Chapter 1
Economics and the Economy
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
8th Edition, McGraw-Hill Education, 2005
PowerPoint presentation by Alex Tackie and Damian Ward
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CHAPTER
1
The Scope and
Method of Economics
Appendix: How to Read and Understand Graphs
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
The Study of Economics
• Economics is the study of
how individuals and
societies choose to use the
scarce resources that
nature and previous
generations have provided.
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Why Study Economics?
• An important reason for
studying economics is to
learn a way of thinking.
• Three fundamental
concepts:
– Opportunity cost
– Marginalism, and
– Efficient markets
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Opportunity Cost
• Opportunity cost is the
best alternative that we
forgo, or give up, when we
make a choice or a
decision.
• Nearly all decisions involve
trade-offs.
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Marginalism
• In weighing the costs and
benefits of a decision, it is
important to weigh only
the costs and benefits that
arise from the decision.
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Marginalism
• For example, when a firm
decides whether to produce
additional output, it considers
only the additional (or
marginal cost), not the sunk
cost.
– Sunk costs are costs that cannot
be avoided, regardless of what is
done in the future, because they
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Efficient Markets
• An efficient market is one in
which profit opportunities are
eliminated almost
instantaneously.
• There is no free lunch! Profit
opportunities are rare because,
at any one time, there are many
people searching for them.
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More Reasons to Study
Economics
• The study of economics is an
essential part of the study of
society.
• Economic decisions often have
enormous consequences.
– During the Industrial
Revolution, new manufacturing
technologies and improved
transportation gave rise to the
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modern factory
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More Reasons to Study
Economics
• An understanding of
economics is essential to
an understanding of global
affairs.
• Voting decisions also
require a basic
understanding of
economics.
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The Scope of Economics
• Microeconomics is the branch of economics
that examines the behavior of individual
decision-making units—that is, business firms
and households.
• Footballers’ wages and the price of oil,
for example, are both microeconomic
issues
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The Scope of Economics
• Macroeconomics is the branch of economics
that examines the behavior of economic
aggregates— income, output, employment, and
so on—on a national scale.
• Gross domestic product, the aggregate
price level and unemployment, for example,
are all macroeconomic issues
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The Scope of Economics
Examples of microeconomic and macroeconomic concerns
Microeconomics
Macroeconomics
Production
Prices
Income
Employment
Production/Output
in Individual
Industries and
Businesses
Price of Individual
Goods and
Services
Distribution of
Income and Wealth
Wages in the auto
industry
Minimum wages
Executive salaries
Poverty
Employment by
Individual
Businesses &
Industries
Jobs in the steel
industry
Number of
employees in a firm
National Income
Total wages and
salaries
Employment and
Unemployment in
the Economy
Total corporate
profits
Total number of
jobs
Unemployment
rate
How much steel
How many offices
How many cars
Price of medical
care
Price of gasoline
Food prices
Apartment rents
National
Production/Output
Aggregate Price
Level
Total Industrial
Output
Gross Domestic
Product
Growth of Output
Consumer prices
Producer Prices
Rate of Inflation
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Market orientation
China
Cuba
Sweden
Hungary
USA
UK
Free
market
economy
Command
economy
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What is Economics?
• ECONOMICS ...
• is the study of how society
decides:
– What
– For whom
– How
to produce...
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The price of oil
Tripled in 1973-74, and doubled again in 1979-80
… and affected people all over the world.
50
40
30
20
10
15
20
00
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95
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90
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85
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80
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75
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70
0
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65
US$ per barrel
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An increase in the price of oil
affects
• What to produce
– less oil-intensive products
• How to produce
– less oil-intensive techniques
• For whom to produce
– oil producers have more buying
power, importers have less
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The distribution of world population
and GNP, 2003
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Population
GNP
LIC
MIC
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HIC
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The production possibility
frontier (1)
• For each level of the output of
one good, the production
possibility frontier shows the
maximum amount of the other
good that can be produced.
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The production possibility
frontier (2)
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Food output (F)
F/G = opportunity cost (=1/2)
A

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F= 4
10
G = 8
6
B
Production
possibility
frontier
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Film output (G)
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The operation of markets
• Market
• a shorthand expression for the
process by which …
– households’ decisions about
consumption of alternative goods
– firms’ decisions about what and how to
produce
– and workers’ decisions about how much
and for whom to work
• … are all reconciled by adjustment of
prices
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Resource allocation
• Resource allocation is crucial for
a society
• and is handled in different ways
in different societies, e.g.:
– Command economy
– Mixed economy
– Free market
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Normative and Positive
Economics
• Positive economics deals with objective
explanation
– e.g. if a tax is imposed on a good its price
will tend to rise
• Normative economics offers
prescriptions based on value
judgements
– e.g. a tax should be imposed on tobacco to
discourage smoking
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