The Scope and Method of Economics

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

  C H A P T E R

 

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Prepared by:  Fernando Quijano  and Yvonn Quijano

 

The Scope and Method of Economics

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Study of Economics

 

• Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Why Study Economics?

 

• Probably the most important reason for studying economics is to learn a way of thinking.
• Three fundamental concepts:
• Opportunity cost
• Marginalism, and
• Efficient markets

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Opportunity Cost

 

• Opportunity cost is the best alternative that we forgo, or give up, when we make a choice or a decision.
• Opportunity costs arise because time and resources are scarce. Nearly all decisions involve trade-offs.

 

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Marginalism

 

• In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that arise from the decision.
• For example, when deciding whether to produce additional output, a firm considers only the additional (or marginal cost), not the sunk cost.
• Sunk costs are costs that cannot be avoided, regardless of what is done in the future, because they have already been incurred.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Efficient Markets

 

• An efficient market is one in which profit opportunities are eliminated almost instantaneously.
• There is no free lunch! Profit opportunities are rare because, at any one time, there are many people searching for them.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

More Reasons to Study Economics

 

• Economics involves the study of societal and global affairs concerning resource allocation.
• Economics is helpful to us as voters. Voting decisions require a basic understanding of economics.
• Money and financial systems are an important component of the economic system, but are not the most fundamental issue in economics.

 

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Scope of Economics

 

• Microeconomics is the branch of economics that examines the functioning of individual industries and the behavior of individual decision-making units—that is, business firms and households.
• Macroeconomics is the branch of economics that examines the economic behavior of aggregates— income, output, employment, and so on—on a national scale.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Diverse Fields of Economics

 

Employment by Individual Businesses  & Industries

Jobs in the steel industry

Number of employees in a  firm

 

Distribution of Income and Wealth

 

Wages in the auto  

industry

Minimum wages

Executive salaries

Poverty

 

Price of Individual Goods and Services

 

Price of medical care

Price of gasoline

Food prices

Apartment rents

 

Production/Output in Individual Industries  and Businesses

 

How much steel

How many offices

How many cars

 

Microeconomics

 

Employment and Unemployment in  the Economy

 

Total number of jobs

Unemployment rate

 

National Income

Total wages and salaries  

 

Total corporate profits

 

Aggregate Price Level

 

Consumer prices

Producer Prices

Rate of Inflation

 

National Production/Output

 

Total Industrial Output

Gross Domestic Product

Growth of Output

 

Macroeconomics

 

Employment

 

Income

 

Prices

 

Production

 

Examples of microeconomic and  macroeconomic concerns

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Method of Economics

 

• Normative economics, also called policy economics, analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action.
• Positive economics studies economic behavior without making judgments. It describes what exists and how it works.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Method of Economics

 

• Positive economics includes:
• Descriptive economics, which involves the compilation of data that describe phenomena and facts.
• Economic theory that involves building models of behavior. A theory is a statement or set of related statements about cause and effect, action and reaction.
• Empirical economics refers to the collection and use of data to test economic theories.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Theories and Models

 

• A theory is a general statement of cause and effect, action and reaction. Theories involve models, and models involve variables.
• A model is a formal statement of a theory. Models are descriptions of the relationship between two or more variables.
• Ockham’s razor is the principle that irrelevant detail should be cut away. Models are simplifications, not complications, of reality.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Theories and Models

 

• A variable is a measure that can change from observation to observation.
• Using the ceteris paribus, or all else equal, assumption, economists study the relationship between two variables while the values of other variables are held unchanged.
• The ceteris paribus device is part of the process of abstraction used to focus only on key relationships.

 

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Theories and Models

 

• In formulating theories and models we must avoid two pitfalls:
• The Post Hoc Fallacy: It is erroneous to believe that if event A happened before event B, then A caused B.
• The Fallacy of Composition: It is erroneous to believe that what is true for a part is also true for the whole. Theories that seem to work well when applied to individuals often break down when they are applied to the whole.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Economic Policy

 

Criteria for judging economic outcomes:

• Efficiency, or allocative efficiency. An efficient economy is one that produces what people want at the least possible cost.
• Equity, or fairness of economic outcomes.
• Growth, or an increase in the total output of an economy.
• Stability, or the condition in which output is steady or growing, with low inflation and full employment of resources.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

How to Read and Understand  Graphs

 

• Each point on the Cartesian plane is a combination of (X,Y) values.

 

• The relationship between X and Y is causal.  For a given value of X, there is a corresponding value of Y, or X causes Y.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Reading Between the Lines

 

• A line is a continuous string of points, or sets of (X,Y) values on the Cartesian plane.

 

• The relationship between X and Y on this graph is negative.  An increase in the value of X leads to a decrease in the value of Y, and vice versa.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Positive and Negative Relationships

 

A downward-sloping line describes a negative relationship between X and Y.

 

An upward-sloping line describes a positive relationship between X and Y.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Components of a Line

 

• The algebraic expression of this line is as follows:

 

Y = a + bX

where:

Y = dependent variable

X = independent variable

 

a = Y-intercept, or value of 
Y when X = 0.

 

b = slope of the line, or the 
rate of change in Y 
given a change in X.

 

+ = positive relationship 
between X and Y

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Different Slope Values

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Strength of the Relationship Between 
X and Y

 

• This line is relatively flat. Changes in the value of X have only a small influence on the value of Y.

 

• This line is relatively steep. Changes in the value of X have a greater influence on the value of Y.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

The Difference Between a Line  and a Curve

 

Equal increments in X lead to diminished increases in Y.

 

Equal increments in X lead to constant increases in Y.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

 

Interpreting the Slope of a  Curve

 

• Graph A has 
  a positive and decreasing slope.

 

• Graph B has 
  a negative slope, then a positive slope.

 

• Graph C shows a negative and increasing relationship between X and Y.

 

• Graph D shows a negative and decreasing slope. 

 

Opportunity cost does not have to be  measured in dollar terms.  The value  of an alternative activity is usually  measured in both monetary and nonmonetary  costs.

Opportunity cost is referred to as implicit cost. Accountants count only explicit costs. Economic cost is higher than accounting costs because it includes implicit, or opportunity, cost.