The Nature and Method of
Economics
Chapter 1
The Economic Perspective
Economics has a number of key concepts:
– Scarcity and choice
– Rational behavior
– Marginalism
Scarcity and Choice
Economists believe that:
– Resources are limited
– Material wants are unlimited
– Therefore society must choose where and
how to spend these limited resources.
Rational behavior
Economists believe that human behavior
reflects rational self-interest. Rational
behavior is when:
– People try to increase their utility
(pleasure, satisfaction).
– People try to decrease their disutility
(pain, dissatisfaction).
Rational behavior
Economists believe that people maximize
their utility in a completely rational and
logical fashion.
Marginalism
Economists focus on marginal analysis:
Marginal analysis is the comparison of
marginal benefits and marginal costs.
Marginalism
Marginal benefit is the additional or extra
benefit that is the result of a choice.
Marginal cost is the additional or extra cost
that is the result of a choice.
Economic Perspective
Economists believe that people compare the
marginal benefits with the marginal costs
whenever they make a decision; that they do
so rationally; and that their decisions are to
maximize their utility.
Scientific Method
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Recognize
Assume
Develop
Hypothesize
Test
Scientific Method: Recognize
• Recognize the problem or
• Identify an issue
Scientific Method: Assume
• Make a series of simplifying assumptions to
manage the problem.
Scientific Method: Develop
• Use the assumptions to create a model
Scientific Method: Hypothesize
• Out of the model create an hypothesis.
• Use the hypothesis to solve the problem.
Scientific Method: Test
• Collect your data.
• Test your hypothesis against the data.
Ceteris Paribus
• Defined as:
• ALL OTHER THINGS BEING EQUAL
Ceteris Paribus
• This means holding everything else
constant, except for the variables in our
hypothesis or model.
• If we hold everything else constant, we hold
it fixed.
• If we hold it fixed, we can ignore it.
Ceteris Paribus
• Ceteris paribus is a key assumption, because
it allows us to treat everything outside of
our model as unimportant.
Fallacy of Composition
• Beware of fallacy of composition!
• Fallacy of composition is the idea that what
is good for one person (or part) is good for
everyone (or the whole).
Post Hoc Fallacy
• One needs to think very carefully in order to
decide whether something is the cause of
something else.
Correlation vs. Causation
• Beware of the difference between
correlation and causation:
• Correlation is coincidence.
• Causation is X causes Y.
Positive vs. Normative Analysis
• Be aware of the difference between positive
and normative approaches!
• Positive analysis is an attempt to do value
free analysis of an economic issue.
• Normative analysis is analysis with openly
stated values.
Economics
• There are two main branches of economics:
– Macroeconomics
– Microeconomics
Macroeconomics
Defined as:
The study of the economy as a whole, or
major sectors of the economy.
Macroeconomics
• In macro, we study:
- Government policies
- Aggregate business behavior
- Aggregate consumer behavior
- Money and banking
Microeconomics
Defined as:
The study of decision making by firms,
households and individuals.
Microeconomics
• In micro, we study:
- How prices are formed.
- How much is to be produced.
- Individual behavior in the marketplace.
- The application of economic logic to a
variety of contemporary problems.