When you have completed your study of this chapter, you will be able to

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C H A P T E R C H E C K L I S T

• When you have completed your study of this
  chapter, you will be able to

Define economics, distinguish between
micro-economics and macroeconomics, and explain
the questions of macroeconomics.
Describe the work of economists as social
scientists.
Explain four core ideas that define the way
economists think about macroeconomic questions.
Explain why economics is worth studying.
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1.1 DEFINITIONS AND QUESTIONS

• Economic questions and problems arise because
  human wants exceed the resources available to
  satisfy those wants.
• Scarcity
• The condition that arises because the available
  resources are insufficient to satisfy wants.
• Faced with scarcity, we must make choiceswe must
  choose among the available alternatives.
• The choices we make depend on the incentives we
  face.

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JARGON

• Economics uses jargon a lot
• Jargon means a special vocabulary
• Economics jargon can be confusing because it
  often gives special meaning to ordinary, every
  day words, that have a different meaning in
  normal usage
• Scarcity is our first example of a jargon word
  in economics.

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Why jargon?

• Jargon allows precision
• Jargon allows shorter statements
• Jargon permits more efficient communication
• Its standard in economics, so we have to know it
  to understand economics

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Quote Joan RobinsonProfessor of Economics at
U. of Cambridge

• You study economics in order to avoid being
  fooled by economists
• But to do that, we have to learn a lot of
  definitions and terminology the jargon of
  economics.

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Bad aspects of Jargon

• Jargon can be used to obfuscate or exclude
• Jargon can be confusing to those who are unsure
  of it
• Unnecessary jargon hinders efficient
  communication rather than helping it

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Economics as a Foreign Language

• ALL economics and economists use jargon to some
  extent
• MOST of economics is common sense
• Except for a very few non-intuitive ideas,
  learning economics amounts to learning how to
  express what you know already in the right
  jargon, i.e. it is like learning a new language

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1.1 DEFINITIONS AND QUESTIONS

• Incentive
• An incentive is a reward or a penaltya carrot
  or a stickthat encourages or discourages an
  action.
• Economics
• The social science that studies the choices that
  we make as we cope with scarcity and the
  incentives that influence and reconcile our
  choices.
• The subject has two broad divisionsmicroeconomics
  and macroeconomics.

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1.1 DEFINITIONS AND QUESTIONS

• Microeconomics
• Microeconomics The study of the economic choices
  that individuals and organizations make, the way
  these choices interact, and the influence that
  governments exert on these choices.
• Macroeconomics
• Macroeconomics The study of the aggregate (or
  total) effects on the national economy and the
  global economy of the economic choices that
  individuals, businesses, other organizations, and
  governments make.

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1.1 DEFINITIONS AND QUESTIONS

• Macroeconomic Questions
• The three big issues that macroeconomics tries to
  understand are
• The standard of living
• The cost of living
• Economic fluctuationsrecessions and expansions

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1.1 DEFINITIONS AND QUESTIONS

• The Standard of Living
• Standard of living
• The level of consumption of goods and services
  that people enjoy, on the average it is measured
  by average income per person.
• Goods and services
• The objects that people value and produce to
  satisfy human wants. Goods are physical objects,
  and services are work done for people.

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1.1 DEFINITIONS AND QUESTIONS

• For most people achieving a high standard of
  living means finding a good job.
• Unemployment
• The state of being available and willing to work
  but unable to find suitable work.

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1.1 DEFINITIONS AND QUESTIONS

• The Cost of Living
• Cost of living
• The number of dollars it takes to buy the goods
  and services that achieve a given standard of
  living.
• Inflation
• A situation in which the cost of living is rising
  and the value of money is shrinking.
• Deflation the reverse, the cost of living is
  falling and each dollar buys more goods and
  services.

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1.1 DEFINITIONS AND QUESTIONS

• Economic Fluctuations Recessions and Expansions
• Business cycle
• A periodic but irregular up-and-down movement in
  production and jobs.
• The worst recession ever was the Great
  Depression.
• Great Depression
• A period during the 1930s in which the economy
  experienced its worst-ever recession.

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1.1 DEFINITIONS AND QUESTIONS

• Figure 1.1 shows a stylized business cycle.

An expansion ends at a peak and a recession ends
at a trough.
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1.2 ECONOMICS A SOCIAL SCIENCE

• The goal of economists is to discover how the
  economic world works. Economists distinguish
  between
• Positive statements What is
• Normative statements What ought to be
• The task of economic science
• To discover and catalog positive statements that
  are consistent with what we observe in the world
  and that enable us to understand how the economic
  world works.

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1.2 ECONOMICS A SOCIAL SCIENCE

• The task can be broken into three steps
• Observing and measuring
• Model building
• Testing
• Observing and Measuring
• Items such as
• Quantities of resources
• Wages and work hours
• Prices and quantities of goods and services
• Taxes and government spending
• Volume of international trade

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1.2 ECONOMICS A SOCIAL SCIENCE

• Model Building
• Economic model
• 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.

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1.2 ECONOMICS A SOCIAL SCIENCE

• Testing
• A models predictions might correspond to or
  conflict with the data.
• Economic theory
• A generalization that summarizes what we
  understand about the economic choices that people
  make and the economic performance of industries
  and nations.

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1.2 ECONOMICS A SOCIAL SCIENCE

• Unscrambling Cause and Effect
• The central idea that economists use to
  unscramble cause and effect is ceteris paribus.
• Ceteris Paribus
• Ceteris paribus means other things being
  equal.
• But ceteris paribus is often a problem in
  economics when testing a model in the real
  world, ceteris is usually NOT paribus, everything
  changes at once.

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1.2 ECONOMICS A SOCIAL SCIENCE

• Economist take three complimentary approaches
• Natural experiments
• Econometric investigations
• Economic experiments

Natural Experiments A situation that arises in
the ordinary course of economic life in which the
one factor of interest changes and other things
remain equal, i.e. unchanged.
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1.2 ECONOMICS A SOCIAL SCIENCE

• Econometric Investigations
• Statistical tools used in economics are called
  econometrics.
• Correlation
• The tendency for the values of two variables to
  move in a predictable and related way.
• Post hoc fallacy
• The error of reasoning that a first event causes
  a second event because the first occurred before
  the second. Does the sun rise because the cock
  crows?

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1.2 ECONOMICS A SOCIAL SCIENCE

• Economic Experiments
• Economic experiments put real subjects in a
  decision making situation and vary the influence
  of interest to discover how the subjects respond
  to one factor at a time. A relatively new
  approach.

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1.3 MACROECONOMIC IDEAS

• Four core ideas
• Macroeconomic performance results from rational
  choices that respond to incentives.
• The standard of living improves when production
  per person increases.
• The cost of living rises when the quantity of
  money increases faster than production.
• Economic fluctuations result from expenditure and
  productivity fluctuations.

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1.3 MACROECONOMIC IDEAS

• Rational Choice and Incentives
• A rational choice is one that uses the available
  resources to most effectively satisfy the wants
  of the person making the choice.
• Cost What You Must Give Up
• Opportunity cost
• The highest-valued alternative forgone.

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1.3 MACROECONOMIC IDEAS

• Benefit Gain Measured by What You Are Willing to
  Give Up
• Benefit
• The gain or pleasure that something brings.
• On the Margin
• Margin
• A choice that is made by comparing all the
  relevant alternatives systematically and
  incrementally.

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1.3 MACROECONOMIC IDEAS

• Marginal cost
• The cost of a one-unit increase in an activity,
  i.e. the rate at which total costs are
  increasing.
• Marginal benefit
• What you gain when you get one more unit of
  something, i.e. the rate at which total benefits
  are increasing.
• We make a rational choice when we take those
  actions for which marginal benefit exceeds or
  equals marginal cost.

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1.3 MACROECONOMIC IDEAS

• The Standard of Living and Productivity
• The dollar value of production increases for
  three reasons
• Prices and wages rise
• The number of people employed increases
• Productivity increases
• Productivity
• Total production per person employed.
• Only an increase in productivity can bring a
  sustained improvement in the standard of living.

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1.3 MACROECONOMIC IDEAS

• The Cost of Living and the Quantity of Money
• A rising cost of living, called inflation, means
  that more dollars are needed to buy the same
  fixed quantity of goods and services.
• Inflation is often caused by an increase in the
  quantity of money that is not matched by an
  increase in the quantity of goods and services.

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1.3 MACROECONOMIC IDEAS

• Expenditure and Productivity Fluctuations
• The business cycle is the least well understood
  aspect of macroeconomic performance.
• The sources of economic fluctuations can be
  grouped into
• Expenditure fluctuations
• Productivity fluctuations

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1.3 MACROECONOMIC IDEAS

• Expenditure Fluctuations
• Expenditure fluctuations can arise from changes
  in interest rates, from changes in profit
  opportunities, or from changes in other
  expectations about the future.
• Productivity Fluctuations
• Productivity fluctuations can arise from negative
  shocks such as an oil price hike or from positive
  events like the spread of information-age
  technologies.

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1.3 MACROECONOMIC IDEAS

• Smoothing the Business Cycle
• Economic fluctuations are undesirable recession
  brings unemployment and overly strong expansion
  brings inflation.
• Macroeconomics tries to develop techniques for
  smoothing the business cycle.

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1.4 WHY ECONOMICS IS WORTH STUDYING

• Two main benefits from studying economics are
• Understanding
• Expanded career opportunities
• Understanding
• Economic ideas are all around you. You cannot
  ignore them.
• As you progress with your study of economics,
  youll gain a deeper understanding of what is
  going on around you.

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1.4 WHY ECONOMICS IS WORTH STUDYING

• Expanded Career Opportunities
• Most students of economics dont become
  economists.
• But knowledge of economics is very useful in
  many fields such as banking, finance, business,
  management, insurance, real estate, law,
  government, journalism, health care and the arts.
• Economics graduates are not the highest-paid
  professionals, but they are close to the top.

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1.4 WHY ECONOMICS IS WORTH STUDYING
Figure 1.1 shows some earnings comparisons.

• Graduates in disciplines that teach problem
  identifying, problem solving, and strategic
  brokering are top of the earnings distribution
• engineering
• computer science
• economics

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1.4 WHY ECONOMICS IS WORTH STUDYING

• The Costs of Studying Economics
• The main cost of studying economics is forgone
  leisure time.
• Most students find that economics is tricky and
  that it takes time to master it is not learning
  facts, it is learning new ways of looking at the
  world.
• The trick is practice, or learning by doing.
• Benefits Versus Costs
• Weigh up your benefits and costs!

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A P P E N D I X C H E C K L I S T

• When you have completed your study of this
  appendix, you will be able to

Interpret a scatter diagram, a time-series graph,
and a cross-section graph.
Interpret the graphs used in economic models.
Define and calculate slope.
Graph relationships among more than two variables.
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APPENDIX MAKING AND USING GRAPHS

• Basic Idea
• A graph enables us to visualize the relationship
  between two variables.
• To make a graph, set two lines perpendicular to
  each other
• The horizontal line is called the x-axis.
• The vertical line is called the y-axis.
• The common zero point is called the origin.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.1 How to make a graph

The horizontal axis (x-axis) measures income.
The vertical axis (y-axis) measures expenditure.
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APPENDIX MAKING AND USING GRAPHS
Point A shows that when income is 10,000,
expenditure is also 10,000.
Point B shows that when income is 30,000,
expenditure is 25,000.
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APPENDIX MAKING AND USING GRAPHS

• Interpreting Data Graphs
• Scatter diagram
• A graph of the value of one variable against the
  value of another variable.
• Time-series graph
• A graph that measures time on the x-axis and the
  variable or variables in which we are interested
  on the y-axis.

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APPENDIX MAKING AND USING GRAPHS

• Trend
• A general tendency for the value of a variable
  to rise or fall.
• Cross-section graph
• A graph that shows the values of an economic
  variable for different groups in a population at
  a point in time.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(a) shows a scatter diagram.

In 1996 (marked 96), income per person was
21,100 and expenditure per person was 20,100.
The data for the 1990s show that as income
increases, expenditure also increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(b) shows another scatter diagram.

In 1993 (marked 93) when the price of an
international phone call was 1.24 a minute, 11.4
billion minutes of calls were made.
The data show that as the price falls, the number
of calls increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(c) shows a times series graph of the
  unemployment rate.

The graph shows when the unemployment rate was

• High and low,

• Rising and falling,

• Rising quickly and slowly and falling quickly and
  slowly.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(d) shows a cross-section graph.

• The graph shows the unemployment rate in seven
  countries in 2002.

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APPENDIX MAKING AND USING GRAPHS

• Interpreting Graphs Used in Economics

• Positive relationship or direct relationship
• A relationship between two variables that move in
  the same direction.

• Linear relationship
• A relationship that graphs as a straight line.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(a) shows a positive (direct)
  relationship.

At a speed of 40 MPH, you travel 200 miles in 5
hourspoint A.
At a speed of 60 MPH, you travel 300 miles in 5
hourspoint B.
As the speed increases, the distance traveled in
5 hours increases proportionately.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(b) shows a
• positive (direct) relationship.

As the distance sprinted increases, recovery time
increases.
But sprint twice as far and it takes more than
twice as long to recoverthe curve gets steeper.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(c) shows a positive (direct)
  relationship.

As study time increases, the number of problems
worked increases.
But study twice as long and the number of
problems you work less than doublethe curve gets
less steep.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.4(a) shows a negative (inverse)
  relationship.

As the time playing tennis increases, the time
playing squash decreases.
Because one more hour of tennis means one hour
less of squash, the relationship between these
two variables is described by a straight line.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.4(b) shows a negative (inverse)
  relationship.

As the journey length increases, the cost per
mile of the trip falls.
But there is a limit to how much the cost per
mile can fall, so the curve becomes less steep as
journey length increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.4(c) shows a negative (inverse)
  relationship.

As leisure time increases, the number of
problems worked decreases.
But the tenth hour of leisure (the first hour of
work) decreases the number of problems worked
most, so the curve becomes steeper as leisure
time increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.5(a) shows a maximum point.

• As the rainfall increases

1. The curve slopes upward as the yield per acre
rises.

• 2. The curve is flat at point A, the maximum
  yield.

3. Then slopes downward as the yield per acre
falls.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.5(a) shows a minimum point.

• As the speed increases

1. The curve slopes downward as the cost per mile
falls.

• 2. The curve is flat at point B, the minimum cost
  per mile.

• 3. The curve slopes upward as the cost per mile
  rises.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.6(a) shows variables that are
  unrelated.

• As the price of bananas increases, the students
  grade in economics remains at 75 percent.

The curve is horizontal.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.6(b) shows variables that are
  unrelated.

• As rainfall in California increases, the output
  of French vineyards remains at 3 billion gallons.

The curve is vertical.
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APPENDIX MAKING AND USING GRAPHS

• The Slope of a Relationship
• Slope
• The change in the value of the variable measured
  on the y-axis divided by the change the value of
  the variable measured on the x-axis.
• Slope ?y ?x.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.7(a) shows a positive slope.

1. When ?x is 4,
2. ?y is 3.
3. Slope (?y/?x) is 3/4.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.7(b) shows a negative slope.

1. When ?x is 4,
2. ?y is 3.
3. Slope (?y/?x) is 3/4.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.7(c) shows the slope of a curve at a
  point.

Slope of the curve at A

• equals the slope of the red line tangent to the
  curve at A.

1. When ?x is 4,
2. ?y is 3.
3. Slope (?y/?x) is 3/4.
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APPENDIX MAKING AND USING GRAPHS

• Relationships Among More Than Two Variables
• To graph a relationship that involves more than
  two variables, we use the ceteris paribus
  assumption.
• Ceteris Paribus
• other things remaining the same.
• Figure A1.8 shows the relationships between ice
  cream consumed, the temperature, and the price of
  ice cream.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.8(a) shows the relationship between
  price and consumption, temperature remaining the
  same.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.8(b) shows the relationship between
  temperature and consumption, price remaining the
  same.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.8(c) shows the relationship between
  price and temperature, consumption remaining the
  same.

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