Chapter 1 - Introduction: What is Economics?

1.1 What is Economics?

Economics studies the choices we make when there is scarcity; it is all about trade-offs. It provides a framework in which we are able to diagnose society’s problems and helps create possible solutions.
- Scarcity is the resources we use to produce goods and services are limited

Factors of Production

(Production inputs or resources) are used by people to produce goods and services.
1. Natural Resources: provided by nature.
2. Labor: the physical and mental effort people use to produce goods or services.
3. Physical Capital: the stock of equipment, machines, structures, and infrastructures used to produce goods and services.
4. Human Capital: the knowledge and skills acquired by a worker through education and experience.
5. Entrepreneurship: the effort used to coordinate the factors of production/to produce and sell products.

Positive versus Normative Analysis

Positive Analysis predicts the consequences of alternative actions by answering “What is?” or “What will be?” questions.
Normative Analysis answers the “What ought to be?” question.
Economists contribute to policy debates by conducting positive analyses of the consequences of alternative actions.
Using the conclusions from the positive analysis, citizens and policymakers could then make a normative decision.

The Three Key Economic Questions: What, How, and Who?

The choices of individuals, firms, and governments answer three questions:
- What products do we produce?
- How do we produce the products?
- Who consumes the products?

Economic Models

Economists use economic models to explore the choices people make (individuals, firms, and other organizations) and the consequences of those choices.
An economic model is an abstraction from reality that enables us to focus our attention on what really matters.

1.2 Economic Analysis and Modern Problems

Economic analysis provides important insights into real-world problems.

Economic View of Traffic Congestion

To an economist, the diagnosis of the congestion problem is straightforward.
In deciding whether to use the highway, you will presumably ignore any costs you impose on others and similarly, your fellow commuters will as well.
One possible solution to the congestion problem is to force people to pay for using the road.
Traffic volume would decrease during rush hours because travelers
- Shift their travel to off-peak times
- Switch to ride-sharing and mass transit
- Shift their travel to less congested routes

Economic View of Poverty in Africa

Economists have found that as a nation’s economy grows, its poorest households share in the general prosperity. One way to reduce poverty in sub-Saharan Africa is to increase economic growth.
Economic growth occurs when a country expands its production facilities (machinery and factories), improves its public infrastructure (highways and water systems), widens educational opportunities, and adopts new technology.
In many cases, institutions impede rather than encourage the sort of investment and risk-taking, entrepreneurship, that causes economic growth and reduces poverty.
As a consequence, economists and policymakers are exploring ways to reform the region’s institutions. They are also challenged with choosing among development projects that will generate the biggest economic boost per dollar spent.

Economic View of the Current World Recession

The financial crisis and the recession that began in late 2007: Many purchasers of homes and properties could not really afford them, and when many homeowners had trouble making their mortgage payments, the trouble spread to banks and other financial institutions.
As a result, businesses found it increasingly difficult to borrow money for everyday use and investment, and economic activity around the world began to contract.

1.3 The Economic Way of Thinking

Four elements of the economic way of thinking: Use assumptions to simplify, Isolate variables-ceteris paribus, Think at the margin, and Rational people respond to incentives.

Use Assumptions to Simplify

Economists use assumptions to make things simpler and focus attention on what really matters
If the economic analysis is based on unrealistic assumptions, that doesn’t mean the analysis is faulty.

Isolate Variables-Ceteris Paribus

Economic analysis often involves variables and how they affect one another.
A variable is a measure of something that can take on different values.
Economists are interested in exploring relationships between two variables.
Alfred Marshall (1842-1942) was a British economist who refined the economic model of supply and demand and provided a label for this process.
Ceteris Paribus is the Latin expression meaning that other variables are held fixed.

Think at the Margin

Economists often consider how a small change in one variable affects another variable and what impact that has on people’s decision-making.
Marginal change is a small, one-unit change in value.

Rational People Respond to Incentives

A key assumption of most economic analysis is that people act rationally, meaning they act in their own self-interest.
Scottish philosopher Adam Smith (1723-1790), who is also considered the founder of economics, wrote that he discovered within humankind that self-interest is more powerful than kindness or altruism.

1.4 Preview of Coming Attractions: Macroeconomics

Macroeconomics is the study of the nation’s economy as a whole; it focuses on the issues of inflation (a general rise in prices), unemployment, and economic growth. It explains why economies grow and change and why economic growth is sometimes interrupted.

Using Macroeconomic to Understand Why Economies Grow

Increases in income translate into a higher standard of living for consumers-better cars, houses, and clothing and more options for food, entertainment, and travel.
People in a growing economy can consume more of all goods and services because the economy has more of the resources needed to produce these products.
Macroeconomics explains why resources increase over time and the consequences for our standard of living.

Using Macroeconomics to Understand Economic Fluctuations

During an economic downturn, some of the economy’s resources are idle. Some workers are unemployed, and some factories are closed.
When the economy grows too rapidly, causing prices rise.
Macroeconomics helps us understand why these fluctuations occur.

Using Macroeconomics to Make Informed Business Decisions

Macroeconomics is used to make informed business decisions.
The government uses various policies to influence interest rates (the price of borrowing the money) and the inflation rate.

1.5 Preview of Coming Attractions: Microeconomics

Microeconomics is the study of the choices made by households (an individual or a group of people living together), firms, and government and how these choices affect the markets for goods and services.

Using Microeconomics to Understand Markets and Predict Changes

Microeconomics is used to better understand how markets work and to predict how various events affect the prices and quantities of products in markets.

Using Microeconomics to Make Personal and Managerial Decisions

We use economic analysis to decide how to spend our time, what career to pursue, and how to spend and save money we earn.
Managers use economic analysis to decide how to produce goods and services, how much to produce, and how much to charge for them.

Using Microeconomics to Evaluate Public Policies

We can use economic analysis to determine how well the government performs its roles in the market economy. As well as exploring the trade-offs associated with various public policies.

1A.1 Using Graphs

Graphing Single Variables

Pie Graph
Bar Graph
Time-Series Graph

Graphing Two Variables

One variable is measured along the horizontal, or x-axis, while the other variable is measured along the vertical, or y-axis.
The origin is the intersection of the two axes, where the values of both variables are zero.
Dashed lines show the values of the two variables at a particular point.
A positive relationship is between two variables if they move in the same direction.
A negative relationship is between two variables if they move in opposite directions.

Computing the Slope

The slope of the curve is the vertical difference between two points (the rise) divided by the horizontal difference (the run).

1A.2 Computing Percentage Changes and Using Equations

Economists often express changes in variables in terms of percentage changes.
Computing Percentage Changes
- Percentage Change = ((New Value -initial value)/Initial Value) x 100