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WHAT IS
ECONOMICS? 1Part
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Objectives
After studying this chapter, you will be able to:
Define economics and distinguish betweenmicroeconomics 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 aboutthe 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 thepowerful forces that shape and change our world.
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Definition of Economics
Scarcity
All economic questions arise because we are unable tosatisfy all our wantsbecause we face scarcity.
Economics is the social science that studies the choicesthat individuals, businesses, governments, and societiesmake as they cope with scarcity.
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Definition of Economics
Microeconomics
Microeconomics is the study of choices made byindividuals and businesses, and the influence ofgovernment on those choices.
Macroeconomics
Macroeconomics is the study of the effects on thenational and global economy of the choices that
individuals, businesses, and governments make.
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Three Big Microeconomic Questions
Microeconomics seeks to understand what determines:
What goods and services are produced
How goods and services are produced
For whom goods and services are produced
Goods and services are the objects that people valueand produce to satisfy wants.
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Three Big Microeconomic Questions
What Goods and Services
are Produced?
Figure 1.1 shows themajor items produced inthe U.S. economy today.
It emphasizes thedominant place of servicesin our economy.
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Three Big Microeconomic Questions
Figure 1.2 shows thetrends in what the U.S.economy has producedover the past 60 years.
It shows the decline ofagriculture, mining,construction, andmanufacturing, and theexpansion of services.
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Three Big Microeconomic Questions
The facts about what weproduce raise the deeperquestion: What determines
the quantities of realtorservices, new homes, DVDplayers, and corn that weproduce?
Microeconomics providessome answers to thesequestions.
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Three Big Microeconomic Questions
How are Goods and Services Produced?
Factors of production are the resources that businessesuse to produce goods and services.
They are grouped into four categories:
Land
Labor
Capital
Entrepreneurship
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Three Big Microeconomic Questions
The gifts of nature that we use to produce goods and
services are land.
The work time and effort that people devote to producinggoods and services is labor.
The qualityof labor depends on human capital, which is
the knowledge and skill that people obtain from education,on-the-job training, and work experience.
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Three Big Microeconomic Questions
The tools, instruments, machines, buildings, and otherconstructions that are used to produce goods and servicesare capital.
The human resource that organizes land, labor, andcapital is entrepreneurship.
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Three Big Microeconomic Questions
Figure 1.3 shows ameasure of the growth ofhuman capital in the
United States over the lastcenturythe percentageof the population that hascompleted different levels
of education.
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Three Big Microeconomic Questions
The facts about how weproduce raise the deeperquestion: What determines
the quantities of capital,labor, and other resourcesthat get used to producegoods and services?
Microeconomics providessome answers to thisquestion.
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Three Big Microeconomic Questions
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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Three Big Microeconomic Questions
Figure 1.4 shows thedistribution of income in
the United States.
The richest 20 percentearn almost 50 percent oftotal income while the
poorest 20 percent earnonly 4 percent of totalincome.
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Three Big Microeconomic Questions
The facts about for whomraise the deeper question:
What determines earnings
and the distribution ofincome that in turndetermine who gets thegoods and servicesproduced?
Microeconomics providessome answers to thisquestion.
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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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Three Big Macroeconomic Questions
What Determines the Standard of Living?
The standard of living is the level of consumption that
people enjoy on the average and is measured by averageincome per person.
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Figure 1.5shows incomeper person per day in anumber of countries andregions.
The United States has oneof the highest standards ofliving, and the nations ofAfrica have the lowest.
Three Big Macroeconomic Questions
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Macroeconomics seeks toexplain differences in thestandard of living across
countries.Macroeconomics alsoseeks to explain the rate atwhich the standard of
living changes.
Three Big Macroeconomic Questions
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Three Big Macroeconomic Questions
What Determines the Cost of Living?
The cost of living is the amount of money it takes to buythe 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 typicalfamily consumes.
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Three Big Macroeconomic Questions
Table 1.1 shows the priceof a Big Mac in ten
countries.
The number of money unitsvaries a lot, but the cost issimilar in each country.
What matters is the rate atwhich 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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Three Big Macroeconomic Questions
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 deflationbrings 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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Three Big Macroeconomic Questions
Why Does Our Economy Fluctuate?
The business cycle is the periodic but irregular up-and-
down movement in production and jobs in an economy.During 2001, the U.S. economy entered a mildrecessionproduction 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 andturning points of a business cycle.
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Three Big Macroeconomic Questions
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Three Big Macroeconomic Questions
Why Does Our Economy Fluctuate?
Economists remain unsure about the sources of economicfluctuations and about the actions that might be taken tosmooth 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
The economic way of thinkingplaces scarcityand itsimplication, choice, at center stage.
You can think about every choice as a tradeoffanexchangegiving up one thing to get something else.
The classic tradeoff is guns versus butter.
Guns and butter stand foranytwo objects of value.
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The Economic Way of Thinking
Microeconomic Tradeoffs
How?Tradeoffsarise when businesses choose amongalternative production technologies.
For Whom?Tradeoffsarise when choices change thedistribution of buying power across individuals.Government redistribution of income from the rich to thepoor creates the big tradeoffthe tradeoff between
equality and efficiency.
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The Economic Way of Thinking
Macroeconomic Tradeoffs
Standard of Living Tradeoffsarise when we choosebetween current consumption and activities that increase
our standard of living.
Activities such as saving and investing, education, andresearch increase future production and consumptionpossibilities, which increases the standard of living.
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The Economic Way of Thinking
Macroeconomic Tradeoffs
An Output-Inflation Tradeoffarises when policymakerschoose how much inflation to endure in order to maintain a
high level of production.
An output-inflation tradeoff arises because a policyaction that lowers inflation also lowers output and a policyaction that boosts output increases inflation.
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The Economic Way of Thinking
Opportunity Cost
Thinking about a choice as a tradeoff emphasizes cost asan opportunity forgone.
The highest-valued alternative that we give up to getsomething is the opportunity cost of the activity chosen.
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The Economic Way of Thinking
Margins and Incentives
People make choices at themargin, which means thatthey evaluate the consequences of making incremental
changesin the use of their resources.
The benefit from pursuing an incremental increase in anactivity is its marginal benefit.
The opportunity cost of pursuing an incremental increasein an activity is its marginal cost.
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The Economic Way of Thinking
Margins and Incentives
Marginal benefit and marginal cost act as an incentiveaninducement to take a particular action.
For any activity, if marginal benefit exceeds marginal cost,people have an incentive to do more of that activity
If marginal cost exceeds marginal benefit, people have anincentive to do less of that activity.
Economists seek to predict choices by looking at changesin incentives.
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Economics: A Social Science
Social Science
Economics is a social science.
Economists distinguish between two types of statements:
What ispositivestatements
What ought to benormativestatements
A positive statement can be tested by checking it againstfacts
A normative statement cannot be tested.
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Economics: A Social Science
Social science
The task of economic science is to discover positivestatements that are consistent with what we observe in theworld 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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Economics: A Social Science
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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Economics: A Social Science
Model Building
Aneconomic model is a description of some aspect ofthe economic world that includes only those features ofthe world that are needed for the purpose at hand.
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Economics: A Social Science
Testing Models
An economic theory is a generalization that summarizeswhat we think we understand about the economic choicesthat people make and the performance of industries and
entire economies.
A theory is a bridge between a model and reality. It is aproposition about which model works.
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Economics: A Social Science
Obstacles and Pitfalls in Economics
Economists cannot easily do experiments and mosteconomic behavior has many simultaneous causes.
To isolate the effect of interest, economists use the logicaldevice called ceteris paribusor other things being equal.
Economists try to isolate cause-and-effect relationships bychanging only one variable at a time, holding all other
relevant factors unchanged.
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Economics: A Social Science
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.
The post hoc fallacyfrom the Latin term post hoc, ergopropter 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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Economics: A Social Science
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 propositionsthat at least 70 percent of all economists polled agreed on.
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WHAT IS
ECONOMICS? 1CHAPTER
THE END