Ch. 1: What is Economics?
 Objectives
• Define economics and distinguish between
microeconomics and macroeconomics
• Explain the big questions of economics
• Explain the key ideas that define the economic way of
thinking
• Explain how economists go about their work as social
scientists
Definition of Economics
Social science that studies the choices that
individuals, businesses, governments, and
societies make as they cope with scarcity and the
incentives that influence and reconcile those
choices.
Micro vs Macro
Microeconomics
– study of choices made by individuals and
businesses, and the influence of government
on those choices.
Macroeconomics
– study of the effects on the national and global
economy of the choices that individuals,
businesses, and governments make.
Economic Questions
 What to produce?
 How to produce?
 Factors of production:
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Land earns rent
Labor earns wages
Capital earns interest/dividends
Entrepreneurship earns profits
 For whom to produce?
Free market vs. Command
• Free market allows individuals and businesses
to decide without government intervention.
• Command centralizes all decisions.
• Mixed market is a combination of extremes.
– Examples:
• Education
• Transportation
• Energy
Types of government intervention
• Direct control
– national defense, police, roads
• Price Controls
• Subsidies
– Ethanol, hybrid cars, crops
• Taxes
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–
–
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Tariffs on imports
Excise taxes on cigarettes, gasoline
Income
Property
• Regulation
– Anti-trust
– Laws designed to encourage competition.
Views on government intervention
• Communists versus Capitalists
• Democrats versus Republicans
• Equity versus Efficiency
Economic Growth
• Economic growth is an expansion in an
economy’s ability to produce goods and
services.
• Economic growth is affected by:
– Capital goods vs consumer goods.
– Education and training.
– Research and development (new tech)
Why does income per capita vary so much around the world?
The Economic Way of Thinking
• Economists assume individuals compare
costs and benefits in decision making.
• Cost is measured by opportunity cost.
– the highest-valued alternative that we give up
to get something is the opportunity cost of
the activity chosen.
The Economic Way of Thinking
• Economists assume that people make decisions
“on the margin”
– evaluate the consequences of making incremental
changes in the use of their resources.
– Marginal Benefit (MB): the benefit from pursuing an
incremental increase in an activity.
– Marginal Cost (MC): The opportunity cost of
pursuing an incremental increase in an activity.
• If MB>MC  pursue more of the activity.
• If MB<MC  pursue less of the activity.
The Economic Way of Thinking
• Economists assume people respond to
incentives.
– Incentives can affect MB or MC
• Taxes
• Subsidies
• Employer compensation methods.
– Incentives are key to reconciling self-interest
and the social interest.
•
•
•
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Pollution
Crime
Fishing
Water usage
The Economic Way of Thinking
• Two types of economic statements:
• positive statements
• normative statements
– A positive statement can be tested by
checking it against facts
– A normative statement cannot be tested.
The Economic Way of Thinking
• Economic models
– a description of some aspect of the economic
world that includes only those features of the
world that are needed for the purpose at hand.
• Testing Models
– Experiments
– Real world data
The Economic Way of Thinking
• Obstacles and Pitfalls in Economics
– Ceteris paribus (other things being the same):
• To isolate the effect of interest, economists use the logical device called
ceteris paribus or “other things being equal”, or “other things being the
same”.
– The fallacy of composition:
• The false conclusion that
– what is true for the parts is true for the whole
– what is true for the whole is true for the parts.
 The post hoc fallacy
• the error of reasoning that a first event causes a second
event because the first occurs before the second