Ch01 Introduction to Economics

8/13/2019 Ch01 Introduction to Economics

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WHAT IS

ECONOMICS? 1CHAPTER


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Objectives

After studying this chapter, you will be able to:

Define economics and distinguish between

microeconomics 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 about

the 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 the

powerful forces that shape and change our world.


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Definition of Economics

Scarcity

All economic questions arise because we are unable to

satisfy all our wantsbecause we face scarcity.

Economicsis the social science that studies the choicesthat individuals, businesses, governments, and societies

make as they cope with scarcity.


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Definition of Economics

Microeconomics

Microeconomicsis the study of choices made by

individuals and businesses, and the influence of

government on those choices.

Macroeconomics

Macroeconomicsis the study of the effects on the

national and global economy of the choices that

individuals, businesses, and governments make.


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Three Big Microeconomic Questions

What Goods and Services

are Produced?

Figure 1.1 shows the

major items produced in

the U.S. economy today.

It emphasizes the

dominant place of services

in our economy.


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trends in what the U.S.

economy has produced

over the past 60 years.

It shows the decline of

agriculture, mining,

construction, and

manufacturing, and the

expansion of services.


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How are Goods and Services Produced?

Factors of productionare the resources that businesses

use to produce goods and services.

They are grouped into four categories:

Land

Labor

Capital

Entrepreneurship


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The tools, instruments, machines, buildings, and other

constructions that are used to produce goods and services

are capital.

The human resource that organizes land, labor, and

capital is entrepreneurship.


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Figure 1.3 shows a

measure of the growth of

human capital in the

United States over the lastcenturythe percentage

of the population that has

completed different levels

of education.


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The facts about howwe

produce raise the deeper

question: What determines

the quantities of capital,labor, and other resources

that get used to produce

goods and services?

Microeconomics providessome answers to this

question.


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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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distribution of income in

the United States.

The richest 20 percent

earn almost 50 percent of

total income while the

poorest 20 percent earnonly 4 percent of total

income.


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The facts about for whom

raise the deeper question:

What determines earnings

and the distribution ofincome that in turn

determine who gets the

goods and services

produced?

Microeconomics provides

some answers to this

question.


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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 livingis the level of consumption that

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


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Figure 1.5shows income

per person per day in a

number of countries and

regions.

The United States has one

of the highest standards of

living, and the nations of

Africa have the lowest.



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Macroeconomics seeks to

explain differences in the

standard of living across

countries.Macroeconomics also

seeks to explain the rate at

which the standard of

living changes.



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What Determines the Cost of Living?

The cost of livingis the amount of money it takes to buy

the 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 typical

family consumes.


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Table 1.1 shows the price

of a Big Mac in ten

countries.

The number of money units

varies a lot, but the cost is

similar in each country.

What matters is the rate at

which 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 deflation

brings 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 cycleis the periodic but irregular up-and-

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

recessionproduction 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 and

turning points of a business cycle.


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Why Does Our Economy Fluctuate?

Economists remain unsure about the sources of economic

fluctuations and about the actions that might be taken to

smooth 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

Theeconomic way of thinkingplaces scarcityand its

implication, choice, at center stage.

You can think about every choice as a tradeoffan

exchangegiving up one thing to get something else.

The classic tradeoff is guns versus butter.

Guns and butter stand for any two objects of value.


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Microeconomic Tradeoffs

The three microeconomic questions become sharper

when we think in terms of tradeoffs.

What? Tradeoffsarise when people choose how to

spend their incomes, when governments choose how to

spend their tax revenues, and when businesses choose

what to produce.


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Microeconomic Tradeoffs

How?Tradeoffsarise when businesses choose among

alternative production technologies.

For Whom?Tradeoffsarise when choices change the

distribution of buying power across individuals.

Government redistribution of income from the rich to the

poor creates the big tradeoffthe tradeoff between

equality and efficiency.


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Macroeconomic Tradeoffs

Standard of Living Tradeoffsarise when we choose

between current consumption and activities that increase

our standard of living.

Activities such as saving and investing, education, and

research increase future production and consumption

possibilities, which increases the standard of living.


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Macroeconomic Tradeoffs

An Output-Inflation Tradeoff arises when policymakers

choose how much inflation to endure in order to maintain a

high level of production.

An output-inflation tradeoffarises because a policy

action that lowers inflation also lowers output and a policy

action that boosts output increases inflation.


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Opportunity Cost

Thinking about a choice as a tradeoff emphasizes cost as

an opportunity forgone.

The highest-valued alternative that we give up to get

something is the opportunity cost of the activity chosen.


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Margins and Incentives

People make choices at themargin, which means that

they evaluate the consequences of making incremental

changesin the use of their resources.

The benefit from pursuing an incremental increase in an

activity is its marginal benefit.

The opportunity cost of pursuing an incremental increase

in an activity is its marginal cost.


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Economics: A Social Science

Social Science

Economics is a social science.

Economists distinguish between two types of statements:

What ispositive statements

What ought to benormative statements

A positive statement can be tested by checking it against

facts

A normative statement cannot be tested.


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Social science

The task of economic science is to discover positive

statements that are consistent with what we observe in the

world 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 modelis a description of some aspect of

the economic world that includes only those features of

the world that are needed for the purpose at hand.


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Testing Models

An economic theoryis a generalization that summarizes

what we think we understand about the economic choices

that people make and the performance of industries and

entire economies.

A theory is a bridge between a model and reality. It is a

proposition about which model works.


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Obstacles and Pitfalls in Economics

Economists cannot easily do experiments and most

economic behavior has many simultaneous causes.

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

Economists try to isolate cause-and-effect relationships by

changing 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.

Thepost hoc fallacyfrom the Latin term post hoc, ergo

propter 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 propositions

that at least 70 percent of all economists polled agreed on.


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WHAT IS

ECONOMICS? 1CHAPTER

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Ch01 Introduction to Economics