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.