1
WHAT İS
ECONOMİCS?
Outline
Choice, Change, Challenge, and Opportunity
A. Economics, the science of
choice, has much to say
about the change, challenge, and opportunity that
we face today. Technological change, terrorism, and
recession provide a landscape that is rich with
problems to be tackled and
choices to be understood.
B. A course in economics helps
students to understand the
powerful forces that shape
and change our world.
I.
Definition of Economics
A. All economic questions
arise because we are unable
to satisfy all our wants—
because we face scarcity. Economics is the social science that
studies the choices that individuals, businesses, governments,
and societies make as they cope with scarcity.
B. Microeconomics is the study
of choices made by individuals and businesses, and
the influence of government
on those choices.
C. Macroeconomics is the study
of the effects on the national and global economy
of the choices that individuals, businesses, and
governments make.
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CHAPTER 1 APPENDIX
II. Three Big Microeconomic Questions
A. What Goods and Services are Produced?
1. Figure 1.1 (page 3) shows the major items produced in the
U.S. economy today. It emphasizes the dominant place of services in our economy.
2. Figure 1.2 (page 3)
shows the trends in what
the U.S. economy has
produced over the past
60 years. It shows the
decline of agriculture,
mining, construction,
and manufacturing, and
the expansion of services. (These trends
have been in place for
the past 150 years.)
3. Microeconomics seeks to
explain what goods and
services are produced.
B. How are Goods and Services
Produced?
1. Factors of production are the resources that are used to produce
goods and services. The “gifts of nature” that we use to produce goods and services are land. The work time and effort
that people devote to producing goods and services is labor.
The quality of labor depends on human capital,
which is the knowledge
and skill that people
obtain from education,
on-the-job training, and
work experience. The
tools, instruments, machines, buildings, and
other constructions that
are used to produce
goods and services are
capital. The human resource that organizes
land, labor, and capital, innovates by creating new goods and services, makes business
decisions, and bears the
risks that arise from those decisions is entrepreneurship.
2. Figure 1.3 (page 4) shows a measure of the growth of human
capital in the United States over the last century—the per-
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centage of the population that has completed different levels
of education.
3. Microeconomics seeks to explain what determines the quantities of capital, labor, and other resources that get used to
produce goods and services.
C. For Whom are Goods and Services Produced?
1. Who gets the goods and services depends on the incomes that
people earn.
2. Land earns rent, labor earns wages, capital earns interest, and
entrepreneurship earns profit.
3. Figure 1.4 (page 5) shows the distribution of income in the
United States. The richest 20 percent earn almost 50 percent
of total income while the poorest 20 percent earn only 4 percent of total income.
4. Microeconomics seeks to explain what determines earnings and
the distribution of income that in turn determines who gets
the goods and services produced.
III. Three Big Macroeconomic Questions
A. What Determines the Standard of Living?
1.
The standard of living is
the level of consumption
that people enjoy on the
average and is measured
by average income per
person.
2. Figure 1.5 (page 6)
shows income per person
per day in a number of
countries and regions.
The United States has
one of the highest standards of living, and the nations of
Africa have the lowest.
3.
Macroeconomics seeks to explain differences in the standard
of living across countries and over time and the rate at
which the standard of
living grows.
B. What Determines the Cost of
Living?
1. The cost of living is the
amount of money it takes
to buy the goods and
services that a typical
family consumes.
2. Table 1.1 (page 7) shows
the price of a Big Mac
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CHAPTER 1 APPENDIX
hamburger in a number of countries.
3. Inflation is a rising cost of living, and deflation is a falling
cost of living.
4. Macroeconomics seeks to explain the forces that determine the
cost of living and the inflation (or deflation) rate.
C. Why Does Our Economy Fluctuate?
1. The business cycle is the periodic but irregular up-and-down
movement in production
and jobs in an economy.
2. Figure 1.6 (page 8) illustrates a stylized
business cycle and the
relationship between the
phases and turning
points of a cycle. An
expansion (production
and jobs increasing more
rapidly than normal) begins at a trough and
ends at a peak. A recession (production and
jobs shrinking) begins at a peak and ends at a trough.
3. Macroeconomics seeks to understand the business cycle and explain the forces that bring expansion and recession.
IV. The Economic Way of Thinking
A. Choices and Tradeoffs
1. The economic way of thinking places scarcity and its implication, choice, at center stage and sees every choice as a
tradeoff—an exchange—giving up one thing to get something
else. “Guns versus Butter” is the classic tradeoff.
B. Microeconomic Tradeoffs
1. The three microeconomic questions become sharper when we
think in terms of tradeoffs.
2. “What?” Tradeoffs arise when people choose how to spend their
incomes, when governments choose how to spend their tax revenues, and when businesses choose what to produce.
3. “How?” Tradeoffs arise when businesses choose among alternative production technologies.
4. “For Whom?” Tradeoffs arise when choices change the distribution of goods and services produced across individuals. Government redistribution of income from the rich to the poor
creates the big tradeoff—the tradeoff between efficiency and
equity.
B. Macroeconomic Tradeoffs
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1. Macroeconomic questions also become sharper when we think in
terms of tradeoffs.
2. Standard of Living Tradeoffs arise when we choose between
current consumption and activities such as saving and investing, education, and research that increase future production
and consumption possibilities.
3. An Output-Inflation Tradeoff arises when policymakers choose
how much inflation to endure in order to maintain a high level of production. The output-inflation tradeoff arises because a
policy action that lowers inflation also lowers output and a
policy action that boosts output increases inflation.
C. Opportunity Cost
1. Thinking about a choice as a tradeoff emphasizes cost is an
opportunity forgone. The highest-valued alternative that we
give up to get something is the opportunity cost of the activity chosen.
D. Margins and Incentives
1. People make choices at the margin, which means that they
evaluate the consequences of making incremental changes to
the allocation of their resources. The benefit from pursuing
an incremental increase in an activity is its marginal benefit.
The opportunity cost of pursuing an incremental increase in
an activity is its marginal cost.
2. Marginal benefit and marginal cost act as an incentive—an inducement 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 an incentive to do less of that
activity. Economists seek to predict choices by looking at
changes in incentives.
V. Economics: A Social Science
A. Economics is a social science. Economists distinguish between
statements that are positive (what is and can be tested) and
normative (what ought to be and cannot be tested).
B. Model Building
1. Economists observe and measure economic activity, build economic models, and test their models.
2. An economic model is 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.
C. Testing Models
1. An economic theory is a generalization that summarizes what we
think we understand about the economic choices that people
make and the performance of industries and entire economies.
D. Obstacles and Pitfalls in Economics
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1. To build and test an economic model, the economist must overcome obstacles and avoid pitfalls.
2. Ceteris Paribus or “other things being equal.” Economists try to
isolate cause-and-effect relationship by changing only one
variable at a time, and hold all other relevant factors unchanged.
3. The fallacy of composition is the false statement that what
is true for the parts is true for the whole or what is true
for the whole is true for the parts.
4. The post hoc fallacy from the Latin term “Post hoc, ergo
propter hoc”—means “after this, therefore because of this”;
the error of reasoning that a first event causes a second
event because the first occurs before the second.
E. Agreement and Disagreement
1. 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 lists twelve different economic propositions that at least 70 percent of all
economists polled will agree upon.)