Ch. 1: What is Economics?

Objectives• Define economics and distinguish between

microeconomics and macroeconomics• Explain the big questions of economics• Explain the key ideas that define the economic way of

thinking• Explain how economists go about their work as social

scientists

Definition of Economics

Social science that studies the choices that individuals, businesses, governments, and societies make as they cope with scarcity and the incentives that influence and reconcile those choices.

Micro vs Macro

Microeconomics – study of choices made by individuals and

businesses, and the influence of government on those choices.

Macroeconomics – study of the effects on the national and global

economy of the choices that individuals, businesses, and governments make.

Economic Questions

What to produce? How to produce?

Factors of production: Land earns rent Labor earns wages Capital earns interest/dividends Entrepreneurship earns profits

For whom to produce?

Free market vs. Command

• Free market allows individuals and businesses to decide without government intervention.

• Command centralizes all decisions.• Mixed market is a combination of extremes.

– Examples:• Education• Transportation• Energy

Types of government intervention

• Direct control – national defense, police, roads

• Price Controls• Subsidies

– Ethanol, hybrid cars, crops

• Taxes– Tariffs on imports, cigarettes, gasoline

• Regulation– Anti-trust– Laws designed to encourage competition.

Views on government intervention

• Communists versus Capitalists

• Democrats versus Republicans

• Equity versus Efficiency

Economic Questions Public ownership and central planning vs. free

markets• State supported education• Nationalized healthcare• Nationalized industries (oil, rail, postal service)

• Government intervention in markets• Price controls• Subsidies / taxes• Anti-trust policy• Maintaining a “competitive” environment• Government ownership/control of resources

Economic Growth

• Economic growth is an expansion in an economy’s ability to produce goods and services.

• Economic growth is affected by:– Capital goods vs consumer goods.– Education and training.– Research and development (new tech)

Why does income per capita vary so much around the world?

The Economic Way of Thinking

• Economists assume individuals compare costs and benefits in decision making.

• Cost is measured by opportunity cost.– the highest-valued alternative that we give up

to get something is the opportunity cost of the activity chosen.

The Economic Way of Thinking

• Economists assume that people make decisions “on the margin”– evaluate the consequences of making incremental

changes in the use of their resources.– Marginal Benefit (MB): the benefit from pursuing an

incremental increase in an activity.– Marginal Cost (MC): The opportunity cost of

pursuing an incremental increase in an activity.• If MB>MC pursue more of the activity.• If MB<MC pursue less of the activity.

The Economic Way of Thinking

• Economists assume people respond to incentives.– Incentives can affect MB or MC

• Taxes• Subsidies• Employer compensation methods.

– Incentives are key to reconciling self-interest and the social interest.

• Pollution• Crime• Steroids in athletic competition

The Economic Way of Thinking

• Two types of economic statements: What is—positive statements What ought to be—normative statements

– A positive statement can be tested by checking it against facts

– A normative statement cannot be tested.

The Economic Way of Thinking

• Model Building– economic model is 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.

• Testing Models– economic theory is a generalization that

summarizes what we think we understand about the economic choices that people make and the performance of industries and entire economies.

–

The Economic Way of Thinking

• Obstacles and Pitfalls in Economics– Ceteris paribus (other things being the same):

• To isolate the effect of interest, economists use the logical device called ceteris paribus or “other things being equal”, or “other things being the same”.

– The fallacy of composition:• The false conclusion that

– what is true for the parts is true for the whole– what is true for the whole is true for the parts.

The post hoc fallacy • the error of reasoning that a first event causes a second

event because the first occurs before the second