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The Scope and Method of Economics

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  • Opportunity cost does not have to be measured in dollar terms. The value of an alternative activity is usually measured in both monetary and nonmonetary costs.
    Opportunity cost is referred to as implicit cost. Accountants count only explicit costs. Economic cost is higher than accounting costs because it includes implicit, or opportunity, cost.
  • Transcript

    • 1. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair CHAPTERCHAPTER 11 Prepared by: Fernando QuijanoPrepared by: Fernando Quijano and Yvonn Quijanoand Yvonn Quijano The Scope and Method ofThe Scope and Method of EconomicsEconomics
    • 2. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Study of EconomicsThe Study of Economics • EconomicsEconomics is the study ofis the study of how individuals and societieshow individuals and societies choose to use the scarcechoose to use the scarce resources that nature andresources that nature and previous generations haveprevious generations have provided.provided.
    • 3. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Why Study Economics?Why Study Economics? • Probably the most important reasonProbably the most important reason for studying economics isfor studying economics is to learnto learn a way of thinking.a way of thinking. • Three fundamental concepts:Three fundamental concepts: • Opportunity costOpportunity cost • MarginalismMarginalism, and, and • Efficient marketsEfficient markets
    • 4. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Opportunity CostOpportunity Cost • Opportunity costOpportunity cost is the bestis the best alternative that we forgo, or givealternative that we forgo, or give up, when we make a choice or aup, when we make a choice or a decision.decision. • Opportunity costs arise becauseOpportunity costs arise because time and resources are scarce.time and resources are scarce. Nearly all decisions involve trade-Nearly all decisions involve trade- offs.offs.
    • 5. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair MarginalismMarginalism • In weighing the costs and benefits of a decision,In weighing the costs and benefits of a decision, it is important to weigh only the costs andit is important to weigh only the costs and benefits that arise from the decision.benefits that arise from the decision. • For example, when deciding whether to produceFor example, when deciding whether to produce additional output, a firm considers only theadditional output, a firm considers only the additionaladditional (or marginal cost), not the sunk cost.(or marginal cost), not the sunk cost. • Sunk costsSunk costs are costs that cannot be avoided,are costs that cannot be avoided, regardless of what is done in the future, becauseregardless of what is done in the future, because they have already been incurred.they have already been incurred.
    • 6. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Efficient MarketsEfficient Markets • AnAn efficient marketefficient market is one in whichis one in which profit opportunities are eliminatedprofit opportunities are eliminated almost instantaneously.almost instantaneously. • There is no free lunch! ProfitThere is no free lunch! Profit opportunities are rare because, atopportunities are rare because, at any one time, there are manyany one time, there are many people searching for them.people searching for them.
    • 7. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair More Reasons to Study EconomicsMore Reasons to Study Economics • Economics involves the study of societal andEconomics involves the study of societal and global affairs concerning resource allocation.global affairs concerning resource allocation. • Economics is helpful to us as voters. VotingEconomics is helpful to us as voters. Voting decisions require a basic understanding ofdecisions require a basic understanding of economics.economics. • Money and financial systems are an importantMoney and financial systems are an important component of the economic system, but are notcomponent of the economic system, but are not the most fundamental issue in economics.the most fundamental issue in economics.
    • 8. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Scope of EconomicsThe Scope of Economics • MicroeconomicsMicroeconomics is the branch of economicsis the branch of economics that examines the functioning of individualthat examines the functioning of individual industries and the behavior of individualindustries and the behavior of individual decision-making units—that is, business firmsdecision-making units—that is, business firms and households.and households. • MacroeconomicsMacroeconomics is the branch of economicsis the branch of economics that examines the economic behavior ofthat examines the economic behavior of aggregatesaggregates— income, output, employment, and— income, output, employment, and so on—on a national scale.so on—on a national scale.
    • 9. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Diverse Fields of EconomicsThe Diverse Fields of Economics Examples of microeconomic and macroeconomic concernsExamples of microeconomic and macroeconomic concerns ProductionProduction PricesPrices IncomeIncome EmploymentEmployment MicroeconomicsMicroeconomics Production/OutputProduction/Output in Individualin Individual Industries andIndustries and BusinessesBusinesses How much steelHow much steel How many officesHow many offices How many carsHow many cars Price of IndividualPrice of Individual Goods and ServicesGoods and Services Price of medicalPrice of medical carecare Price of gasolinePrice of gasoline Food pricesFood prices Apartment rentsApartment rents Distribution ofDistribution of Income andIncome and WealthWealth Wages in the autoWages in the auto industryindustry Minimum wagesMinimum wages Executive salariesExecutive salaries PovertyPoverty Employment byEmployment by IndividualIndividual Businesses &Businesses & IndustriesIndustries Jobs in the steelJobs in the steel industryindustry Number ofNumber of employees in aemployees in a firmfirm MacroeconomicsMacroeconomics NationalNational Production/OutputProduction/Output Total IndustrialTotal Industrial OutputOutput Gross DomesticGross Domestic ProductProduct Growth of OutputGrowth of Output Aggregate PriceAggregate Price LevelLevel Consumer pricesConsumer prices Producer PricesProducer Prices Rate of InflationRate of Inflation National IncomeNational Income Total wages andTotal wages and salariessalaries Total corporateTotal corporate profitsprofits Employment andEmployment and Unemployment inUnemployment in thethe EconomyEconomy Total number ofTotal number of jobsjobs UnemploymentUnemployment raterate
    • 10. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Method of EconomicsThe Method of Economics • Normative economicsNormative economics,, also called policyalso called policy economics, analyzes outcomes of economiceconomics, analyzes outcomes of economic behavior, evaluates them as good or bad, andbehavior, evaluates them as good or bad, and may prescribe courses of action.may prescribe courses of action. • Positive economicsPositive economics studies economicstudies economic behavior without making judgments. Itbehavior without making judgments. It describes what exists and how it works.describes what exists and how it works.
    • 11. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Method of EconomicsThe Method of Economics • Positive economics includes:Positive economics includes: • Descriptive economicsDescriptive economics, which involves the, which involves the compilation of data that describe phenomena andcompilation of data that describe phenomena and facts.facts. • Economic theoryEconomic theory that involves building models ofthat involves building models of behavior. A theory is a statement or set of relatedbehavior. A theory is a statement or set of related statements about cause and effect, action andstatements about cause and effect, action and reaction.reaction. • Empirical economicsEmpirical economics refers to the collectionrefers to the collection and use of data to test economic theories.and use of data to test economic theories.
    • 12. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Theories and ModelsTheories and Models • AA theorytheory is a general statement of cause andis a general statement of cause and effect, action and reaction. Theories involveeffect, action and reaction. Theories involve models, and models involve variables.models, and models involve variables. • AA modelmodel is a formal statement of a theory.is a formal statement of a theory. Models are descriptions of the relationshipModels are descriptions of the relationship between two or more variables.between two or more variables. • Ockham’s razorOckham’s razor is the principle that irrelevantis the principle that irrelevant detail should be cut away. Models aredetail should be cut away. Models are simplifications, not complications, of reality.simplifications, not complications, of reality.
    • 13. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Theories and ModelsTheories and Models • AA variablevariable is a measure that can change fromis a measure that can change from observation to observation.observation to observation. • Using theUsing the ceteris paribus,ceteris paribus, oror all else equal,all else equal, assumptionassumption, economists study the relationship, economists study the relationship between two variables while the values of otherbetween two variables while the values of other variables are held unchanged.variables are held unchanged. • The ceteris paribus device is part of the processThe ceteris paribus device is part of the process of abstraction used to focus only on keyof abstraction used to focus only on key relationships.relationships.
    • 14. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Theories and ModelsTheories and Models • In formulating theories and models we mustIn formulating theories and models we must avoid two pitfalls:avoid two pitfalls: • TheThe Post Hoc FallacyPost Hoc Fallacy: It is erroneous to believe that: It is erroneous to believe that if event A happened before event B, then A caused B.if event A happened before event B, then A caused B. • TheThe Fallacy of CompositionFallacy of Composition: It is erroneous to: It is erroneous to believe that what is true for a part is also true for thebelieve that what is true for a part is also true for the whole. Theories that seem to work well when appliedwhole. Theories that seem to work well when applied to individuals often break down when they are appliedto individuals often break down when they are applied to the whole.to the whole.
    • 15. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Economic PolicyEconomic Policy Criteria for judging economic outcomes:Criteria for judging economic outcomes: • EfficiencyEfficiency, or allocative efficiency. An efficient, or allocative efficiency. An efficient economy is one that produces what people want ateconomy is one that produces what people want at the least possible costthe least possible cost.. • EquityEquity, or, or fairness of economic outcomes.fairness of economic outcomes. • GrowthGrowth, or, or an increase in the total output of anan increase in the total output of an economy.economy. • StabilityStability, or the condition in which output is steady, or the condition in which output is steady or growing, with low inflation and full employmentor growing, with low inflation and full employment of resources.of resources.
    • 16. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair How to Read and Understand GraphsHow to Read and Understand Graphs • Each point on the CartesianEach point on the Cartesian plane is a combination ofplane is a combination of (X,Y) values.(X,Y) values. • The relationship between XThe relationship between X and Y is causal. For a givenand Y is causal. For a given value of X, there is avalue of X, there is a corresponding value of Y, orcorresponding value of Y, or X causes Y.X causes Y.
    • 17. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Reading Between the LinesReading Between the Lines • AA lineline is a continuous stringis a continuous string of points, or sets of (X,Y)of points, or sets of (X,Y) values on the Cartesianvalues on the Cartesian plane.plane. • The relationship between XThe relationship between X and Y on this graph isand Y on this graph is negative. An increase in thenegative. An increase in the value of X leads to avalue of X leads to a decreasedecrease in the value of Y,in the value of Y, and vice versa.and vice versa.
    • 18. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Positive and Negative RelationshipsPositive and Negative Relationships AA downward-slopingdownward-sloping line describes aline describes a negative relationshipnegative relationship between X and Y.between X and Y. AnAn upward-slopingupward-sloping lineline describes a positivedescribes a positive relationship between Xrelationship between X andand Y.Y.
    • 19. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Components of a LineThe Components of a Line • The algebraic expression ofThe algebraic expression of this line is as follows:this line is as follows: Y = a + bX where:where: Y = dependent variabledependent variable X = independent variableindependent variable a = Y-interceptY-intercept, or value of, or value of YY whenwhen XX = 0.= 0. b = slopeslope of the line, or theof the line, or the rate of change inrate of change in YY given a change ingiven a change in XX.. + = positive relationshippositive relationship betweenbetween XX andand YY b = ∆ ∆ Y X Y Y X X = − − 1 0 1 0
    • 20. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Different Slope ValuesDifferent Slope Values b = = 5 1 0 0 5. b = − = − 7 1 0 0 7. b = = 0 1 0 0 b = = ∞ 1 0 0
    • 21. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Strength of the Relationship BetweenStrength of the Relationship Between X and YX and Y • This line isThis line is relatively flatrelatively flat.. Changes in the value of X haveChanges in the value of X have only a small influence on theonly a small influence on the value of Y.value of Y. • This line isThis line is relatively steeprelatively steep.. Changes in the value of X have aChanges in the value of X have a greater influence on the value ofgreater influence on the value of Y.Y.
    • 22. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Difference Between a Line and a CurveThe Difference Between a Line and a Curve Equal increments inEqual increments in XX lead to diminishedlead to diminished increases inincreases in YY.. Equal increments inEqual increments in XX lead to constantlead to constant increases inincreases in YY..
    • 23. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Interpreting the Slope of a CurveInterpreting the Slope of a Curve • Graph A hasGraph A has a positive anda positive and decreasingdecreasing slope.slope. • Graph B hasGraph B has a negativea negative slope, then aslope, then a positive slope.positive slope. • Graph C showsGraph C shows a negative anda negative and increasingincreasing relationshiprelationship betweenbetween XX andand YY.. • Graph DGraph D shows ashows a negative andnegative and decreasingdecreasing slope.slope.