ch 01 the art and science of economic analysis micro econ4
TRANSCRIPT
Chapter 1 ECON4 William A. McEachern
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The Art and Science
of
Economic Analysis
The Economic Problem
• Wants, desires: unlimited
• Resources: scarce
– Not freely available
• Economic choice
• Economics
– How people use scarce resources to
satisfy unlimited wants
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Resources
• Inputs; factors of production
– Used to produce goods and services
• Goods and services are scarce
because resources are scarce
1. Labor
2. Capital
3. Natural resources
4. Entrepreneurial ability
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Resources
• Labor
– Physical and mental effort used to
produce goods and services
– We allocate our time to different uses
– Payment: Wage
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Resources
• Capital
– Buildings, equipment, and human skills
used to produce goods and services
– Physical capital
• Human creations used to produce goods
and services
– Human capital
• Knowledge and skill people acquire to
increase their productivity
– Payment for physical capital: Interest5© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
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Resources
• Natural resources
– All gifts of nature
– Renewable resource
• Can be drawn on indefinitely if used
conservatively
– Exhaustible resource
• Does not renew itself
• Available in a limited amount
– Payment: Rent
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Resources
• Entrepreneurial ability
– Imagination required to develop a new
product or process
– Skill needed to organize production
– Willingness to take the risk of profit or
loss
– Payment: Profit
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Resources
• Entrepreneur
– Profit-seeking decision maker who starts
with an idea
– Organizes an enterprise to bring that
idea to life
– Assumes the risk of the operation
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Goods and Services
• Good
– Tangible product used to satisfy human
wants
• Service
– Activity, or intangible product, used to
satisfy human wants
• Scarcity
– When the amount people desire exceeds
the amount available at a zero price
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Goods and Services
• Scarce good/service
– The amount people desire exceeds the
amount available at a zero price
• Choice
– Give up some goods and services
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Goods and Services
• Bads
– We want none of them; not even at a
zero price
• Free goods and services
• “There is no such thing as a free lunch”
– Involve a cost to someone
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Economic Decision Makers
• Households
– Consumers
• Demand goods and services
– Resource owners
• Supply resources
• Firms, Governments, Rest of the World
– Demand resources
– Produce goods and services
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Markets
• Market
– Set of arrangements by which buyers
and sellers carry out exchange at
mutually agreeable terms
• Product markets
– Goods and services are bought and sold
• Resource markets
– Resources are bought and sold
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A Simple Circular-Flow Model
• Flow of
– Resources
– Products
– Income
– Revenue
• Among economic decision makers
• Interaction
– Households
– Firms14© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
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15
Exhibit 1The simple circular-flow model for households and firms
Households earn income by
supplying resources to the
resource market, as shown
in the lower portion of the
model. Firms demand these
resources to produce goods
and services, which they
supply to the product
market, as shown in the
upper portion of the model.
Households spend their
income to demand these
goods and services. This
spending flows through the
product market as revenue
to firms.
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Rational Self-Interest
• Individuals are rational
– Make the best choice
– Given the available information
– Maximize expected benefit
• With a given cost
– Minimize expected cost
• For a given benefit
• The lower the personal cost of helping
others, the more help we offer
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Choice Requires Time & Information
• Time and information
– Scarce
– Valuable
• Rational decision makers
– Willing to pay for information
• Improve choices
– Acquire information:
• Additional benefit expected exceeds the
additional cost
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Economic Analysis Is Marginal Analysis
• Comparison
– Expected marginal benefit
– Expected marginal cost
• Marginal
– Incremental, additional, extra
• Rational decision maker:
– Change the status quo if expected
marginal benefit exceeds expected
marginal cost
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Microeconomics & Macroeconomics
• Microeconomics
– Study of the economic behavior in
particular markets
• Individual economic choices
• Markets coordinate the choices of economic
decision makers
• Individual pieces of the puzzle
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Microeconomics & Macroeconomics
• Macroeconomics
– Study of the economic behavior of entire
economies
• Performance of the economy as a whole
• Economic fluctuations
– Rise and fall of economic activity
• Relative to the long-term growth trend of the
economy
– Business cycles
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Science of Economic Analysis
• Economic theory / model
– Simplification of economic reality
– Make predictions about cause and effect
in the real world
• Good theory
– Guide
– Sort, save, understand information
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The Scientific Method
1. Identify the question and define
relevant variables
2. Specify assumptions
– Other-things-constant
– Behavioral assumptions
3. Formulate the hypothesis
– Key variables relate to each other
4. Test the hypothesis - evidence
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The Scientific Method
• Variable
– A measure that can take on different
values at different times
• Other-things-constant assumption
– Other variables remain unchanged
– Ceteris paribus
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The Scientific Method
• Behavioral assumption
– Describes the expected behavior of
economic decision makers, what
motivates them
• Hypothesis
– Theory about how key variables relate
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25
Exhibit 2The Scientific Method: Step by Step
The steps of the
scientific method are
designed to develop
and test hypotheses
about how the world
works. The objective is
a theory that predicts
outcomes more
accurately than the
best alternative theory.
A hypothesis is
rejected if it does not
predict as accurately
as the best alternative.
A rejected hypothesis
can be modified or
reworked in light of the
test results.
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Normative Versus Positive
• Positive economic statement
– Can be proved or disproved by reference
to facts
– ‘What is’
• Normative economic statement
– Reflects an opinion, which cannot be
proved or disproved by reference to the
facts
– ‘What should be’
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Predicting Average Behavior
• Individual behavior
– Difficult to predict
– Random actions of individuals
• Offset one another
• Average behavior of groups
– Predicted more accurately
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Pitfalls of Faulty Economic Analysis
• Fallacy = incorrect idea / belief
• The fallacy that association is causation
– If two variables are associated in time,
one must necessarily cause the other
• The fallacy of composition
– What is true for the individual, or part,
must necessarily be true for the group, or
the whole
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Pitfalls of Faulty Economic Analysis
• The mistake of ignoring the secondary
effects
– Unintended consequences
• Secondary effects
– Unintended consequences of economic
actions that may develop slowly over
time as people react to events
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30
Exhibit 4Median Annual Pay by College Major
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Appendix
31
Understanding Graphs
• Origin
• Horizontal axis
• Vertical axis
• Graph
• Functional relation
– The value of the dependent variable
depends on the value of the independent
variable
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5
32
Basics of a graph
15
10
5
20
y
Vert
ical axis
a
b
Any point on a graph
represents a combination
of particular values of two
variables.
Here point a represents
the combination of 5 units
of variable x (measured on
the horizontal axis) and 15
units of variable y
(measured on the vertical
axis).
Point b represents 10
units of x and 5 units of y.
0
Origin
2015105 x
Horizontal axis
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33
Exhibit 6U.S. Unemployment rate since 1900
A time-series graph depicts the behavior of some economic variable over time.
Shown here are U.S. unemployment rates since 1900.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix
34
Drawing Graphs
• Types of relations between variables
– Positive; direct
• As one variable increases, the other
increases
– Negative; inverse
• As one variable increases, the other
decreases
– Independent; unrelated
• As one variable increases, the other
remains unchanged
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 7
35
Schedule Relating Distance Traveled to Hours Driven
The distance traveled per day depends on the number of hours driven per day,
assuming an average speed of 50 miles per hour. This table shows combinations of
hours driven and distance traveled. These combinations are shown as points in
Exhibit 7.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 8
36
a
b
c
d
e
Graph Relating Distance Traveled to Hours Driven
0 4321Hours driven per day
5
150
100
50
200
Dis
tance t
ravele
d p
er
day (
mile
s)
250
Points a through e depict different combinations of hours driven per day and the
corresponding distances traveled. Connecting these points creates a graph.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix
37
The Slope of a Straight Line
• Slope
– Change in vertical variable
– For a given increase in horizontal
variable
• Slope = Change in the vertical distance/
Increase in the horizontal distance
• Slope of a straight line
– The same value along the line
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
38
Exhibit 9 (a), (b)Alternative slopes for straight lines
(a) Positive relation
0x
2010
10
15
20
y
5
10
Slope = 5/10 = 0.5
(b) Negative relation
0x
2010
10
3
20
y
10
Slope = - 7 /10 = - 0.7
-7
The slope of a line indicates how much the vertically measured variable changes for
a given increase in the variable measured along the horizontal axis. Panel (a) shows
a positive relation between two variables; the slope is 0.5, a positive number. Panel
(b) depicts a negative, or inverse, relation. When the x variable increases, the y
variable decreases; the slope is 0.7, a negative number.© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
39
Exhibit 9 (c), (d)Alternative slopes for straight lines
(c) No relation: zero slope
0x
2010
10
15
20
y
Slope = 0/10 = 0
(d) No relation: assumed infinite slope
0x
10
10
20
y
10
Slope = 10 /0 = ∞
10
Panels (c) and (d) represent situations in which two variables are unrelated. In panel
(c), the y variable always takes on the same value; the slope is 0. In panel (d), the x
variable always takes on the same value; the slope is mathematically undefined but
we simplify by assuming the slope is infinite.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix
40
Slopes
• Value of slope
– Depends on units of measurement
– Measures marginal effects
• Slope of a curved line
– Differs along the curve
• Slope of a curved line at one point
– Slope of the tangent
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41
Exhibit 10Slope depends on the unit of measure
(a) Measured in feet
0Feet of copper tubing
65
5
$6
Total
cost
1
1
Slope = 1/1 = 1
(b) Measured in yards
0Yards of copper tubing
21
3
$6
Total
cost
3
1
Slope = 3/1 = 3
The value of the slope depends on the units of measure. In panel (a), output is
measured in feet of copper tubing; in panel (b), output is measured in yards.
Although the cost is $1 per foot in each panel, the slope is different in the two
panels because copper tubing is measured using different units.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
42
Exhibit 11Slope at different points on a curved line
0 40302010x
30
20
10
40
y
a
bB
A The slope of a curved line varies
from point to point. At a given
point, such as a or b, the slope of
the curve is equal to the slope of
the straight line that is tangent
to the curve at the point.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 12
43
Curves with both positive and negative slopes
0 x
y
a
b
Some curves have both positive and negative slopes. The hill-shaped curve (in red)
has a positive slope to the left of point a, a slope of 0 at point a, and a negative
slope to the right of that point.
The U-shaped curve (in blue) starts off with a negative slope, has a slope of 0 at
point b, and has a positive slope to the right of that point.
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Appendix
44
Line Shifts
• Change in the assumption
– Changes the relationship between
variables
– Expressed by a line shift
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
45
Exhibit 13
0 4321
Hours driven per day
5
150
100
50
200
Dis
tance t
ravele
d p
er
day (
mile
s)
250
Shift of line relating distance traveled to hours driven
f
T’
d
T
Line T appeared originally in
Exhibit 7 to show the relation
between hours driven and
distance traveled per day,
assuming an average speed of 50
miles per hour. If the average
speed is only 40 miles per hour,
the entire relation shifts to the
right to T, indicating that any given
distance traveled requires more
driving time. For example, 200
miles traveled takes 4 hours of
driving at 50 miles per hour but 5
hours at 40 miles per hour. This
figure shows how a change in
assumptions, in this case, the
average speed assumed, can
shift the entire relationship
between two variables.
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