ECON 203 Week 1

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CASE FAIR OSTER

P R I N C I P L E S O F

MICROECONOMICST E N T H E D I T I O N

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CASE FAIR OSTER

1

PART I INTRODUCTION TO ECONOMICS

The Scope andMethod of conomicsCHAPTER OUTLINE

Why Study Economics?To Learn a Way of Thinking

To Understand Society

To Understand Global Affairs

To Be an Informed Citizen

The Scope of EconomicsMicroeconomics and

Macroeconomics

The Diverse Fields of Economics

The Method of EconomicsDescriptive Economics and

Economic Theory

Theories and Models

Economic Policy

An Invitation

Appendix: How to Read

and Understand Graphs

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economics The study of howindividuals and societies choose to usethe scarce resources that nature andprevious generations have provided.

Economics is the study of how individuals and societies chooseto use the scarce resources that nature and previous generationshave provided. The key word in this definition is choose.

Economics is a behavioral, or social, science. In large measure, itis the study of how people make choices. The choices that peoplemake, when added up, translate into societal choices.

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Three fundamental concepts:

Opportunity cost

Marginalism

Efficient markets

To Learn a Way of Thinking

Why Study Economics?

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Opportunity Cost

opportunity cost The best alternative thatwe forgo, or give up, when we make achoice or a decision.

Scarce resources are the reason for the

existence of opportunity costs.

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Marginalism

marginalism The process of analyzing theadditional or incremental costs or benefitsarising from a choice or decision.

sunk costs Costs that cannot be avoided

because they have already been incurred.

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Efficient MarketsNo Free Lunch

efficient market A market in whichprofit opportunities are eliminatedalmost instantaneously.

The study of economics teaches us a wayof thinking and helps us make decisions.

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To Understand Society


Economic dynamics greatly alter thecomposition of society.

Agrarian societyIndustrial RevolutionIntegrated CircuitsInternetdot com eraInformation Economy

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 essentialto an understanding of global affairs.

To Be an Informed Citizen

To be an informed citizen requires a basicunderstanding of economics.

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"Economics is the science of choice. It began with Aristotle but got mixed up

with ethics in the Middle Ages. Adam Smith separated it from ethics, andWalrus mathematized it. Alfred Marshall tried to narrow it, and Keynesmade is fashionable. Robbins widened it, and Samuelson dynamized it,but modern science made it statistical and tried to confine it again.

But the science won't stay put. It keeps cropping up all over the place. There isan economics of money and trade, of production and consumption, ofdistribution and development. There is also an economics of welfare,manners, language, industry, music, and art. There is an economics ofwar and an economics of power. There is even an economics of love.

Economics seems to apply to every nook and cranny of human experience. Itis an aspect of all conscious action. Whenever decisions are made, thelaw of economy is called into play. Whenever alternatives exist, life takeson an economic aspect. It has always been so. But how can it be?

It can be because economics is more than just the most developed of thesciences of control. It is a way of looking at things, an ordering principle,a complete part of everything. It is a system of thought, a life game, anelement of pure knowledge.

Robert Mundell


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Microeconomics and Macroeconomics

The Scope of Economics

microeconomics The branch of economics thatexamines the functioning of individual industriesand the behavior of individual decision-makingunitsthat is, firms and households.

Microeconomics looks at the individual unitthe household,the firm, the industry. It sees and examines the trees.

Macroeconomics looks at the whole, the aggregate. It seesand analyzes the forest.

macroeconomics The branch of economicsthat examines the economic behavior ofaggregatesincome, employment, output, andso onon a national scale.

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Microeconomics and Macroeconomics


TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

Divisions

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 autoindustry

Minimum wageExecutive salariesPoverty

Employment by

individual businesses

and industries

Jobs in the steelindustry

Number of employeesin a firm

Number ofaccountants

Macroeconomics National

production/output

Total industrial outputGross domestic

productGrowth of output

Aggregate price level

Consumer pricesProducer pricesRate of inflation

National income

Total wages andsalaries

Total corporateprofits

Employment and

unemployment inthe economy

Total number of jobsUnemployment rate

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TABLE 1.2 The Fields of Economics

Behavioral economics uses psychological theories relating to emotions and social context to helpunderstand economic decision making and policy. Much of the work in behavioraleconomics focuses on the biases that individuals have that affects the decisionsthey make.

Comparative economic

systems

examines the ways alternative economic systems function. What are the

advantages and disadvantages of different systems?

Econometrics applies statistical techniques and data to economic problems in an effort to testhypotheses and theories. Most schools require economics majors to take at leastone course in statistics or econometrics.

Economic development focuses on the problems of low-income countries. What can be done to promotedevelopment in these nations? Important concerns of development for economistsinclude population growth and control, provision for basic needs, and strategies forinternational trade.

Economic history traces the development of the modern economy. What economic and political eventsand scientific advances caused the Industrial Revolution? What explains thetremendous growth and progress of post-World War II Japan? What caused theGreat Depression of the 1930s?

Continued...

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TABLE 1.2 The Fields of Economics (continued)

Environmental economics studies the potential failure of the market system to account fully for the impacts ofproduction and consumption on the environment and on natural resource depletion.Have alternative public policies and new economic institutions been effective incorrecting these potential failures?

Finance examines the ways in which households and firms actually pay for, or finance, their

purchases. It involves the study of capital markets (including the stock and bondmarkets), futures and options, capital budgeting, and asset valuation.

Health economics analyzes the health care system and its players: government, insurers, health careproviders, and patients. It provides insight into the demand for medical care, healthinsurance markets, cost-controlling insurance plans (HMOs, PPOs, IPAs),government health care programs (Medicare and Medicaid), variations in medicalpractice, medical malpractice, competition versus regulation, and national healthcare reform.

The history of economic

thought,

which is grounded in philosophy, studies the development of economic ideas andtheories over time, from Adam Smith in the eighteenth century to the works ofeconomists such as Thomas Malthus, Karl Marx, and John Maynard Keynes.Because economic theory is constantly developing and changing, studying thehistory of ideas helps give meaning to modern theory and puts it in perspective.

Industrial organization looks carefully at the structure and performance of industries and firms within aneconomy. How do businesses compete? Who gains and who loses?

Continued...

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TABLE 1.2 The Fields of Economics (continued)

International economics studies trade flows among countries and international financial institutions. What arethe advantages and disadvantages for a country that allows its citizens to buy andsell freely in world markets? Why is the dollar strong or weak?

Labor economics deals with the factors that determine wage rates, employment, and unemployment.How do people decide whether to work, how much to work, and at what kind of job?

How have the roles of unions and management changed in recent years?

Law and economics analyzes the economic function of legal rules and institutions. How does the lawchange the behavior of individuals and businesses? Do different liability rules makeaccidents and injuries more or less likely? What are the economic costs of crime?

Public economics examines the role of government in the economy. What are the economic functionsof government, and what should they be? How should the government finance theservices that it provides? What kinds of government programs should confront theproblems of poverty, unemployment, and pollution? What problems doesgovernment involvement create?

Urban and regional

economics

studies the spatial arrangement of economic activity. Why do we have cities? Whyare manufacturing firms locating farther and farther from the center of urban areas?

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The Method of Economics

positive economics An approach to economics thatseeks to understand behavior and the operation ofsystems without making judgments. It describes whatexists and how it works.

normative economics An approach to economicsthat analyzes outcomes of economic behavior,evaluates them as good or bad, and may prescribecourses of action. Also calledpolicy economics.

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Descriptive Economics and Economic Theory


descriptive economics The compilation ofdata that describe phenomena and facts.

economic theory A statement or set ofrelated statements about cause and effect,action and reaction.

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Theories and Models


model A formal statement of a theory, usuallya mathematical statement of a presumedrelationship between two or more variables.

variable A measure that can change from timeto time or from observation to observation.

Ockhams razorThe principle that irrelevantdetail should be cut away.

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All Else Equal: Ceteris Paribus

ceter is par ibu s, orall else equal A device

used to analyze the relationship betweentwo variables while the values of othervariables are held unchanged.

Theories and Models


Using the device of ceteris paribus is one part of the process of

abstraction. In formulating economic theory, the concept helpsus simplify reality to focus on the relationships that interest us.

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Expressing Models in Words, Graphs, and Equations

Theories and Models


Methods of expressing the quantitative relationship between two variables:

Graphing (as presented in appendix)

Equations, for example:

C= .90 Y and S= .10Y

If over time U.S. households collectively spend, or consume, 90percent of their income and save 10 percent of their income, wecould then write:

where Cis consumption spending, Yis income, and S is saving.

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Cautions and Pitfalls

Theories and Models


The Post Hoc Fallacy

post ho c, ergo p ropter hocLiterally, afterthis (in time), therefore because of this. A

common error made in thinking aboutcausation: If Event A happens before EventB, it is not necessarily true that A caused B.

The Fallacy of Composition

fallacy of composition The erroneousbelief that what is true for a part isnecessarily true for the whole.

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Testing Theories and Models: Empirical Economics

Theories and Models


empirical economics The collection and use

of data to test economic theories.

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Economic Policy


Criteria for judging economic outcomes:

1. Efficiency

2. Equity3. Growth

4. Stability

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Efficiency

Economic Policy


Equity

efficiency In economics, allocative efficiency. An

efficient economy is one that produces whatpeople want at the least possible cost.

equity Fairness.

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Growth

Economic Policy


Stability

economic growth An increase in the total

output of an economy.

stability A condition in which nationaloutput is growing steadily, with low inflationand full employment of resources.

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You cannot begin to understand how a societyfunctions without knowing something about itseconomic history and its economic system.

Learning to think in this very powerful way will

help you better understand the world.

As you proceed, it is important that you keep trackof what you have learned in earlier chapters. Thiscourse has a plan; it proceeds step-by-step, eachsection building on the last. Make sure you

understand where it fits in the big picture.

An Invitation

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A graph is a two-dimensional representationof a set of numbers, or data.

How to Read and Understand Graphs

CHAPTER 1 APPENDIX

A time series graph shows how a singlemeasure or variable changes over time.

Time Series Graphs

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Time Series Graphs

TABLE 1A.1 Total Disposable

Personal Income in the United States,

19752009 (in billions of dollars)

Year

Total

Disposable

Personal

Income Year

Total

Disposable

Personal

Income

19751976197719781979198019811982198319841985198619871988198919901991

1992

1,187.31,302.31,435.01,607.31,790.82,002.72,237.12,412.72,599.82,891.53,079.33,258.83,435.33,726.33,991.44,254.04,444.9

4,736.7

19931994199519961997199819992000200120022003200420052006200720082009

4,921.65,184.35,457.05,759.66,074.66,498.96,803.37,327.27,648.58,009.78,377.88,889.49,277.39,915.7

10,403.110,806.410,923.6

FIGURE 1A.1 Total Disposable PersonalIncome in the United States: 19752009 (in

billions of dollars)

CHAPTER 1 APPENDIX

Appendix

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Graphing Two Variables on a Cartesian Coordinate System

Appendix

FIGURE 1A.2 A Cartesian CoordinateSystem

A Cartesian coordinate system is

constructed by drawing two

perpendicular lines: a vertical

axis (the Y-axis) and a horizontalaxis (theX-axis). Each axis is a

measuring scale.


CHAPTER 1 APPENDIX

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A graph is a simple two-dimensional geometric

representation of data.

This graph displays the data from Table 1A.2.

Along the horizontal scale (X-axis), we measure

household income. Along the vertical scale (Y-

axis), we measure household consumption.

Note: At pointA, consumption equals $22,304

and income equals $10,263.

At point B, consumption equals $31,751 and

income equals $27,442.

TABLE 1A.2 Consumption Expenditures

and Income, 2008

Average Income

before Taxes

Average

Consumption

Expenditures

Bottom fifth2nd fifth3rd fifth4th fifthTop fifth

$ 10,26327,44247,19674,090

158,652

$ 22,30431,75142,65958,63297,003

FIGURE 1A.3 Household Consumption andIncome

Plotting Income and Consumption Data for Households


CHAPTER 1 APPENDIX

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Slope

FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope

2 1

2 1

Y YY

X X X


Apositive slope indicates that increases inXare

associated with increases in Yand that decreases

inXare associated with decreases in Y.

A negative slope indicates the opposite

whenXincreases, Ydecreases; and when

Xdecreases, Yincreases.

CHAPTER 1 APPENDIX

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FIGURE 1A.5 Changing Slopes along Curves


Slope

CHAPTER 1 APPENDIX

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TABLE 1A.3 Aggregate National Income and

Consumption for the United States,19302009 (in billions of dollars)

Aggregate National Income Aggregate Consumption

193019401950196019701980

1990200020052006200720082009

82.990.9

263.9473.9929.5

2433.0

5059.88938.911,273.812,031.212,448.212,635.212,280.0

70.171.3

192.2331.8648.3

1,755.8

3,835.56,830.48,819.09,322.79,826.4

10,129.910,089.1

FIGURE 1A.6 National Income andConsumption

Some Precautions

It is important to think carefully about what is

represented by points in the space defined by the

axes of a graph.

In this graph, we have graphed income with

consumption, as in Figure 1A.3, but here each

observation point is national income and aggregate

consumption in different years, measured in billions

of dollars

CHAPTER 1 APPENDIX

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