CHAPTER 1: What is Economics?

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CHAPTER 1What is Economics?
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CHAPTER CHECKLIST

• Define economics, distinguish between
  microeconomics and macroeconomics, and explain
  the questions of macroeconomics.
• Describe the work of economists as social
  scientists.
• Explain four core ideas that define way
  economists think about macroeconomic questions.
• Explain why economics is worth studying.

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I. Introduction A Definition of Economics

• Economics is the science of choice the science
  that explains the choices that we make and how
  those choices change as we cope with scarcity.
• Societys wants exceed the resources available to
  satisfy them.
• Rich and poor alike are faced with scarcity.

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Texts

• This course will use this text
• Bade Parkin, Foundations of Macroeconomics, 1st
  edition
• This comes in a package, with a Study Guide, a CD
  of exercises etc., access to web resources and
  phone help.
• Practice with Study Guide or CD or web multiple
  choice questions/sample quizzes is the best way
  to prepare for tests
• Explore what is in the package its costing you
  about 80, get your moneys worth out of it.

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Using Bade-Parkin

• Dont bring the text to class
• Do read it -- preferably before and after the
  class that the chapter is assigned for
• Do use the CD/web and the Study Guide -- it is
  best to do it with some friends, rather than
  alone.

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Email and the Web

• If you dont have an FSU email address, get one
  as soon as possible. You will get lots of
  important information about this class by email.
  It is easy to get email forwarded from your FSU
  garnet account to your preferred email account.
• By the end of the semester, there will be lots of
  material for the class on the web. See
  http//mailer.fsu.edu/jcobbe/eco2013.htm

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JARGON

• Economics uses jargon a lot
• Jargon means a special vocabulary
• Economics jargon can be confusing because it
  often gives special meaning to ordinary, every
  day words, that have a different meaning in
  normal usage

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Why jargon?

• Jargon allows precision
• Jargon allows shorter statements
• Jargon permits more efficient communication
• Its standard in economics, so we have to know it
  to understand economics

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Quote Joan RobinsonProfessor of Economics at
U. of Cambridge

• You study economics in order to avoid being
  fooled by economists

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Bad aspects of Jargon

• Jargon can be used to obfuscate or exclude
• Jargon can be confusing to those who are unsure
  of it
• Unnecessary jargon hinders efficient
  communication rather than helping it

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Economics as a Foreign Language

• ALL economics and economists use jargon to some
  extent
• MOST of economics is common sense
• Except for a very few non-intuitive ideas,
  learning economics amounts to learning how to
  express what you know in the right jargon, i.e.
  it is like learning a new language

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LECTURE TOPICS

• Definitions and Questions
• Economics A Social Science
• Macroeconomic Ideas
• Why Economics Is Worth Studying

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1.1 DEFINITIONS AND QUESTIONS

• All economic questions and problems arise because
  human wants exceed the resources available to
  satisfy them.
• Scarcity
• The condition that arises because the available
  resources are insufficient to satisfy wants.
• Economics
• Studies the choices that individuals, businesses,
  government, and entire societies make as they
  cope with scarcity.

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1.1 DEFINITIONS AND QUESTIONS

• Microeconomics
• Microeconomics The study of the choices that
  individuals and businesses make, the way these
  choices interact, and the influence that
  governments exert on these choices. Micro
  small
• Macroeconomics
• Macroeconomics The study of the aggregate (or
  total) effects on the national economy and the
  global economy of the choices that individuals,
  businesses, and governments make. Macro big

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1.1 DEFINITIONS AND QUESTIONS

• Macroeconomic Questions
• The three big issues that macroeconomics tries to
  understand are
• The standard of living
• The cost of living
• Economic fluctuationsrecessions and expansions

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1.1 DEFINITIONS AND QUESTIONS

• The Standard of Living
• Standard of living
• The level of consumption of goods and services
  that people enjoy, on the average it is measured
  not perfectly by average income per person.
• Goods and services
• The objects that people value and produce to
  satisfy human wants. Goods are physical objects,
  and services are things done for people.

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1.1 DEFINITIONS AND QUESTIONS

• For most people achieving a high standard of
  living means finding a good job.
• Unemployment
• The state of being available and willing to work
  but unable to find suitable work.

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1.1 DEFINITIONS AND QUESTIONS

• The Cost of Living
• Cost of living
• The number of dollars it takes to buy the goods
  and services that achieve a given standard of
  living.
• Inflation
• A situation in which the cost of living is rising
  and the value of money is shrinking.

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1.1 DEFINITIONS AND QUESTIONS

• Economic Fluctuations Recessions and Expansions
• Business cycle
• A periodic but irregular up-and-down movement in
  production and jobs.
• The worst recession ever was the Great
  Depression.
• Great Depression
• A period during the 1930s in which the economy
  experienced its worst-ever recession.

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1.1 DEFINITIONS AND QUESTIONS

• Figure 1.1 shows a business cycle.

An expansion ends at a peak and a recession ends
at a trough.
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1.2 ECONOMICS A SOCIAL SCIENCE

• The goal of economists is to discover how the
  economic world works. Economists distinguish
  between
• Positive statements What is
• Normative statements What someone thinks
  ought to be
• The task of economic science
• To discover and catalog positive statements that
  are consistent with what we observe in the world
  and that help us to understand how the economic
  world works.

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1.2 ECONOMICS A SOCIAL SCIENCE

• The task can be broken into three steps
• Observing and measuring
• Model building
• Testing
• Observing and Measuring
• Items such as
• Quantities of resources
• Wages and work hours
• Prices and quantities of goods and services
• Taxes and government spending
• Volume of international trade

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1.2 ECONOMICS A SOCIAL SCIENCE

• Model Building
• Economic model
• A description of some aspect of the economic
  world that includes only those features of the
  world that are needed for the purpose at hand.

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Models

• Economics uses models a lot
• A model is an abstraction, a simplification, that
  concentrates on a few things, excluding detail
  that is not essential to the task at hand.
• Horses for courses -- if the model serves its
  purpose, then lack of detail and realism doesnt
  matter. Example

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1.2 ECONOMICS A SOCIAL SCIENCE

• Testing
• A models predictions might correspond to or
  conflict with the data.
• Economic theory
• A generalization that summarizes what we
  understand about the economic choices that people
  make and the economic performance of industries
  and nations.

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1.2 ECONOMICS A SOCIAL SCIENCE

• Unscrambling Cause and Effect
• The central idea that economists use to
  unscramble cause and effect is ceteris paribus.
• Ceteris Paribus
• Ceteris paribus means other things being
  equal.
• But ceteris paribus can be a problem in
  economics when trying to test a model in the
  real world, usually ceteris is not paribus.

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1.2 ECONOMICS A SOCIAL SCIENCE

• Economist take three complimentary approaches
• Natural experiments
• Econometric investigations
• Economic experiments

Natural Experiments A situation that arises in
the ordinary course of economic life in which the
one factor of interest changes and other things
dont.
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1.2 ECONOMICS A SOCIAL SCIENCE

• Econometric Investigations
• Economic investigations use statistical tools.
• Correlation
• The tendency for the values of two variables to
  move in a predictable and related way.
• Post hoc fallacy
• The error of reasoning that a first event causes
  a second event because the first occurred before
  the second.

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Two Fallacies

• Post hoc ergo propter hoc -- correlation is not
  causation.
• After this, therefore because of this --
  obviously a fallacy does the sun rise because
  the cock crows?
• The Fallacy of Composition -- what is true for
  one may not be true for all.

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1.2 ECONOMICS A SOCIAL SCIENCE

• Economic Experiments
• Economic experiments put real subjects in a
  decision making situation and vary the influence
  of interest to discover how the subjects respond
  to one factor at a time. A relatively new
  approach.

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1.3 MACROECONOMIC IDEAS

• Four core ideas
• Rational choice
• Standard of living
• Cost of living
• Economic fluctuations

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1.3 MACROECONOMIC IDEAS

• Rational Choice
• Using the available resources to most effectively
  satisfy the wants of the person making the
  choice. Also called optimization.
• Cost What You Must Give Up
• Opportunity cost
• The highest-valued alternative forgone.

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1.3 MACROECONOMIC IDEAS

• Benefit Gain Measured by What You Are Willing to
  Give Up to get it.
• Benefit
• The gain or pleasure that something brings.
• On the Margin
• Margin
• A choice that is made by comparing all the
  relevant alternatives systematically and
  incrementally.

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1.3 MACROECONOMIC IDEAS

• Marginal cost
• The cost of a one-unit increase in an activity
• Marginal benefit
• What you gain when you get one more unit of
• something.
• We make a rational choice when we take those
  actions for which marginal benefit exceeds or
  equals marginal cost.

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IDEA 2

• We usually make choices in small steps, or at the
  margin, and choices are influenced by incentives.
• Marginal Benefit vs. Marginal Cost
• Incentives are inducements to take particular
  actions
• By looking for changes in marginal cost and
  marginal benefits, we can predict the way choices
  will change in response to changes in incentives.

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Implication .

• Economics is good at assessing small changes from
  existing situations
• Economics is NOT good at dealing with the
  consequences of big changes -- it is hard to do a
  cost-benefit study of a revolution
• Natura non facit saltum -- Marshall, Economics
  as natural history of peoples behavior.

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1.3 MACROECONOMIC IDEAS

• The Standard of Living and Productivity
• The dollar value of production can increase for
  three reasons
• Prices and wages rise
• People employed increases
• Productivity increases
• Productivity, measured nationally, is
• total production per person employed.

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1.3 MACROECONOMIC IDEAS

• The Cost of Living and the Quantity of Money
• A rising cost of living, inflation, means that
  more dollars are needed to buy the same fixed
  quantity of goods and services.
• Inflation is caused by an increase in the
  quantity of money that is not matched by an
  increase in the quantity of goods and services,
  ceteris paribus. Would this still be correct if
  we had a shift from paying workers weekly to
  paying them monthly?

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1.3 MACROECONOMIC IDEAS

• Expenditure and Productivity Fluctuations
• Sources of economic fluctuations can be grouped
  as
• Expenditure fluctuations
• Productivity fluctuations
• Smoothing the Business Cycle
• Economic fluctuations are undesirable recession
  brings unemployment and overly strong expansion
  brings inflation.
• Macroeconomics tries to smooth the business
  cycle.

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Two ways of analyzing economic issues

• Efficiency -- how do we maximize the total value
  of all production, ignoring who gets it and who
  bears the costs?
• Equity -- what are the distributional
  implications, i.e. who benefits and who loses?

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Need both to be complete

• The U.S. tradition is to emphasize the efficiency
  aspect of economic questions
• However, all economic decisions normally have
  equity implications as well as efficiency ones,
  and an economic analysis is incomplete without
  discussion of the equity aspects.

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• How Economists Study Issues
• Economists attempt to discover an explanation for
  how economic systems work -- to predict.
• Economists distinguish between Positive
  Statements and Normative Statements
• Positive statements are about how things actually
  are -- facts could show a positive statement was
  false if it was false..
• Normative statements are about what ought to be,
  involve opinion or value judgements -- they
  cannot be shown to be false.

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Economics and Politics

• Efficiency statements will usually be positive,
  so although we may disagree about the facts we
  can use them, try to find truth.
• Equity statements can be positive, but often
  quickly become normative, reflecting opinions
  about who should benefit or bear the cost -- and
  often these views feed into political
  disagreements.

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1.4 WHY ECONOMICS IS WORTH STUDYING

• Two main benefits from studying economics are
• Understanding
• Expanded career opportunities
• Understanding
• Economic ideas are all around you. You cannot
  ignore them.
• As you progress with you study of economics,
  youll gain a deeper understanding of what is
  going on around you.

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1.4 WHY ECONOMICS IS WORTH STUDYING

• Expanded Career Opportunities
• Most students of economics dont become
  economists.
• But knowledge of economics is useful in many
  fields such as banking, finance, business,
  management, insurance, real estate, law,
  government, journalism, health care and the arts.
• Economics graduates are not the highest-paid
  professional, but they are close to the top.

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1.4 WHY ECONOMICS IS WORTH STUDYING
1.4 WHY ECONOMICS IS WORTH STUDYING

• Figure 1.2
• Graduates in disciplines that teach problem
  identifying and solving and strategic brokering
  are top of the earnings distribution
• engineering
• computer science
• economics

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4.1 WHY ECONOMICS IS WORTH STUDYING
1.4 WHY ECONOMICS IS WORTH STUDYING

• The Costs of Studying Economics
• The main cost of studying economics is forgone
  leisure time.
• Most students find that economics is difficult
  and that it takes time and effort to master.
• The trick is practice, or learning by doing.
• Benefits Versus Costs
• Weigh up your benefits and costs!

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APPENDIX CHECKLIST

• Interpret a scatter diagram, a time-series graph,
  and a cross-section graph.
• Interpret the graphs used in economic models.
• Define and calculate slope.
• Graph relationships among more than two variables.

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APPENDIX MAKING AND USING GRAPHS

• Basic Idea
• A graph enables us to visualize the relationship
  between two variables.
• To make a graph set two lines perpendicular to
  each other
• The horizontal line is called the x-axis.
• The vertical line is called the y-axis.
• The common zero point is called the origin.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.1 How to make a graph

The horizontal axis (x-axis) measures income.
The vertical axis (y-axis) measures expenditure.
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APPENDIX MAKING AND USING GRAPHS

• Interpreting Data Graphs
• Scatter diagram
• A graph of the value of one variable against the
  value of another variable.
• Time-series graph
• A graph that measures time on the x-axis and the
  variable or variables in which we are interested
  on the y-axis.

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APPENDIX MAKING AND USING GRAPHS

• Trend
• A general tendency for the value of a variable
  to rise or fall.
• Cross-section graph
• A graph that shows the values of a variable for
  different groups at the same point in time.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(b) shows a scatter diagram.

As the price per minute falls, the number of
minutes called increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(b) shows a scatter diagram.

• As the price falls, the number of calls
  increases.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(c) shows a
• times-series graph.

The graph shows when unemployment was

• high and low.

• Increased and decreased.

• Changed quickly and slowly.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.2(d) shows a cross-section graph.

• The graph shows the unemployment rate in seven
  countries in 1999.

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APPENDIX MAKING AND USING GRAPHS

• Interpreting Graphs Used in Economic

• Positive relationship or direct relationship
• A relationship between two variables that move in
  the same direction.

• Linear relationship
• A relationship that graphs as a straight line.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(a) shows a positive (direct)
  relationship.

As the speed increases, the distance traveled
increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(b) shows a positive (direct)
  relationship.

As the speed increases, the distance traveled
increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(b) shows a
• positive (direct) relationship.

As the distance sprinted increases, recovery time
increases.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.3(c) shows a positive (direct)
  relationship.

• As study time increases, the number of problems
  worked increases.

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APPENDIX MAKING AND USING GRAPHS

• Negative relationship or inverse relationship
• A relationship between two variables that move in
  opposite directions.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.4(a) shows a negative (inverse)
  relationship.

• As the time playing tennis increases, the time
  playing squash decreases along a straight line.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.4(b) shows a negative (inverse)
  relationship.

• As the journey length increases, the cost per
  mile of the trip falls along a curve that becomes
  less steep.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.4(c) shows a negative (inverse)
  relationship.

• As leisure time increases, the number of
  problems worked decreases along a curve that
  becomes steeper.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.5(a) shows a maximum point.

• As the rainfall increases

1. The curve slopes upward as the yield per acre
rises.

• 2. The curve is flat at point A, the maximum
  yield.

3. Then slopes downward as the yield per acre
falls.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.5(a) shows a minimum point.

• As the speed increases

1. The curve slopes downward as the cost per mile
falls.

• 2. The curve is flat at point B, the minimum cost
  per mile.

• 3. The curve slopes upward as the cost per mile
  rises.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.6(a) shows variables that are
  unrelated.

• As the price of bananas increases, the students
  grade in economics remains at 75 percent.

The curve is horizontal.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.6(b) shows variables that are
  unrelated.

• As rainfall in California increases, the output
  of French vineyards remains at 3 billion gallons.

The curve is vertical.
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APPENDIX MAKING AND USING GRAPHS

• The Slope of a Relationship
• Slope
• The change in the value of the variable measured
  on the y-axis divided by the change the value of
  the variable measured on the x-axis.
• Slope ?y ?x.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.7(a) shows a positive slope.

1. When ?x is 4,
2. ?y is 3.
3. Slope (?y/?x) is 3/4.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.7(b) shows a negative slope.

1. When ?x is 4,
2. ?y is 3.
3. Slope (?y/?x) is 3/4.
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APPENDIX MAKING AND USING GRAPHS

• Figure A1.7(c) shows the slope of a curve at a
  point.

Slope of the curve at A

• equals the slope of the red line tangent to the
  curve at A.

1. When ?x is 4,
2. ?y is 3.
3. Slope (?y/?x) is 3/4.
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APPENDIX MAKING AND USING GRAPHS

• Relationships Among More Than Two Variables
• To graph a relationship that involves more than
  two variables, we use the ceteris paribus
  assumption.
• Ceteris Paribus
• other things remaining the same.
• Figure A1.8 shows the relationships between ice
  cream consumed, the temperature, and the price of
  ice cream.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.8(a) shows the relationship between
  price and consumption, temperature remaining the
  same.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.8(b) shows the relationship between
  temperature and consumption, price remaining the
  same.

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APPENDIX MAKING AND USING GRAPHS

• Figure A1.8(c) shows the relationship between
  price and temperature, consumption remaining the
  same.