2CHAPTER 1 What is Economics CHAPTER 1 What is Economics? a “Aside from Religion, economics is perhaps the most pervasive yet least understood force in American life.” Jon Meacham – Editor, Newsweek Magazine September 24, 2007
3After studying this chapter, you will be able to: Define economics and distinguish between microeconomics and macroeconomicsExplain the two big questions of economicsWhat are the consequences of choices (what, how, and for whom)?Does self-interest unintentionally promote social interest?Explain the key ideas that define the economic way of thinkingExplain how economists go about their work as social scientists and policy advisers
4Economics and ChoiceEconomics is the study of the choices people make to cope with scarcity.Economics is sometimes called the science of choice — the science that explains the choices that people make and predicts how choices change as circumstances change.
5How Economists ThinkEconomists, as professionals, try to stand clear of emotion and to approach their work with the detachment, rigor, and objectivity of scientists.The first step in this process is to identify the fundamental economic problem: scarcity.
6ScarcityWhen wants exceed the resources available to satisfy them, there is scarcity.People have unlimited wants.Resources to satisfy those wants are limited.
7Scarcity and Poverty Scarcity is not poverty. The poor and the rich alike face scarcity.Faced with scarcity, people must make choices.
8Choice and Opportunity Cost Choosing more of one thing means having less of something else.The opportunity cost of any action is the best foregone alternative.There is no such thing as a free lunch. Every choice involves an opportunity cost.
9Opportunity CostOpportunity cost is the single best alternative foregone (it varies over people).For example, the opportunity cost of attending ECO 211 class is eithersleepingworkingstudyinggoing to the beachtaking another class
10Marginal AnalysisEconomic analysis uses marginal analysis to study choices made by people, businesses and governments.Choices are made in small steps — at the margin.
11Marginal Cost and Marginal Benefit The cost of a small increase in an activity is called marginal cost.The benefit that arises from a small increase in an activity is called marginal benefit.
12What Economists DoEconomic questions can be divided into two big groups: microeconomics and macroeconomics.
13MicroeconomicsMicroeconomics is the study of the decisions of people and businesses and the interaction of those decisions in markets.Goal: to explain the prices and quantities of individual goods and services.
14MacroeconomicsMacroeconomics is the study of the national economy and the global economy and the way that economic aggregates grow and fluctuate.Goal: to explain average prices and total employment, income, and production.
15Economic Science and Economic Policy Economic science is the attempt to understand the economic world. Science makes predictions.Economic policy is the attempt to improve the economic world. Policy makes prescriptions.Policies made without science usually will not be very good.
16Economic ScienceEconomists distinguish between what is and what ought to be.Statements about what is are called positive statements.Statements about what ought to be are called normative statements.
17Positive Versus Normative A positive statement can be tested by checking it against facts.A normative statement depends on values and cannot be scientifically tested.
18Economic TheoriesEconomists create theories by building and testing models.We learn as much from theories that fail as is learned from theories that are confirmed.When a theory fails, it prompts us to revise other models.
19Economic Science is Young Economics as a science is just over 200 years old.Adam Smith’s The Wealth of Nations (1776) marks the beginning of our subject.Compared to physics and chemistry, however, we’re newcomers.
20Economic PolicyEconomic policy is the attempt to devise government actions and to design institutions that might improve economic performance.
21Objectives of Economic Policy EfficiencyEquityGrowthStability
22EfficiencyWhen economic efficiency has been achieved, production costs are as low as possible and consumers are as satisfied as possible with the combination of goods and services that are being produced.When economic efficiency is achieved, noone can be made better off without someone else being made worse off.
23Conditions That Produce Economic Efficiency Efficient production (called production efficiency)Efficient consumption (called allocative efficiency)Efficient exchange (called trade efficiency)
24Equity Equity is economic justice or fairness. An efficient economy is not necessarily an equitable economy.The definition of equity (or fairness) remains a matter about which reasonable people disagree.Hence, of the four economic policy objectives, equity is the most difficult to define.
25GrowthEconomic growth is the increase in income and output per person.Growth results from the ongoing advance of technology, accumulation of capital, and improved education.Government policies can encourage or discourage growth.
26StabilityEconomic stability is the absence of wide fluctuations in the economic growth rate, the level of employment, and average prices.Macroeconomics is devoted to the study of these problems.
27Why Economists Disagree Some disagreements are about what is possible — positive economics. These disagreements are often settled by gathering more evidence.Other disagreements are about what is desirable — normative economics. These arise from differences in values or priorities.
28The Economy: An Overview What goods and services will be produced and in what quantities?How will they be produced?When will they be produced?Where will they be produced?Who will consume them?
29ProductionGoods and services are the objects that people value and produce to satisfy human wants.Agriculture accounts for less than 1 percent of total U.S. production, manufactured goods for 22 percent, and services for 77 percent.In China, agriculture accounts for 11 percent of total production, manufactured goods for 47 percent, and services for 43 percent.
30Production Breakdown in Three Countries The breakdown of production into agricultural, manufacturing, and services depends on the level of economic development
31Decision Makers Households are groups of people that live together. Firms are organizations that use resources to produce goods and services.Government is an organization that sets laws and rules, taxes, spends, and provides public services.
32MarketsA market is any arrangement that enables buyers and sellers to get information and to do business with each other.Goods markets are markets for goods and services.Factor markets are markets for factors of production.
33Factors of ProductionFactors of production are the economy’s productive resources, including:LaborLandCapitalEntrepreneurial ability
34LaborLabor is the time and effort people devote to producing goods and services.The price of labor is the wage rate.
35Land Land is natural resources used to produce goods and services. The price of land is called rent.
36CapitalCapital (sometimes called physical capital) is all the equipment, buildings, tools and other manufactured goods used to produce other goods and services.The price of physical capital is the interest rate.Physical capital is to be distinguished from human capital, which is the productivity inherent in people.
37Entrepreneurial Ability Entrepreneurial ability is a special type of human resource that organizes the other three factors of production, makes business decisions, innovates, and bears business risk.Entrepreneurship is rewarded with profit.
38Coordinating Decisions In free market societies, conflicting choices by households, firms, and governments are resolved by markets.Markets coordinate individual decisions through adjustments in market pricesPrices are the primary rationing mechanism in a market economy
39Alternative Coordinating Mechanisms In other societies, a command mechanism is used. A command mechanism is a method of determining what, how, when, and where goods and services are produced and who consumes them, using a hierarchical organization structure in which people carry out the instructions given to them.In a command economy, prices are not the primary mechanism that rations goods and services