Introduction: What
Is Economics?
PREPARED BY:
FERNANDO QUIJANO, YVONN QUIJANO,
KYLE THIEL & APARNA SUBRAMANIAN
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
chapter
1.1
WHAT IS ECONOMICS?
• scarcity
The resources we use to produce
goods and services are limited.
• economics
The study of choices when there is
scarcity.
Here are some examples of scarcity and the trade-offs associated with
making choices:
•
You have a limited amount of time. If you take a part-time job, each
hour on the job means one less hour for study or play.
•
A city has a limited amount of land. If the city uses an acre of land
for a park, it has one less acre for housing, retailers, or industry.
•
You have limited income this year. If you spend $17 on a music CD,
that’s $17 less you have to spend on other products or to save.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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1.1
WHAT IS ECONOMICS?
• factors of production
The resources used to produce goods and services; also known as production inputs.
• natural resources
Resources provided by nature and used to produce goods and
services.
• labor
The physical and mental effort people use to produce goods and
services.
• physical capital
The stock of equipment, machines, structures, and infrastructure
that is used to produce goods and services.
• human capital
The knowledge and skills acquired by a worker through education
and experience.
• entrepreneurship
The effort used to coordinate the factors of production—natural
resources, labor, physical capital, and human capital—to produce
and sell products.
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1.1
WHAT IS ECONOMICS?
Positive Versus Normative Analysis
• positive analysis
Answers the question “What is?” or “What will be?”
• normative analysis
Answers the question “What ought to be?”
Table 1.1 COMPARING POSITIVE AND NORMATIVE QUESTIONS
Positive Questions
• If the government increases the minimum wage,
how many workers will lose their jobs?
• If two office-supply firms merge, will the price of
office supplies increase?
• How does a college education affect a person’s
productivity and earnings?
• How do consumers respond to a cut in income
taxes?
• If a nation restricts shoe imports, who benefits and
who bears the cost?
Normative Questions
• Should the government increase the minimum
wage?
• Should the government block the merger of two
office-supply firms?
• Should the government subsidize a college
education?
• Should the government cut taxes to stimulate the
economy?
• Should the government restrict imports?
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chapter
1.1
WHAT IS ECONOMICS?
The Three Key Economic Questions: What, How, and Who?
The choices made by individuals, firms, and governments answer
three questions:
1 What products do we produce?
2 How do we produce the products?
3 Who consumes the products?
Economic Models
• economic model
A simplified representation of an
economic environment, often
employing a graph.
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chapter
1.2
ECONOMIC ANALYSIS AND MODERN PROBLEMS
Economic View of Traffic Congestion
To an economist, the diagnosis of the congestion problem is
straightforward. When you drive onto a busy highway during rush
hour, your car takes up space and decreases the distance between
the vehicles on the highway. The normal reaction to a shorter
distance between moving cars is to slow down. So when you enter
the highway, you force other commuters to spend more time on the
highway.
One possible solution to the congestion problem is to force people to
pay for using the road, just as they pay for gasoline and tires.
The job for the economist is to compute the appropriate congestion
tax and predict the consequences of imposing the tax.
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chapter
1.2
ECONOMIC ANALYSIS AND MODERN PROBLEMS
Economic View of Japan’s Economic Problems
Following World War II, Japan grew rapidly, with per capita income
increasing by about 4 percent per year between 1950 and 1992. But
in 1992, the economy came to a screeching halt. For the next 10
years, per capita income either decreased or increased slightly.
The challenge for economists was to develop a set of policies to get
the Japanese economy moving again.
Economists responded by designing policies to stimulate spending
by consumers and businesses and to make needed changes to the
Japanese financial system.
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chapter
1.3
THE ECONOMIC WAY OF THINKING
Four elements of the economic way of thinking:
1 Use Assumptions to Simplify
Economists use assumptions to make things simpler and focus
attention on what really matters.
2 Isolate Variables—Ceteris Paribus
Economic analysis often involves variables and how they affect
one another.
• variable
A measure of something that can take
on different values.
• ceteris paribus
The Latin expression meaning other
variables being held fixed.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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1.3
THE ECONOMIC WAY OF THINKING
3 Think at the Margin
Economists often consider how a small change in one variable
affects another variable and what impact that has on people’s
decision making.
• marginal change
A small, one-unit change in
value.
4 Rational People Respond to Incentives
A key assumption of most economic analysis is that people
act rationally, meaning that they act in their own self-interest.
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PEDALING FOR TELEVISION TIME
APPLYING THE CONCEPTS #1: Do people respond to
incentives?
To illustrate the notion that people are rational and
respond to incentives, consider an experiment conducted
by researchers at St. Luke’s Roosevelt Hospital in New
York City. The researchers addressed the following
question: If a child must pedal a stationary bicycle to run
a television set, will he watch less TV?
• Children were put into two groups:
•
Control group: Obese children randomly assigned to a TV with a
stationary bike in front of the TV – no pedaling required to watch TV.
•
Treatment group: Obese children randomly assigned to a TV with a
stationary bike in front of it – pedaling is required to watch TV.
• Outcome: The control group watched TV 21 hours on average and the treatment
group only 2 hours on average per week.
© 2007 Pearson/Prentice Hall, Survey of Economics: Principles, Applications & Tools, 3e, O’Sullivan • Sheffrin • Perez
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Extra Application 3
FREAKONOMICS
Economist Steven Levitt, one of the authors of the best selling book “Freakonomics,”
answers a host of questions typically not tackled by most economists. One of the
questions is related to realtors and agency relationships. In other words, do realtors really
work for real estate sellers? Does a real estate agent have an incentive to get you the
highest price?
• According to Levitt, it is in the best interest of the realtor to convince sellers to take
an offer lower than they would receive if the property remained on the market.
• Since the percentage of the sales price that real estate salespersons receive from
selling a house is a very small fraction, a $10,000 increase in sales price might net a
real estate professional another $150 commission for a tremendous amount of
additional work.
• It is in the real estate salesperson’s best interest to convince the seller to make the
quick sale and take the first reasonable offer.
• Levitt points toward evidence that real estate professionals tend to leave their own
properties on the market longer and receive 2-3% more in sales price.
Economics is truly a social science that can be used to explain quite a bit of human
behavior.
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LONDON SOLVES ITS CONGESTION PROBLEM
APPLYING THE CONCEPTS #2: What is the role of prices in
allocating resources?
To illustrate the economic way of thinking, let’s
consider again how an economist would approach
the problem of traffic congestion.
• Use assumptions to simplify
• Isolate variables—ceteris paribus
• Think at the margin
If the government imposes a congestion tax to reduce congestion during rush hour, the
question for the economist is: How high should the tax be? Determine the cost imposed
by the marginal driver:
•
Driver forces each of 900 commuters to spend 2 extra seconds on the highway
•
Total travel time increases by 30 minutes
•
Value of time is $16 per hour
•
Appropriate congestion tax is $8.00
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chapter
1.4
PREVIEW OF COMING ATTRACTIONS:
MACROECONOMICS
• macroeconomics
The study of the nation’s economy as a
whole; focuses on the issues of inflation,
unemployment, and economic growth.
Macroeconomics explains why economies grow and change
and why economic growth is sometimes interrupted. Let’s look
at three ways we can use macroeconomics.
To Understand Why Economies Grow
Macroeconomics explains why some resources increase over
time and how an increase in resources translates into a higher
standard of living.
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1.4
PREVIEW OF COMING ATTRACTIONS:
MACROECONOMICS
To Understand Economic Fluctuations
All economies, including ones that experience a general trend
of rising per capita income, are subject to economic
fluctuations, including periods when the economy shrinks.
To Make Informed Business Decisions
A manager who studies macroeconomics will be better
equipped to understand the complexities of interest rates and
inflation and how they affect the firm.
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chapter
1.5
PREVIEW OF COMING ATTRACTIONS:
MICROECONOMICS
• microeconomics
The study of the choices made by
households, firms, and government
and how these choices affect the
markets for goods and services.
Three ways we can use microeconomic analysis are:
To Understand Markets and Predict Changes
One reason for studying microeconomics is to better
understand how markets work and to predict how various
events affect the prices and quantities of products in markets.
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1.5
PREVIEW OF COMING ATTRACTIONS:
MICROECONOMICS
To Make Personal and Managerial Decisions
On the personal level, we use economic analysis to decide
how to spend our time, what career to pursue, and how to
spend and save the money we earn. As workers, we use
economic analysis to decide how to produce goods and
services, how much to produce, and how much to charge for
them.
To Evaluate Public Policies
We can use economic analysis to determine how well the
government performs its roles in the market economy.
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