Chapter 1 Introduction: What is Economics?

Check this out!
At the beginning of each chapter you see a list like the following,
which is a list in chapter 1:
After reading this chapter, you should be able to:
Define economics and the features of the economic perspective.
Describe the role of economic theory in economics.
Distinguish microeconomics from macroeconomics and positive
economics from normative economics.
List the categories of scarce resources and delineate the nature of
the economizing problem.
Apply production possibilities analysis, increasing opportunity
costs, and economic growth.
Explain how economic growth and international trade increase
consumption possibilities.
(Appendix) Understand graphs, curves, and slopes as they
relate to economics.
You provide answers
So, you know what to look for in a chapter. I have a road map
on the syllabus for the chapters we will cover.
A way to really learn economic ideas is to work through
examples. Let’s jump right into an example. This is an example
from what I will call personal economics. Say you have $10 to
spend and you are looking a candy bars and pops.
Say candy bars have a price of $1 per unit and pops have a price
of $1.25 per unit.
So, in your personal life you have some money and when you
buy stuff you have to pay prices.
Consumption Possibilities
Here let’s create a table that lists various
combinations of pop and candy bars you
can consume with your $10.
Note if you buy no pop you can use the
whole $10 on candy bars and thus if you take
$10 and divide by $1 you see you can have
10/1 = 10 candy bars.
If you buy 1 pop you have $10 minus
$1.25 left to spend and thus can have (10
– 1.25)/1 = 8.75 candy bars.
Don’t worry, for now say you can buy
fractional amounts of goods (you can
buy ½ gallon of gas, right?).
Pops Candy bars
Units of
Here I took the data in the
table and did a rough graph –
it is close to being exact, but
not perfect.
In a graph
Note I took the first column and made it the “x”
variable. The x intercept is the point where the
amount of y = 0 and you look at the corresponding
amount of x. Here we have the point (8, 0), where
you remember you put the x value first.
The y intercept here is (0, 10).
In the current context the
intercepts are the maximum
amounts of either item one can
have when devoting
Units of
all the money to the
The x
purchase of 1 type of
The slope
Let’s play a word association game. I will say something and
you write something down. Parker………………………..
(did you write short and dumpy?)
How many of you wrote rise over the run? You can put your
hand down now. A fuller way to express this is that between
any two points on a line take the change in the y variable and
divide by the change in the x variable between those two
The slope, part 2
Let’s take the 2 intercept points (0, 10) and (8, 0). The y values
here are 10 and 0 and so the change in y is (10 – 0) = 10.
In the same order the x values are 0 and 8 and so the change is
(0 – 8) = -8.
The slope is (10 – 0)/(0 – 8) = 10/-8 = -1.25. Now the slope is
an indication of the change in y for each unit change in x. This
means if you want 1 more pop you have to give up 1.25 candy
bars. I say give up 1.25 candy bars because when the slope is
negative the two variables move in opposite directions.
What have we learned?
Here the $10 is a personal resource that can be used in many
ways. Most people have a limited amount of resources.
Because of this there is a
1) A limited amount of items that can be purchased, and
2) A trdae-off in that as you want more of 1 item you have to
give up some amount of the other item. In fact, the slope is
an indication of how much y must be given up for each
addityional unit of x.
Let’s turn to some definitions of economics.
What is Economics?
Some definitions of economics:
The social science concerned with how individuals,
institutions, and society make optimal choices under
conditions of scarcity.
Economics is the study of how people allocate their
limited resources in an attempt to satisfy their
unlimited wants.
The study of how people make choices under
conditions of scarcity and of the results of those choices
for society.
Note a key point of the definition of economics - limited resources
and unlimited wants.
Scarcity really is the condition that human wants always exceed
what can be produced with the limited resources and time that we
have available.
Because of scarcity, choices must be made as to how to use our
Some folks who study economics like to say there is an “economic
way of thinking.” In other words, there are certain aspects to
looking at the world from an economic perspective.
Opportunity cost
The opportunity cost of something is what you give up to get it.
The consequence of limited resources and unlimited wants - scarcity - is
that choices of how to use resources must be made. If we use resources
to produce one thing we can not, obviously, use those very resources to
produce something else.
From the above statement we understand that there is a trade-off each
time we do one thing. If we do one thing, what we give up the ability to
do is called the opportunity cost of what we do.
Really the opportunity cost of an activity is the value we would have
received had we done the next best activity.
All costs in economics are opportunity costs.
The Basic Economic Problem
This first part of the economic way of viewing the world is a
statement of what we say is a fact – there is scarcity (limited
resources but unlimited wants).
The second part of the economic way of thinking is the idea
that people, when they act or do things, have a purpose or
are on a mission.
The third part of the economic way of thinking is really a
method employed to make sense of information that is
I will get back to these pieces of the economic way of
thinking, but I want to digress and explain briefly what are
considered the basic economic resources.
Basic Economic Resources
Land, labor, capital and entrepreneurial ability are the 4 basic
economic resources from a larger, societal point of view. This
is different from the starting personal economic story.
Land includes the soil, water, trees and other natural
Labor is that human effort that is not entrepreneurial. You
could say labor is the working.
Capital (or capital goods) includes all those man made tools
and stuff we use to make other goods.
Entrepreneurial ability is that human effort devoted to the
combining of the other three resources in production of
goods and services.
In economics we make a major assumption about people.
This assumption is that people ACT in their own selfinterest or have a purpose. This is what we mean by
Another way to understand the idea that people are
rational is to say that people have well defined goals and
they try to fulfill their goals the best way they can.
So, when I say people are on a mission I mean they are
rational or act with a purpose.
A big idea here is that people try to maximize their utility.
Utility is the happiness or satisfaction people get from
consuming goods and services.
I get a lot of utility from listening to the group Green Day.
In their song Warning there is a line that goes, “did you
remember to pay the utility.”
Please do not confuse their use of the word utility, where
they mean paying a bill to a utility company such as the
electric company, with our use. We mean happiness or
satisfaction! You can get some satisfaction, yes you can.
(By the way, lots of words used in an econ class are used
elsewhere. Often the word used in the class has a special
meaning different from the one used elsewhere.)
Marginal Analysis
The third part of the economic way of thinking is a method we
call marginal analysis. I will use an example to give you the
feel for marginal analysis.
In our personal example from before you had $10 to spend on
candy bars and pop. Many of us face the same prices – like
$1.25 per pop and $1 per candy bar. So, even if we have
different resource limits (money to spend) we still have the
same trade-off – one more pop means we give up 1.25 candy
Marginal analysis
How many pops should a person have?
Rule of thumb: Change your behavior (like how many pops
to have) when the marginal benefits are at least as great (or
better) than the marginal costs.
With a pop you get fizziness and liquid. These make you
happy. With a candy bar you get chewiness and nougat and
the like. These make you happy.
Take another pop if the extra (marginal) utility of the pop is
at least as great as as the marginal utility lose from having
less candy. Different people will have different valuations
and thus end up a different amounts of pop.
Marginal Analysis
Note here for a person the
marginal benefit curve for pop is
downward sloping and the
marginal cost is upward sloping.
Qright is the right amount of pop
for the person. Qlo is too low
because on additional units the
benefits are greater than the costs
(less candy). Quahi is way too high
because while the additional units
of pop have positive benefit the
costs in terms of candy given up is
even higher (that is what the height
of the curve means!). Conclusion:
the right amount is where MB=MC.
Quantity of
Introduction to Principles of Microeconomics
What has been going on in the gasoline market lately?
Is the BCS in college football a monopoly?
These two questions, while seemingly simple questions, have
complex answers. The attempt here in this course is to get you to
view questions like these from an economic perspective.
Economics is not the only way to view the world, but it is the point
of this class.
We are in this together. I will try to do my part. I hope you will do
the same. Please ask questions.
Let’s do it!
Economics is a science really!
In economics, like other scientific fields, models are used
to predict and explain activity or actions. A model is
judged to be useful by how well it predicts and explains
these actions.
The better the predictions and explanations, the better
the model.
There are two main branches of economics as a science:
microeconomics and macroeconomics.
Economic Models
Have you every used a map of a city so that you could drive
around to places you wanted to get to?
Was the map part of a circular globe? Maps I have used
were flat, but they were fairly decent.
As a model of the world the map being flat wasn’t true, but
it was useful.
Economic models may have assumptions built into them
that are not exactly true, like maps of the world assuming
the world is flat, but they help us make sense of the world.
Microeconomic topics
Economics has two main branches of study: micro and macro
There is a organization called the Council on Economic
Education and folks there have an idea of what you should learn
in a college level econ class like the one you are in (a micro
class). The major content areas in microeconomics are
A. The Basic Economic Problem
i) scarcity ii) opportunity cost iii) choice
B. Markets and Price Determination
i) determinants of supply and demand ii) utility
iii) elasticity iv) price ceilings and price floors
C. Theories of the Firm
i) revenues ii) costs iii) marginal analysis
iv) market structures
(more on next slide)
Microeconomic topics
D. Factor Markets
i) wages ii) rents iii) interest iv) profits
v) income distribution
E. The microeconomic role of government in a Market Economy
i) public goods ii) maintaining competition iii) externalities
iv) taxation v) income redistribution vi) public choice
F. International Economics
i) comparative advantage ii) trade barriers
iii) exchange rates
So, this slide and the last slide provides a nice blueprint for the
topics we will want to cover this term. We may not go in the
same order as the information here. Maybe you can write on
these sheets what chapters cover which topics.
Macroeconomic topics
Some macro topics (ECO 202 is a macro course)
1) How the national economy works - we are
concerned about things like inflation, unemployment,
international trade and economic growth.
2) We will ask what role the government plays in the
economy and explore what impact that role has on the
economic system.
3) We will want to understand how changes in
variables such as the interest rate affect our lives in the
roles we play in households, firms, and governments.
Positive and normative
What is the difference in the following two statements?
1) Raising the minimum wage will not change the
unemployment rate at all.
2) I think we should raise the minimum wage.
To me both of these statements sound like my opinion.
BUT, the first may, or may not, be right. It is a statement
that can be put to the test. If economics were like
chemistry you could conduct an experiment to see if the
statement is true. (In fact, statistical tools help
economics be like chemistry.)
Positive and normative
Statements like 1) above that can be put to the test are
POSITIVE economic statements. Much of the work in science
is formulating and testing positive statements.
Statement 2) above is a statement about what someone thinks
SHOULD BE. We call it a normative economic statement.
Most folks have normative views about the economy, even
when their positive understanding is weak. It’s okay to have
opinions, right? I hope you learn enough about the positive
aspects so you can decide for yourself whose opinions you will
want to value and whose opinions you can ignore (Dudball!)
A pet peeve about weather
When I watch the local news I want the weather person to
stick to the positive aspects of meterology. I can live with
a statement like, “tomorrow it will be 27 degrees with
winds blowing 10 to 15 miles out of the northwest.”
I do not like the normative views the weather person
shares with me. They usually say stuff like, “better have
your heavy coat tomorrow.” My point is I can make up
my own mind once they tell me what the conditions will
be. I do not need a recommendation about what I should
Ceteris Paribus
Ceteris Paribus (sounds like say tear iss pay ribus) is a flashy way
of saying all else the same or other things equal.
The point is that when we use models and make positive
statements they are in a certain context. The statements apply in
that context. If the context is different the statements might not
still apply.
We have an idea that we will explore more later that goes
something like the following: The lower the price of x the greater
quantity of x a person will desire, ceteris paribus. The main point
is we want to focus only on how the price influences the desire,
although the desire is influenced by many things (like how much
you like the good, how much income you have, how much other
related goods cost, for example).

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