservices.
Inthenextthreesections,wewilltakeacloserlookatthefactorsof
productionweusetoproducethegoodsandservicesweconsume.The
threebasicbuildingblocksoflabor,capital,andnaturalresourcesmaybe
usedindifferentwaystoproducedifferentgoodsandservices,butthey
stilllieatthecoreofproduction.Wewillthenlookattherolesplayedby
technologyandentrepreneursinputtingthesefactorsofproductionto
work.Aseconomistsbegantograpplewiththeproblemsofscarcity,
choice,andopportunitycosttwocenturiesago,theyfocusedonthese
concepts,justastheyarelikelytodotwocenturieshence.
Labor
Laborishumaneffortthatcanbeappliedtoproduction.Peoplewhowork
torepairtires,pilotairplanes,teachchildren,orenforcelawsareallpartof
theeconomyslabor.Peoplewhowouldliketoworkbuthavenotfound
employmentwhoareunemployedarealsoconsideredpartofthelabor
availabletotheeconomy.
Insomecontexts,itisusefultodistinguishtwoformsoflabor.Thefirstis
thehumanequivalentofanaturalresource.Itisthenaturalabilityan
untrained,uneducatedpersonbringstoaparticularproductionprocess.
Butmostworkersbringfarmore.Theskillsaworkerhasasaresultof
education,training,orexperiencethatcanbeusedinproductionare
calledhumancapital.Studentswhoareattendingacollegeoruniversity
areacquiringhumancapital.Workerswhoaregainingskillsthrough
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experienceorthroughtrainingareacquiringhumancapital.Childrenwho
arelearningtoreadareacquiringhumancapital.
Theamountoflaboravailabletoaneconomycanbeincreasedintwo
ways.Oneistoincreasethetotalquantityoflabor,eitherbyincreasingthe
numberofpeopleavailabletoworkorbyincreasingtheaveragenumber
ofhoursofworkperweek.Theotheristoincreasetheamountofhuman
capitalpossessedbyworkers.
Capital
Longago,whenthefirsthumanbeingswalkedtheearth,theyproduced
foodbypickingleavesorfruitoffaplantorbycatchingananimaland
eatingit.Weknowthatveryearlyon,however,theybeganshapingstones
intotools,apparentlyforuseinbutcheringanimals.Thosetoolswerethe
firstcapitalbecausetheywereproducedforuseinproducingother
goodsfoodandclothing.
Modernversionsofthefirststonetoolsincludesaws,meatcleavers,hooks,
andgrinders;allareusedinbutcheringanimals.Toolssuchashammers,
screwdrivers,andwrenchesarealsocapital.Transportationequipment,
suchascarsandtrucks,iscapital.Facilitiessuchasroads,bridges,ports,
andairportsarecapital.Buildings,too,arecapital;theyhelpustoproduce
goodsandservices.
Capitaldoesnotconsistsolelyofphysicalobjects.Thescoreforanew
symphonyiscapitalbecauseitwillbeusedtoproduceconcerts.Computer
softwareusedbybusinessfirmsorgovernmentagenciestoproducegoods
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andservicesiscapital.Capitalmaythusincludephysicalgoodsand
intellectualdiscoveries.Anyresourceiscapitalifitsatisfiestwocriteria:
1. Theresourcemusthavebeenproduced.2. Theresourcecanbeusedtoproduceothergoodsandservices.
Onethingthatisnotconsideredcapitalismoney.Afirmcannotusemoney
directlytoproduceothergoods,somoneydoesnotsatisfythesecond
criterionforcapital.Firmscan,however,usemoneytoacquirecapital.
Moneyisaformoffinancialcapital.Financialcapitalincludesmoneyand
otherpaperassets(suchasstocksandbonds)thatrepresentclaimson
futurepayments.Thesefinancialassetsarenotcapital,buttheycanbe
useddirectlyorindirectlytopurchasefactorsofproductionorgoodsand
services.
NaturalResources
Therearetwoessentialcharacteristicsofnaturalresources.Thefirstis
thattheyarefoundinnaturethatnohumanefforthasbeenusedtomake
oralterthem.Thesecondisthattheycanbeusedfortheproductionof
goodsandservices.Thatrequiresknowledge;wemustknowhowtouse
thethingswefindinnaturebeforetheybecomeresources.
Consideroil.Oilinthegroundisanaturalresourcebecauseitisfound(not
manufactured)andcanbeusedtoproducegoodsandservices.However,
250yearsagooilwasanuisance,notanaturalresource.Pennsylvania
farmersintheeighteenthcenturywhofoundoiloozingupthroughtheir
soilweredismayed,notdelighted.Nooneknewwhatcouldbedonewith
theoil.Itwasnotuntilthemid-nineteenthcenturythatamethodwas
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foundforrefiningoilintokerosenethatcouldbeusedtogenerateenergy,
transformingoilintoanaturalresource.Oilisnowusedtomakeallsorts
ofthings,includingclothing,drugs,gasoline,andplastic.Itbecamea
naturalresourcebecausepeoplediscoveredandimplementedawaytouse
it.
Definingsomethingasanaturalresourceonlyifitcanbeusedtoproduce
goodsandservicesdoesnotmeanthatatreehasvalueonlyforitswoodor
thatamountainhasvalueonlyforitsminerals.Ifpeoplegainutilityfrom
theexistenceofabeautifulwildernessarea,thenthatwildernessprovides
aservice.Thewildernessisthusanaturalresource.
Thenaturalresourcesavailabletouscanbeexpandedinthreeways.One
isthediscoveryofnewnaturalresources,suchasthediscoveryofa
depositoforecontainingtitanium.Thesecondisthediscoveryofnewuses
forresources,ashappenedwhennewtechniquesallowedoiltobeputto
productiveuseorsandtobeusedinmanufacturingcomputerchips.The
thirdisthediscoveryofnewwaystoextractnaturalresourcesinorderto
usethem.Newmethodsofdiscoveringandmappingoildepositshave
increasedtheworldssupplyofthisimportantnaturalresource.
TechnologyandtheEntrepreneur
Goodsandservicesareproducedusingthefactorsofproductionavailable
totheeconomy.Twothingsplayacrucialroleinputtingthesefactorsof
productiontowork.Thefirstistechnology,theknowledgethatcanbe
appliedtotheproductionofgoodsandservices.Thesecondisan
individualwhoplaysakeyroleinamarketeconomy:theentrepreneur.
Anentrepreneurisapersonwho,operatingwithinthecontextofamarket
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economy,seekstoearnprofitsbyfindingnewwaystoorganizefacto