Learning Objectives
 Discuss the difference between microeconomics
and macroeconomics
 Evaluate the role that rational self-interest plays in
economic analysis
 Explain why the study of economics
is a science
 Distinguish between positive and normative
economics
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Defining Economics
Economics
– The study of how people allocate their limited
resources to satisfy their unlimited wants
– The study of how people make choices
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Defining Economics
Resources
– Things used to produce other things to satisfy
people’s wants
Wants
– What people would buy if their incomes were
unlimited
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Defining Economics
With limited income (resources),
people must make choices to satisfy their
wants.
We never have enough of everything,
including time, to satisfy our every desire.
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Defining Economics
Individuals, businesses, and nations face
alternatives, and choices must be made.
Economics studies how these choices are
made.
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The Power of Economic
Analysis
 The economic way of thinking is a framework to
analyze solutions to economic problems.
– How much time to study
– Choosing which courses to take
– Whether troops should be sent abroad
 Incentives
– Rewards for engaging in a particular activity
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The Power of Economic
Analysis
The economic way of thinking gives you
the power to reach informed conclusions
about what is happening in the world.
Economic analysis helps you make better
decisions, and increases your understanding
when watching, listening to, or reading the
news.
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The Power of Economic
Analysis
Economic analysis is a way of thinking
about all decisions.
– Your education, career, financing your home,
family
– Your involvement in the business world, or in
politics as a voter
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Microeconomics versus Macroeconomics
 Microeconomics
– The study of decision making undertaken by
individuals (or households) and by firms
– Like looking though a microscope to focus on the
smaller parts of the economy
• Decision of a worker to work overtime or not
• A family’s choice of having a baby
• An individual firm advertising
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Microeconomics versus Macroeconomics
Macroeconomics
– The study of the behavior of the economy as a
whole
– Deals with economy wide phenomena
• The national unemployment rate
• The rate of growth in the money supply
• The national government’s budget deficit
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Microeconomics versus Macroeconomics
Macroeconomics deals with aggregates, or
totals, such as total output in an economy.
Modern economic theory blends micro and
macro concepts.
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The Economic Person:
Rational Self-Interest
Economists assume that individuals
act as if motivated by self-interest and
respond predictably to opportunities
for gain.
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The Economic Person:
Rational Self-Interest
Rationality Assumption
– The assumption that people do not intentionally
make decisions that would leave them worse
off
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The Economic Person:
Rational Self-Interest
Questions
– Does the fact that some people make apparently
irrational choices invalidate the rationality
assumption in economics?
– Can economic models be applied to situations
in which behavior is at odds with what we
expect from rational people?
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The Economic Person:
Rational Self-Interest
Responding to incentives
– Rationality and the use of incentives
– Making choices
• Balancing cost and benefits
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The Economic Person:
Rational Self-Interest
Some examples of incentives
– Responding to positive incentives
• Schoolchildren getting gold stars, working to have a
“better life” for yourself
– Responding to negative incentives
• Penalties, punishments, using credit cards to avoid
check overdrafts
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The Economic Person:
Rational Self-Interest
Defining self-interest
– The pursuit of one’s goals, does not always
mean increasing one’s wealth
• Prestige
• Friendship
• Love
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Example:
The Perceived Value of Gifts
The perceived value of gifts
– Often, the recipient of the gift places a value on
it far less than the market value.
– Should we substitute gift certificates for
physical gifts?
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Economics as a Science
Models or Theories
– Simplified representations of the real
world used as the basis for predictions
or explanations
• A map is the quintessential model
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Economics as a Science
Assumptions
– The set of circumstances in which a model is
applicable
– Every model, or theory, must be based on a set
of assumptions.
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Example: Getting Directions
A map is a simplifying model of reality.
The degree of simplification varies across
maps; some contain more detail than others.
Economic models attempt to focus on what
is relevant to the problem at hand and omit
what is not.
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Economics as a Science
Ceteris Paribus Assumption
– Nothing changes except the factor or factors
being studied.
– “Other things constant”
– “Other things equal”
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Economics as a Science
Economics is an empirical science.
– Real-world data is used to evaluate the
usefulness of a model.
– Models are useful if they predict economic
phenomena.
– Economic models predict how people react, not
how they think.
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Economics as a Science
Behavioral Economics
– Approach to the study of consumer behavior
• Emphasizes psychological limitations
and complications which may interfere
with rational decision making
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Economics as a Science
Bounded Rationality
– Hypothesis that people are nearly, not fully,
rational
• They cannot examine every choice available
to them
• Use simple rules of thumb to sort alternatives
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Positive versus
Normative Economics
Positive Economics
– Purely descriptive statements or scientific
predictions; “If A, then B,” a statement
of what is
Normative Economics
– Analysis involving value judgments; relates to
whether things are good or bad, a statement of
what ought to be
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Summary Discussion
of Learning Objectives
 Microeconomics versus macroeconomics
– Economics is the study of how individuals make
choices to satisfy wants.
– Microeconomics is the study of decision making by
individual households and individual firms.
– Macroeconomics is the study of nationwide
phenomena, such as inflation and
unemployment levels.
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Summary Discussion
of Learning Objectives
Self-interest in economic analysis
– Rational self-interest is the assumption that
individuals behave in a reasonable (rational)
way in making choices to further their interests.
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Summary Discussion
of Learning Objectives
Economics as a science
– Economists use models, or theories, that are
simplified representations of the real world to
analyze and make predictions about the real
world.
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Summary Discussion
of Learning Objectives
The difference between positive and
normative economics
– Positive economics deals with what is, whereas
normative economics deals with what ought to
be.
– Positive statements are of the “if…then”
variety, while normative ask what “should, or
could” be.
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