Unit 1 – Foundations and Fundamentals of Economics
Chapter 1:
The Nature of Economics
 Consumers, businesses and government all make choices
 These choices determine how society uses it’s resources
 For example people may choose to purchase huge quantities of personal
computers, therefore society’s resources are used to produce these
 The Government may choose to upgrade the highway system or improve
education
 HOW these choices are made is at the heart of economics
ECONOMICS is the social science that studies how people use scarce
resources to satisfy their unlimited wants.
SCARCITY AND CHOICE
 The resources for satisfying human wants are limited
 Collectively we want more than we can produce with our limited resources
 Economists help to determine the use of scarce resources to satisfy the
“most important” wants.
 Because resources are desirable and scarce, we must makes choices for the
use of these resources
 ECONOMICS is the study of “choice”.
THE IMPORTANCE OF ECONOMICS
 Enables us to improve the performance of the economy and help deal
with many problems that face our country
 eg. A decision to build more war planes instead of spending more
money on education will have short run and long run implications
 Enhances our understanding of world affairs
 Helps us be informed citizens
 Develops logical thinking and problem solving skills
1
ECONOMISTS work in private firms, education, government, research, nonprofit organizations, for themselves, and international organizations
ECONOMIC METHODOLOGY – (the whirlybird)
 The factors involved in real world economic events are often quite
complex
 The scientific economist creates and works with models or theories to
abstract from the real world
 A MODEL is a simplified version of the reality that facilitates the
understanding of complex economic problems
ECONOMIC ASSUMPTIONS
 Assumptions are statements that describe the model’s operating conditions
The ceteris paribus assumption means, all things being equal.
PREDICTIONS
 Economists formulate models and theories so that they can make
economic predictions
 Predictions are statements about the general direction of events from the
fulfillment of certain conditions
 Economic forecasting assigns future values to certain economic variables
on the basis of known relations
 Gives a specific value for a particular variable
Prediction:
If interest rates increase, the level of investment spending will
fall, ceteris paribus
Forecast:
By the end of the year, gas prices will fall by 10%
2
POSITIVE and NORMATIVE ECONOMICS
 Positive economic statements are statements of facts expressed in a
testable, or verifiable manner
 These statements may be true or false
 eg. There are 4000 students at IONA is a positive statement (albeit a false
statement)
 A positive economic statement is: an increase in interest rates will cause a
decrease in the demand for housing
 Normative economic statements are value judgments or statements of
opinion about what “ought to be”.
 They cannot be verified
 Interest rates should be reduced is an example of a normative statement
ECONOMIC VARIABLES
 A variable is anything that can assume different values under different
situations
 Anything that does not vary is a constant
 ENDOGENOUS VARIABLES are variables that can be explained
within a model
 EXOGENOUS VARIABLES are variables that are determined by
factors outside a model
 A STOCK VARIABLE is a quantity existing a particular time eg. There
are 7, 000 books in the library (no time dimension)
 A FLOW VARIABLE is the measure of a change in a variable per unit
of time eg. There are 600 books taken out of the library per day
ECONOMIC THEORY helps us to understand how the economy
functions and enables us to solve real-world problems.
3
ECONOMIC POLICY is a course of action designed to achieve some
specific economic objective
Every society determines the priorities of their economic objectives eg.
price stability, full employment, economic growth, equitable distribution of
income, economic freedom, economic security, satisfactory balance of
payments etc.
These goals often conflict and therefore choices must be made
MICROECONOMICS
 aka price theory deals with the behaviour of individual economic
units
MACROECONOMICS
 aka Income and employment theory deals with the behaviour of
economic groups
4