Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-1 Chapter 1 The nature and method of economics

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-2 Learning objectives Is the study of economics of consequence or importance? What is the methodology of economics? In other words, how should we study economics? What are the proper methods by which the study of economics is best achieved? What specific problems, limitations and pitfalls can we encounter in studying economics? What characterises or identifies an ‘economic perspective’?

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-3 The roles of economics Economics is concerned with the efficient use of limited productive resources for the purpose of attaining the maximum satisfaction of our material wants Why study economics? John Maynard Keynes offered this response: ‘The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.’ Keynes, 1936

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-4 The age of the economists Adam Smith David Ricardo John Stuart Mill Karl Marx Jon Maynard Keynes Plus many modern contributors

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-5 The roles of economics Economics for citizenship –To create well-informed members of society Economics in business –To provide business with strategic information and interpretations Personal applications –To assist individuals, as workers and income receivers, to gain and retain economic security

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-6 Methodology of economics What do economists do? What are their goals? What methods do they use? –Economists derive economic principles that are useful in formulating policies designed to solve economic problems The methods used by economists are: 1. Facts — descriptive or empirical economics concerned with gathering facts relevant to an economic problem 2. Principles or theories — economists generalise about economic behaviour formulating economic theory 3. Policies — formulating policies for correcting the problem under scrutiny called applied economics

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-7 Induction and deduction Induction –A method of reasoning that proceeds from facts to generalisations Deduction –Reasoning from assumptions to conclusions by testing a hypothesis

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-8 Descriptive economics Complex in economics unlike physical sciences –Economics is a social science involving the complexities of individuals and institutions –Facts are difficult to gather and interpret –Economists must use discretion in collecting data, and must distinguish economic from non-economic facts

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-9 Economic theory Facts must be arranged systematically, interpreted and generalised to derive appropriate economic theory Theories or principles are the end result of economic analysis. These are meaningful statements drawn from facts

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-10 Terminology of economic theory Economists use the terms ‘laws',' principles’, ‘theories’ and ‘models’ to represent generalisations, or statements of regularity, concerning the economic behaviour of individuals and institutions A model is a simplified picture of reality, an abstract generalisation of how the relevant data actually behave

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-11 Generalisations in economics Economic principles are generalisations, and subject to exceptions and to quantitatively imprecise statements Economic principles are often stated in terms of averages or statistical probabilities Generalisations, properly handled and interpreted, can be both meaningful and useful

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-12 Economic theory The ‘other things being equal’ assumption –The process of analysis, that all other variables, other than the one being considered are constant, often referred to as ceteris paribus Abstractions in economics –Economic theories do not encompass the full complexity of reality –An economic model enables us to understand reality because it avoids the details of reality

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-13 Microeconomics and macroeconomics Macroeconomics deals with the economy as a whole, or with the basic subdivisions or aggregates that make up the economy –An aggregate is a collection of specific economic units that are treated as if they were one unit Microeconomics is concerned with specific economic units and a detailed consideration of the behaviour of these individuals units

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-14 Policy economics: positive and normative Positive economics deals with facts (and theories about these facts) and avoids value judgments. Attempts to set out scientific statements about economic behaviour Normative economics are based upon someone’s value judgments about what the economy should be like or what particular policy action should be recommended, based on a given economic generalisation or relationship. It embodies subjective feeling about ‘what ought to be’ –Normative economic statements come into play at the level of policy economics

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-15 Economic goals 1.Economic growth 2.Full employment 3. Economic efficiency 4. Price-level stability 5. Economic freedom 6. An equitable distribution of income 7. Economic security 8. External balance

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-16 Economic goals (cont.) Interpretation –The basic economic goals inevitably entail problems of interpretation — what are ‘sizeable’, ‘high degree’ and ‘equitable’? Complementary goals –Some of the goals are complementary Conflicting goals –Many goals are conflicting or mutually exclusive, and involve trade-offs Priorities –When goals conflict, society has to prioritise

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-17 Formulating economic policy Three basic steps in policy formulation: 1.Stating goals –Define the goals clearly 2.Policy options –State and recognise the possible effects of alternative policies designed to achieve the goal 3.Evaluation –Review the policies and evaluate their effectiveness

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-18 Pitfalls to objective thinking Bias Loaded terminology Definitions Fallacy of composition –What is true for the individual or part is not necessarily true for the group or whole Cause and effect –Post-hoc fallacy –Correlation versus causation Economic quackery

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-19 The economic perspective Scarcity and choice –Resources are limited and this necessitates choices Rational behaviour –Behaviour that involves decisions and actions in order to achieve the greatest satisfaction or maximum fulfilment of goals –People will make different choices, because their circumstances, preferences and available information differ

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-20 The economic perspective (cont.) Marginalism: benefits and costs –Decision that compares marginal benefits and marginal costs –Incremental benefits available from any changes are compared to the incremental costs of making the change

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-21 Graphs and their meaning Appendix to Chapter 1

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-22 Constructing a graph Two-dimensional graph –Horizontal axis representing independent variable –Vertical axis representing dependent variable –Intersection (0) is origin

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-23 Direct and indirect relationships Graphing relationships between variables –Direct relationship where the values of two related variable change in the same direction e.g. consumption and income –Inverse relationship where the values of two related variables move in opposite directions e.g. ticket prices and attendance

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-24 Direct relationship 0 $500 $400 $300 $200 $100 $100 $200 $300 $400 Consumption (C) Income (Y) Consumption C = Y a b c d e As Y increases, C increases

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-25 Inverse relationship 0 $25 $20 $15 $10 $ Ticket Price (P) Attendance in thousands (Q) Ticket demand a b c d f As P increases, Q decreases e P = 25 – 1.25Q

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-26 Dependent and independent variables Dependent variable – The variable which changes as a consequence of a change in some other (independent) variable Independent variable –The variable which causes a change in some other (dependent) variable

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-27 Other variables held constant When economists plot the relationship between any two variables, they assume that ‘other things being equal’; that is, all other factors that might affect consumption, are presumed to be constant or unchanged

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-28 Slope of a straight line The ratio of the vertical change (the rise or fall) to the corresponding horizontal change involved in moving between two points

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-29 Positive slope o a b c d e $100 $200 $300 $400 Income (Y) $500 $400 $300 $200 $100 Consumption (C) Consumption horizontal change = +100 vertical change = +50 C = Y

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-30 – Negative slope $25 $20 $15 $10 $5 Ticket price (P) a b c d f Attendance in thousands (Q) Ticket demand P = 25 – 1.25Q e

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-31 Slope of a line Three addenda Measurement units –The slope of a line is affected by the choice of units for either variable Marginal analysis –The slope of a line measures marginal changes Infinite and zero slopes –Variables that are unrelated or independent of one another will be represented by a line parallel to the vertical or horizontal axis, and will have a slope of infinity or zero, respectively

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-32 Slope of a line (cont.) Intercept –The vertical intercept is the point at which the line meets the vertical axis Equation form –Linear equation y = a + bx where: y = the dependent variable a = the vertical intercept b = the slope of the line x = the independent variable

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-33 a a Slope of a non-linear relationship or curve P A A Tangent X Y

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 1-34 Slope of a curve (cont.) X Y b b P