1
What Is Economics?
Why does public discussion of economic policy so
often show the abysmal ignorance of the
participants? Whey do I so often want to cry at
what public figures, the press, and television
commentators say about economic affairs?
Robert M. Solow
Contents
♦ Ideas for Beyond the Final Exam
♦ Inside the Economist’s Toolkit
♦ Appendix: Using Graphs: A Review
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Ideas for Beyond the Final
Exam
● Idea 1: How Much Does It Really Cost?
♦ Opportunity cost = value of the best forgone
alternative to any decision
♦ All actions  opportunity costs
♦ Opportunity costs  true economic costs
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Ideas for Beyond the Final
Exam
● Idea 2: The Market Strikes Back
♦ Markets set prices.
♦ Government may intervene.
♦ Markets may “strike back.”
■Example: rent control reduces the supply of
housing.
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Ideas for Beyond the Final
Exam
● Idea 3: The Surprising Principle of
Comparative Advantage
♦ When two nations trade, both benefit.
♦ Comparative advantage = the production of
goods with the lowest opportunity cost
♦ Comparative advantage  specialization
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Ideas for Beyond the Final
Exam
● Idea 4: Trade is a Win-Win Situation
♦ Trade  benefits for both buyers & sellers
♦ Restrictions on trade   benefits
♦ Intervention into markets   costs
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Ideas for Beyond the Final
Exam
● Idea 5: The Importance of Thinking at the
Margin
♦ Marginal = small change
♦ Marginal costs = change in costs
♦ Rational decisions = comparison of costs to
benefits at the margin
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Ideas for Beyond the Final
Exam
● Idea 6: Externalities: Shortcoming of the
Market Cured by Market Methods
♦ Externalities = effects of transactions on third
parties
♦ Externalities  social costs
♦ Market failure  need for government
intervention
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Ideas for Beyond the Final
Exam
● Idea 7: The Trade-off between Efficiency
and Equality
♦ More efficiency  more output & jobs
♦ More equality  less efficiency
♦ Labor markets distribute income efficiently, not
equally.
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Ideas for Beyond the Final
Exam
● Idea 8: The Short-Run Trade-off between
Inflation and Unemployment
♦ Low unemployment  rising prices
♦ High unemployment  falling prices
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Ideas for Beyond the Final
Exam
● Idea 9: Productivity Growth Is (Almost)
Everything in the Long Run
♦ Productivity growth  more output
♦ More output  higher living standards
♦ In the long run, productivity growth is (almost)
everything.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Inside the Economist’s
Toolkit
● Economics as a Discipline
♦ Economics is the most scientific of the social
sciences.
♦ Yet, it is much more social than the natural
sciences.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Inside the Economist’s
Toolkit
● The Need for Abstraction
♦ Real world complexity  simplification in
economic theory
♦ The “art” of economics: focus on the essential;
ignore the trivial.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Inside the Economist’s
Toolkit
● The Role of Economic Theory
♦ Economic theory = explanation of why
economic events occur
♦ Correlation  causality
♦ Economic theories  predictions
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Inside the Economist’s
Toolkit
● What Is an Economic Model?
♦ Economic model = formal statement of
economic theory
♦ Usually expressed in mathematics, with
equations and graphs
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Inside the Economist’s
Toolkit
● Reasons for Disagreements: Imperfect
Information and Value Judgments
♦ Among economists,
♦ agreement > disagreement
■Imperfect information  disagreements
■Value judgments  disagreements
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Appendix
Using Graphs: A Review
Graphs Used in Economic
Analysis
● Display large quantity of data quickly
● Facilitate data interpretation and analysis
● Important statistical relationships more
apparent than from written descriptions or
long lists of numbers
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Two-Variable Diagrams
● Variable = something measured by a
number
♦ Examples: price and quantity
● View two variables together to see if they
exhibit a relationship.
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1-1 Quantities of Natural
Gas Demanded at Various Prices
TABLE
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1-1 Hypothetical
Demand Curve for Gas
FIGURE
6
6
5
5
Price
Price
D
4
a
P
3
b
2
1
4
P
3
a
b
2
D
1
0
20
40
60
Q
80 100 120 140
Quantity
(a)
0
20
40
60
Q
80 100 120 140
Quantity
(b)
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The Definition and
Measurement of Slope
● Slope = ratio of vertical change to
horizontal change
♦ Rise/run
♦ Measure of steepness of the line
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The Definition and
Measurement of Slope
● The slope of a straight line
♦ Negative slope = one variable rises while the
other variable falls
■ The two variables move in opposite directions.
♦ Positive slope = two variables rise and fall
together
■ The two variables move in the same direction.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE
1-2a Negative Slope
Y
Negative
slope
0
X
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE
1-2b Positive Slope
Y
Positive
slope
0
X
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Definition and
Measurement of Slope
♦ Zero slope = the variable on the horizontal
axis can be any value while the
variable on the vertical axis is fixed
■ Horizontal line
♦ Infinite slope = the variable on the vertical
axis can be any value while the
variable on the horizontal axis is fixed
■ Vertical line
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FIGURE
1-2c Zero Slope
Y
Zero
slope
0
X
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE
1-2d Infinite Slope
Y
Infinite
slope
0
X
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Definition and
Measurement of Slope
● The slope of a straight line
♦ Slope is constant along a straight line.
♦ Slope can be measured between any two
points on one axis and the corresponding two
points on the other axis.
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1-3
How to Measure Slope
FIGURE
Y
Y
3
Slope = —
10
C
11
C
9
8
0
1
Slope = —
10
B
A
3
13
(a)
X
8
0
B
A
3
13
X
(b)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Definition and
Measurement of Slope
● The slope of a curved line
♦ Slope changes from point to point on a
curved line.
■Curved line bowed toward the origin has a
negative slope.
● Variables change in opposite directions.
■Curved line bowed away from the origin has a
positive slope.
● Variables change in the same direction.
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1-4a
Negative Slope in Curved Lines
FIGURE
Y
Negative
slope
0
X
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1-4b
Positive Slope in Curved Lines
FIGURE
Y
Positive
slope
0
X
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Definition and
Measurement of Slope
● The slope of a curved line
♦ A curved can have both a positive and
negative slope depending on where on the
curve is measured.
♦ The slope at a point on a curved-line is
measured by a line tangent to that point.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
1-4c,d Behavior of Slope
in Curved Lines
FIGURE
Y
Y
Negative
slope
Positive
slope
Negative
slope
Positive
slope
0
X
0
X
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1-5 How to Measure
Slope at a Point on a Curve
FIGURE
Y
r
8
D
7
6
5
R
t
F
C
E
4
G
T
3
r
M
2
1
0
A
t
B
1
2
3
4
5
6
7
8
9
10
X
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Rays Through the Origin and
45-degree Lines
● Y-intercept = point at which a line
touches the y axis
● Ray through the origin = straight line
graph with a y-intercept of zero
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1-6
Rays through the Origin
FIGURE
Y
Slope = + 2
5
Slope = + 1
4
B
3 C
A
2
K
1
E
0
1
2
Slope = + 1
–
2
D
3
4
5
X
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Squeezing 3 Dimensions
into 2: Contour Maps
● Some problems involve more than two
variables
● Economic “contour map” called a
production indifference map
♦ Shows how variable Z changes as we change
either X or Y
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1-8
An Economic Contour Map
FIGURE
Y
Yards of Cloth per Day
80
70
60
50
A
40
Z = 40
B
30
Z = 30
20
Z = 20
10
Z = 10
0
10
20
30
40
50
60
70
80
X
Labor Hours per Day
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