ECO 201 Chapter 1, Fall 2016

2 of  36 © 2014 Pearson Education, Inc. 3 of  36 © 2014 Pearson Education, Inc. 1 PART I INTRODUCTION TO ECONOMICS The Scope and Method of Economics C  H  A  P  T  E  R      O  U  T  L  I  N  E Why Study Economics? To Learn a Way of Thinking To Understand Society To Be an Informed Citizen The Scope of Economics Microeconomics and Macroeconomics The Diverse Fields of Economics The Method of Economics Theories and Models Economic Policy An Invitation Appendix: How to Read and Understand Graphs 4 of  36 © 2014 Pearson Education, Inc. economics The  study  of  how  individuals  and  societies  choose  to  use  the scarce  resources  that  nature  and  previous  generations  have  provided. The  key  word  in  this  definition  is  choose. Economics  is  a  behavioral,  or  social,  science.  In  large  measure,  it  is  the  study of  how  people  make  choices.  The  choices  that  people  make,  when  added  up, translate  into  societal  choices. 5 of  36 © 2014 Pearson Education, Inc. Three  fundamental  concepts: § Opportunity  cost § Marginalism § Efficient  markets To  Learn  a  Way  of  Thinking Why  Study  Economics? 6 of  36 © 2014 Pearson Education, Inc. Opportunity  Cost opportunity  cost The  best  alternative  that  we  forgo,  or  give  up,  when  we make  a  choice  or  a  decision. scarce Limited. 7 of  36 © 2014 Pearson Education, Inc. Marginalism marginalism The  process  of  analyzing  the  additional  or  incremental  costs  or benefits  arising  from  a  choice  or  decision. Efficient  Markets—No  Free  Lunch efficient  market A  market  in  which  profit  opportunities  are  eliminated  almost instantaneously. The  study  of  economics  teaches  us  a  way  of  thinking  and  helps  us make  decisions. 8 of  36 © 2014 Pearson Education, Inc. To  Understand  Society Industrial  Revolution The  period  in  England  during  the  late  eighteenth  and early  nineteenth  centuries  in  which  new  manufacturing  technologies  and improved  transportation  gave  rise  to  the  modern  factory  system  and  a massive  movement  of  the  population  from  the  countryside  to  the  cities. The  study  of  economics  is  an  essential  part  of  the  study  of  society. To  Be  an  Informed  Citizen To  be  an  informed  citizen  requires  a  basic  understanding  of  economics. 9 of  36 © 2014 Pearson Education, Inc. E C O N O M I C S I N P R A C T I C E iPod  and  the  World A  sticker  that  says  “Made  in  China”  can often  be  misleading. Indeed,  for  the  iPod,  which  is  composed  of many  small  parts,  it  is  almost  impossible  to accurately  tell  exactly  where  each  piece was  produced  without  pulling  it  apart. From  an  economics  point  of  view,  one often  has  to  dig  a  little  deeper  to  see  what is  really  going  on. THINKING  PRACTICALLY 1. What  do  you  think  accounts  for  where components  of  the  iPod  are  made? 10 of  36 © 2014 Pearson Education, Inc. Microeconomics  and  Macroeconomics The  Scope  of  Economics microeconomics The  branch  of  economics  that  examines  the  functioning of  individual  industries  and  the  behavior  of  individual  decision-­making units—that  is,  firms  and  households. Microeconomics  looks  at  the  individual  unit—the  household,  the  firm,  the industry.  It  sees  and  examines  the  “trees.” Macroeconomics  looks  at  the  whole,  the  aggregate.  It  sees  and  analyzes the  “forest.” macroeconomics The  branch  of  economics  that  examines  the  economic behavior  of  aggregates—income,  employment,  output,  and  so  on—on  a national  scale. 11 of  36 © 2014 Pearson Education, Inc. TABLE  1.1    Examples  of  Microeconomic   and  Macroeconomic   Concerns Division of  Economics Production Prices Income Employment Microeconomics Production/output in  individual industries  and businesses How  much  steel How  much  office space How  many  cars Prices  of  individual goods  and  services Price  of  medical  care Price  of  gasoline Food  prices Apartment  rents Distribution  of income  and wealth Wages  in  the auto  industry Minimum   wage Executive salaries Poverty Employment  by individual businesses  and industries Jobs  in  the  steel industry Number  of employees  in  a  firm Number  of accountants Macroeconomics National production/output Total  industrial output Gross  domestic product Growth  of  output Aggregate  price  level Consumer  prices Producer  prices Rate  of  inflation National  income Total  wages  and salaries Total  corporate profits Employment  and unemployment   in the  economy Total  number  of  jobs Unemployment   rate 12 of  36 © 2014 Pearson Education, Inc. The  Diverse  Fields  of  Economics TABLE  1.2    The  Fields  of  Economics Behavioral  economics uses  psychological  theories  relating  to  emotions  and  social  context  to  help understand  economic  decision  making  and  policy.  Much  of  the  work  in behavioral  economics  focuses  on  the  biases  that  individuals  have  that  affect the  decisions  they  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 test  hypotheses  and  theories.  Most  schools  require  economics  majors  to  take at  least  one  course  in  statistics  or  econometrics. Economic  development focuses  on  the  problems  of  low-­income  countries.  What  can  be  done  to promote  development  in  these  nations?  Important  concerns  of  development for  economists  include  population   growth  and  control,  provision  for  basic needs,  and  strategies  for  international   trade. Economic  history traces  the  development  of  the  modern  economy.  What  economic  and  political events  and  scientific  advances  caused  the  Industrial  Revolution?  What explains  the  tremendous  growth  and  progress  of  post-­World  War  II  Japan? What  caused  the  Great  Depression  of  the  1930s? Continued... 13 of  36 © 2014 Pearson Education, Inc. TABLE  1.2    The  Fields  of  Economics  (continued) Environmental economics studies  the  potential   failure  of  the  market  system  to  account  fully  for  the impacts  of  production  and  consumption  on  the  environment   and  on  natural resource  depletion.   Have  alternative  public  policies  and  new  economic institutions  been  effective  in  correcting  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  bond  markets),  futures  and  options,  capital  budgeting,   and  asset valuation. Health  economics analyzes  the  health  care  system  and  its  players:  government,  insurers,  health care  providers,  and  patients.  It  provides  insight  into  the  demand  for  medical care,  health  insurance  markets,  cost-­controlling  insurance  plans  (HMOs, PPOs,  IPAs),  government  health  care  programs  (Medicare  and  Medicaid), variations  in  medical  practice,  medical  malpractice,  competition   versus regulation,   and  national  health  care  reform. The  history  of  economic thought, which  is  grounded  in  philosophy,  studies  the  development   of  economic  ideas and  theories  over  time,  from  Adam  Smith  in  the  eighteenth   century  to  the works  of  economists  such  as  Thomas  Malthus,  Karl  Marx,  and  John  Maynard Keynes.  Because  economic  theory  is  constantly  developing   and  changing, studying  the  history  of  ideas  helps  give  meaning  to  modern  theory  and  puts  it in  perspective. Continued... The  Diverse  Fields  of  Economics 14 of  36 © 2014 Pearson Education, Inc. TABLE  1.2    The  Fields  of  Economics  (continued) Industrial  organization looks  carefully  at  the  structure  and  performance  of  industries  and  firms  within an  economy.  How  do  businesses  compete?  Who  gains  and  who  loses? International   economics studies  trade  flows  among  countries  and  international   financial  institutions. What  are  the  advantages  and  disadvantages  for  a  country  that  allows  its citizens  to  buy  and  sell  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 law  change  the  behavior  of  individuals  and  businesses?  Do  different  liability rules  make  accidents  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 functions  of  government,   and  what  should  they  be?  How  should  the government  finance  the  services  that  it  provides?  What  kinds  of  government programs  should  confront  the  problems  of  poverty,  unemployment,   and pollution?   What  problems  does  government  involvement  create? Urban  and  regional economics studies  the  spatial  arrangement  of  economic  activity.  Why  do  we  have  cities? Why  are  manufacturing  firms  locating  farther  and  farther  from  the  center  of urban  areas? The  Diverse  Fields  of  Economics 15 of  36 © 2014 Pearson Education, Inc. The  Method  of  Economics positive  economics An  approach  to  economics  that  seeks  to  understand behavior  and  the  operation  of  systems  without  making  judgments. It  describes  what  exists  and  how  it  works. normative  economics An  approach  to  economics  that  analyzes  outcomes of  economic  behavior,  evaluates  them  as  good  or  bad,  and  may  prescribe courses  of  action.  Also  called  policy  economics. 16 of  36 © 2014 Pearson Education, Inc. Theories  and  Models model A  formal  statement  of  a  theory,  usually  a  mathematical  statement  of  a presumed  relationship  between  two  or  more  variables. variable A  measure  that  can  change  from  time  to  time  or  from  observation  to observation. Ockham’s  razor The  principle  that  irrelevant  detail  should  be  cut  away. 17 of  36 © 2014 Pearson Education, Inc. All  Else  Equal:  Ceteris  Paribus ceteris  paribus,  or all  else  equal A  device  used  to  analyze  the  relationship between  two  variables  while  the  values  of  other  variables  are  held unchanged. Using  the  device  of  ceteris  paribus is  one  part  of  the  process  of  abstraction. In  formulating  economic  theory,  the  concept  helps  us  simplify  reality  to  focus on  the  relationships  that  interest  us. 18 of  36 © 2014 Pearson Education, Inc. Expressing  Models  in  Words,  Graphs,  and  Equations We  use  both  graphs  and  equations  to  capture  the  quantitative  side  of  our economic  observations  and  predictions. 19 of  36 © 2014 Pearson Education, Inc. Cautions  and  Pitfalls What  Is  Really  Causal? post  hoc,  ergo  propter  hoc Literally,  “after  this  (in  time),  therefore  because of  this.” A  common  error  made  in  thinking  about  causation:  If  Event  A  happens  before Event  B,  it  is  not  necessarily  true  that  A  caused  B. The  Fallacy  of  Composition fallacy  of  composition The  erroneous  belief  that  what  is  true  for  a  part  is necessarily  true  for  the  whole. 20 of  36 © 2014 Pearson Education, Inc. Testing  Theories  and  Models:  Empirical  Economics empirical  economics The  collection  and  use  of  data  to  test  economic theories. 21 of  36 © 2014 Pearson Education, Inc. E C O N O M I C S I N P R A C T I C E Does  Your  Roommate  Matter  for  Your  Grades? If  you  choose  mischievous  friends  and  you  misbehave,  are  your  friends  causing your  misbehavior  or  does  an  inclination  toward  mischief  cause  your  choice  of friends? Several  recent  economics  studies  of  the  effect  of  roommates  on  college  grades help  to  sort  out  causality  in  peer  effects. Bruce  Sacerdote,  a  professor  at  Dartmouth  college—one  of  many  schools  that randomly  assign  roommates  to  freshmen—used  data  on  freshmen  academic and  social  performance,  combined  with  their  background  data,  to  test  the  peer effects  from  different  types  of  roommates. He  found  strong  roommate  effects  on  grade  point  average,  effort  in  school,  and fraternity  membership. THINKING  PRACTICALLY 1. Would  you  expect  college  seniors  who  choose  their  own  roommates  to  have  more  or less  similar  grades  than  college  freshmen  who  are  assigned  as  roommates? Why  or  why  not? 22 of  36 © 2014 Pearson Education, Inc. Economic  Policy Four  criteria  in  judging  economic  outcomes: 1. Efficiency 2. Equity 3. Growth 4.    Stability 23 of  36 © 2014 Pearson Education, Inc. Efficiency Equity efficiency In  economics,  allocative  efficiency.  An  efficient  economy  is  one  that produces  what  people  want  at  the  least  possible  cost. equity Fairness. 24 of  36 © 2014 Pearson Education, Inc. Growth Stability economic  growth An  increase  in  the  total  output  of  an  economy. stability A  condition  in  which  national  output  is  growing  steadily,  with  low inflation  and  full  employment  of  resources. 25 of  36 © 2014 Pearson Education, Inc. You  cannot  begin  to  understand  how  a  society  functions  without  knowing something  about  its  economic  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  track  of  what  you  have learned  in  earlier  chapters.  This  book  has  a  plan;;  it  proceeds  step-­by-­step, each  section  building  on  the  last.  Make  sure  you  understand  where  it  all fits  in  the  big  picture. An  Invitation 26 of  36 © 2014 Pearson Education, Inc. R  E  V  I  E  W    T  E  R  M  S    A  N  D    C  O  N  C  E  P  T  S ceteris  paribus, or all  else  equal economic  growth economics efficiency efficient  market empirical  economics equity fallacy  of  composition Industrial  Revolution macroeconomics marginalism microeconomics model normative  economics Ockham’s  razor opportunity  cost positive  economics post  hoc,  ergo  propter  hoc scarce stability variable 27 of  36 © 2014 Pearson Education, Inc. A  graph is  a  two-­dimensional  representation  of  a  set  of  numbers,  or  data. How  to  Read  and  Understand  Graphs CHAPTER  1  APPENDIX A  time  series  graph shows  how  a  single  measure  or  variable  changes over  time. Time  Series  Graphs 28 of  36 © 2014 Pearson Education, Inc. TABLE  1A.1    Total  Disposable  Personal Income  in  the  United  States,  1975–2012 (in  billions  of  dollars) Year Total Disposable Personal Income Year Total Disposable Personal Income 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1,187.3 1,302.3 1,435.0 1,607.3 1,790.8 2,002.7 2,237.1 2,412.7 2,599.8 2,891.5 3,079.3 3,258.8 3,435.3 3,726.3 3,991.4 4,254.0 4,444.9 4,736.7 4,921.6 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 5,184.3 5,457.0 5,759.6 6,074.6 6,498.9 6,803.3 7,327.2 7,648.5 8,009.7 8,377.8 8,889.4 9,277.3 9,915.7 10,423.6 11,024.5 10,772.4 11,127.1 11,549.3 11,930.6 ‚ FIGURE  1A.1 Total  Disposable  Personal  Income  in  the United  States:  1975–2012  (in  billions  of  dollars) 29 of  36 © 2014 Pearson Education, Inc. Graphing  Two  Variables X-­axis The  horizontal  line  against  which  a  variable  is  plotted. Y-­axis The  vertical  line  against  which  a  variable  is  plotted. origin The  point  at  which  the  horizontal  and  vertical  axes  intersect. Y-­intercept The  point  at  which  a  graph  intersects  the  Y-­axis. X-­intercept The  point  at  which  a  graph  intersects  the  X-­axis. 30 of  36 © 2014 Pearson Education, Inc. 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  point  A,  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  fifth 2nd  fifth 3rd  fifth 4th  fifth Top  fifth $      10,263 27,442 47,196 74,090 158,652 $    22,304 31,751 42,659 58,632 97,003  FIGURE  1A.2 Household  Consumption  and  Income Plotting  Income  and  Consumption   Data  for  Households 31 of  36 © 2014 Pearson Education, Inc. positive  relationship A  relationship  between  two  variables,  X and  Y,  in  which a  decrease  in  X is  associated  with  a  decrease  in  Y,  and  an  increase  in  X is associated  with  an  increase  in  Y. negative  relationship A  relationship  between  two  variables,  X and  Y,  in  which a  decrease  in  X is  associated  with  an  increase  in  Y and  an  increase  in  X is associated  with  a  decrease  in  Y. 32 of  36 © 2014 Pearson Education, Inc. Slope slope A  measurement  that  indicates  whether  the  relationship  between variables  is  positive  or  negative  and  how  much  of  a  response  there  is  in  Y (the  variable  on  the  vertical  axis)  when  X (the  variable  on  the  horizontal  axis) changes. 2 1 2 1 Y Y Y X X X = 33 of  36 © 2014 Pearson Education, Inc. ‚ FIGURE  1A.3 A  Curve  with  (a)  Positive  Slope  and  (b)  Negative  Slope A  positive slope  indicates  that increases  in  X are  associated with  increases  in  Y and  that decreases  in  X are  associated with  decreases  in  Y. A  negative slope indicates  the  opposite— when  X increases,  Y decreases;;  and  when  X decreases,  Y increases. 34 of  36 © 2014 Pearson Education, Inc.  FIGURE  1A.4 Changing  Slopes  Along  Curves 35 of  36 © 2014 Pearson Education, Inc. TABLE  1A.3    Aggregate  National  Income and  Consumption  for  the United  States,  1930–2012 (in  billions  of  dollars) Aggregate National  Income Aggregate Consumption 1930 1940 1950 1960 1970 1980 1990 2000 2005 2006 2007 2008 2009 2010 2011 2012 82.9 90.9 263.9 473.9 929.5 2433.0 5059.8 8938.9 11,273.8 12,031.2 12,396.4 12,609.1 12,132.6 12,811.4 13,358.9 13,720.9 70.1 71.3 192.2 331.8 648.3 1,755.8 3,835.5 6,830.4 8,803.5 9,301.0 9,772.3 10,035.5 9,845.9 10,215.7 10,729.0 11,119.5  FIGURE  1A.5 National  Income  and  Consumption 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.2,  but  here  each  observation  point  is national  income  and  aggregate  consumption  in  different  years,  measured  in  billions  of  dollars. 36 of  36 © 2014 Pearson Education, Inc. graph negative  relationship origin positive  relationship slope time  series  graph X-­axis X-­intercept Y-­axis Y-­intercept A  P  P  E  N  D  I  X    R  E  V  I  E  W    T  E  R  M  S    A  N  D    C  O  N  C  E  P  T  S