1 chapter part i introduction to economics the scope and method of economics
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1Chapter
PART I INTRODUCTION TO ECONOMICS
The Scope and Methodof Economics
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1The Scope and Method
of Economics
PART I INTRODUCTION TO ECONOMICS
Why Study Economics?To Learn a Way of ThinkingTo Understand SocietyTo Understand Global AffairsTo Be an Informed Voter
The Scope of EconomicsMicroeconomics and MacroeconomicsThe Diverse Fields of Economics
The Method of EconomicsTheories and ModelsEconomic Policy
Appendix: How to Read and Understand Graphs
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economics The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.
Economics is the study of how individuals and societies choose to use the scarceresources that nature and previous generations have provided. The key word in thisdefinition is choose. Economics is a behavioral, or social science. In large measure it isthe study of how people make choices. The choices that people make, when added up,translate into societal choices.
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There are four main reasons to study economics:
• to learn a way of thinking,• to understand society,• to understand global affairs, and • to be an informed voter.
WHY STUDY ECONOMICS?
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s Three fundamental concepts:Opportunity costMarginalism, andEfficient markets
TO LEARN A WAY OF THINKING
WHY STUDY ECONOMICS?
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opportunity cost The best alternative that we forgo, or give up, when we make a choice or a decision.
scarce Limited.
WHY STUDY ECONOMICS?
Opportunity Cost
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marginalism The process of analyzing the additional or incremental costs or benefits arising from a choice or decision.
sunk costs Costs that cannotbe avoided, regardless of what isdone in the future, because theyhave already been incurred.
Marginalism and Sunk Costs
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efficient market A marketin which profit opportunities areeliminated almost instantaneously.
Efficient Markets—No Free Lunch
The study of economics teaches us a way of thinking and helps us make decisions.
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Industrial Revolution Theperiod in England during the lateeighteenth and early nineteenthcenturies in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities.
TO UNDERSTAND SOCIETY
The study of economics is an essential part of the study of society.
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TO UNDERSTAND GLOBAL AFFAIRS
An understanding of economics is essential to an understanding of global affairs.
The events of September 11, 2001, dealt a blow to the tourism industry and left airlines in deep financial trouble.
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TO BE AN INFORMED VOTER
When we participate in the political process, we are voting on issues that require a basic understanding of economics.
A knowledge of economics is essential to be an informed voter.
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microeconomics The branch of economics that examines the functioning of individual industries and the behavior of individual decision-making units—that is, business firmsand households.
THE SCOPE OF ECONOMICS
MICROECONOMICS AND MACROECONOMICS
macroeconomics The branch of economics that examines the economic behavior of aggregates—income, employment, output, and so on—on a national scale.
Microeconomics looks at the individual unit—the household, the firm, the industry. Itsees and examines the “trees.” Macroeconomics looks at the whole, the aggregate. Itsees and analyzes the “forest.”
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sTHE SCOPE OF ECONOMICS
THE DIVERSE FIELDS OF ECONOMICS
TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns
DIVISION OF ECONOMICS PRODUCTION PRICES INCOME EMPLOYMENT
Microeconomics Production/output in individual industries and businesses How much steelHow much office spaceHow many cars
Price of individual goods and services
Price of medical carePrice of gasolineFood pricesApartment rents
Distribution of income and wealth
Wages in the auto industryMinimum wageExecutive salariesPoverty
Employment by individual businesses and industries
Jobs in the steel industryNumber of employees in a firmNumber of accountants
Macroeconomics National production/output
Total industrial outputGross domestic productGrowth of output
Aggregate price level
Consumer pricesProducer pricesRate of inflation
National income
Total wages and salaries Total corporate profits
Employment and unemployment in the economy
Total number of jobsUnemployment rate
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positive economics An approach to economics that seeks to understand behavior and the operation of systems without making judgments. It describeswhat exists and how it works.
normative economics An approach to economics that analyzes outcomes of economic behavior, evaluates them asgood or bad, and may prescribe courses of action. Also called policy economics.
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descriptive economics The compilation of data that describe phenomena and facts.
Descriptive Economics and Economic Theory
economic theory A statement or set of related statements about cause and effect, action and reaction.
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model A formal statement of a theory, usually a mathematical statement of a presumed relationship between two or more variables.
variable A measure that can change from time to time or from observation to observation.
THEORIES AND MODELS
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Ockham’s razor The principle that irrelevant detail should be cut away.
Maps are useful abstract representations of reality.
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ceteris paribus, or all else equal A device used to analyze the relationship between two variables while the values of other variables are held unchanged.
All Else Equal: Ceteris Paribus
Using the device of ceteris paribus is one part of the process of abstraction. In formulatingeconomic theory, the concept helps us simplify reality to focus on the relationshipsthat interest us.
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The most common method of expressing the quantitative relationship between two variables is graphing that relationship on a two-dimensional plane.
Expressing Models in Words, Graphs, and Equations
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Cautions and Pitfalls
The Post Hoc Fallacy
post hoc, ergo propter hoc Literally, “after this (in time), therefore because of this.” A common error made in thinkingabout causation: If Event A happens before Event B, it is not necessarily true that A caused B.
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The Fallacy of Composition
fallacy of composition The erroneous belief that what is true for a part is necessarily true for the whole.
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empirical economics Thecollection and use of data to testeconomic theories.
Testing Theories and Models: Empirical Economics
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ECONOMIC POLICY
Criteria for judging economic outcomes:
1. Efficiency
2. Equity
3. Growth
4. Stability
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efficiency In economics, allocative efficiency. An efficienteconomy is one that produces what people want at the least possible cost.
Efficiency
equity Fairness.
Equity
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economic growth An increase in the total output of an economy.
Growth
stability A condition in whichnational output is growing steadily, with low inflation and full employment of resources.
Stability
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ceteris paribus
descriptive economics
economic growth
economic theory
economics
efficiency
efficient market
empirical economics
equity
fallacy of composition
Industrial Revolution
macroeconomics
marginalism
microeconomics
model
normative economics
Ockham’s razor
opportunity cost
positive economics
post hoc, ergo propter hoc
scarce
stability
sunk costs
variable
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HOW TO READ AND UNDERSTAND GRAPHS
Appendix
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A time series graph shows how a single variable changes over time.
TIME SERIES GRAPH
FIGURE 1A.1 Total Disposable Personal Income in the United States: 1975–2005 (in billions of dollars)
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TABLE 1A.1 Total Disposable Personal Income in the UnitedStates, 1975–2005 (in billions of dollars)
YEAR TOTAL DISPOSABLEPERSONAL INCOME
YEAR TOTAL DISPOSABLEPERSONAL INCOME
19751976197719781979198019811982198319841985198619871988
1,181.41,299.9 1,436.01,614.8 1,808.2 2,019.8 2,247.9 2,406.82,586.02,887.63,086.53,262.53,459.53,752.4
19891990199119921993199419951996199719981999200020012002200320042005
4,016.34,293.64,474.84,754.64,935.35,165.45,422.65,677.75,968.26,355.66,627.47,120.27,393.27,827.78,159.98,646.98,945.6
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GRAPHING TWO VARIABLES ON A CARTESIANCOORDINATE SYSTEM
Appendix
The Cartesian coordinate system is the most common method of graphing two variables. This system is constructed by simply drawing two perpendicular lines: a horizontal line, or X-axis, and a vertical line, or Y-axis. The axes contain measurement scales that intersect at 0 (zero). This point is called the origin. FIGURE 1A.2 A Cartesian Coordinate System
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This line slopes upward, indicating that there seems to be a positive relationship between income and spending.
Points A and B, above the 45° line, show that consumption can be greater than income.
TABLE 1A.2 Consumption Expendituresand Income, 2003
AVERAGEINCOME
BEFORE TAXES
AVERAGECONSUMPTIONEXPENDITURES
Bottom fifth 2nd fifth3rd fifth4th fifthTop fifth
$ 8,20121,47837,54261,132
127,146
$ 18,49226,72936,21350,46881,731
FIGURE 1A.3 Household Consumptionand Income
PLOTTING INCOME AND CONSUMPTION DATAFOR HOUSEHOLDS
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The slope of the line indicates whether the relationship between the variables is positive or negative.
The slope of the line is computed as follows:
2 1
2 1
Y Y Y
X X X
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A downward-sloping line describes a negative relationship between X and Y.
An upward-sloping line describes a positive relationship between X and Y.
FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope
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FIGURE 1A.5 Changing Slopes Along Curves
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TABLE 1A.3 Aggregate National Income and Consumption for the United States, 1930-2004(in billions of dollars)
AGGREGATE NATIONAL INCOME
AGGREGATE CONSUMPTION
193019401950196019701980199020002004
75.681.1
241.0427.5837.5
2,243.04,642.17,984.4
10,339.6
70.271.2
192.7332.3648.9
1,762.93,831.56,683.78,229.9
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FIGURE 1A.6 National Income and Consumption
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