Lecture 1. What is Economics?
• Economics, Scarcity and Choices
• Microeconomics and Macroeconomics
• Positive Economics and Normative
Economics
• Why study Economics
• The method of Economics
Economics, Scarcity, and
Choice
• A good definition of economics
– Study of choice under conditions of
scarcity
• Scarcity
– Situation in which the amount of
something available is insufficient to
satisfy the desire for it (Human beings
have unlimited wants and needs in
general)
Scarcity and Individual Choice
• Two basic limitations for individuals
– Scarce time
– Scarce spending power
• Limitations force each of us to make choices
• The scarcity of resources—and the choices it
forces us to make—is the source of all of the
problems studied in economics
• Examples: Dating & Getting A in this class
Microeconomics
• Study of behavior of individual households,
firms, and governments
• Choices they make
• Interaction in specific markets
• Focuses on individual parts of an economy,
rather than the whole
• Examples:
 How many management trainee jobs will open up for college
graduates?
 How would U.S. phone companies be affected by a tax on imported
cell phones?
Macroeconomics
• Study of the economy as a whole
• Focuses on big picture and ignores fine
details
• Examples:
 Instead of focusing on the production of carrots, it looks at GDP.
 Instead of focusing on the employment of management trainees, it
considers total employment (or unemployment rate) in the economy.
 Instead of asking why credit card loans carry high interest rate than
home mortgage loans, it asks what makes interest rates in general
rise or fall.
Why Economists Disagree
• Two economists asked whether the States should
eliminate all government-imposed barriers to trading with
the rest of the world. The first economist says, ‘Yes.’ but
the other says, ‘No’.
– The two economists may disagree about what will happen if
trade barriers were eliminated. In this case, the disagreement is
positive.
– Both economists might agree that opening up international trade
would benefit most Americans, but harm some of them.
• The first economist might put more emphasis on benefits to the
overall economy
• The second economist might put more emphasis on preventing
harm to a particular group.
In this case, the disagreement is normative.
Positive Economics
• Study of how economy works
• Accuracy of positive statements can be
tested and quantified.
• Examples: An decrease in the personal
income tax will increase the growth rate of
the economy.
Normative Economics
• Use Value Judgment to study what should
be
• Normative statements cannot be proved or
disproved by the facts alone
• Example: The goal of any country’s
economic policy should be to increase the
well-being of its poorest, most vulnerable
citizens.
The Methods of Economics
• Model. What is a model?
– A Model is an Abstract representation of
reality.
– A Model should be as simple as possible to
accomplish its purpose.
– A model should contain the right amount of
details.
Drive from Ames to Chicago
Drive from Chicago O’Hare International Airport to
Hilton Tower Chicago
Assumptions and Conclusions
• Simplifying assumptions
• Way of making a model simpler without affecting
any of its important conclusions
• Example: When we study the behavior of
consumers, we assume that there are only two
goods to choose from.
• Critical assumptions
• Affect conclusions of a model in important ways
• Example: When we study the behavior of business
firms, we assume that firms try to earn the highest
possible profit.
Why Study Economics
•
•
•
•
To Understand the World Better
To Achieve Social Change
To Help prepare for Other Careers
To become an Economist
– Median annual wage and salary earnings of
economists were $72,780 in May 2004.
Check out
http://stats.bls.gov/oco/ocos055.htm
How to Study Economics
• Economics must be studied actively, not
passively
• What does active studying mean?
– Closing the book periodically and reproducing what
you have learned
– Reading with a pencil in your hand and a blank sheet
of paper in front of you
– Listing the steps in each logical argument
– Retracing the cause-and-effect steps in each model
– Drawing the graphs that represent the model
– Thinking about the basic principles of economics and
how they relate to what you are learning
Appendix: Tables and Graphs
Table A.1 Advertising and Sales at Len & Harry’s
Advertising
($1,000s per Month)
2
3
6
7
11
12
Sales
($1,000s per Month)
46
49
58
61
73
76
Appendix: Tables and Graphs
Sales
($1,000 per 76
73
Month
E
61
58
D
C
49
46
40
B
A
1
2
F
3
4
5
6
7
8
9
10 11 12
Advertising
($1,000 per Month)
Measuring the Slope of a Curve
Sales
($1,000 per
Month
1. The slope of this
curve at point B . . .
54
53
C
49
46
43
H
40
4. sales increase from 43
to 49 units (ΔY= 6). So
the curve's slope at
point B is = 6/3 = 2.
D
2. is the slope of the
straight line tangent to
the curve at point B.
B
A
3. Along the tangent line,
when advertising
increases from 0 to 3
units (ΔX = 3)
1 2 3 4 5 6 7 8 9
Advertising
($1,000 per Month)
Straight Lines with Different
Slopes and Vertical Intercepts
(a)
Y
b>0
a
b=0
b<0
0
X
Straight Lines with Different
Slopes and Vertical Intercepts
(b)
Y
a>0
a=0
0
X
a<0
Shifts in the Graph of Advertising
and Sales
Sales
($1,000 per
Month
July
64
C'
June
58
C
September
C''
6
Advertising
($1,000 per Month)
Shifts of Curved Lines and Straight
Lines
(a)
Y
An increase in Z causes an
increase in Y at any value of X
C'
C
X