Module The Study of Economics NEW PICTURE TO COME 1 KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: How scarcity and choice are central to the study of economics The importance of opportunity cost in individual choice and decision making The difference between positive economics and normative economics When economists agree and why sometimes disagree What makes macroeconomics different from microeconomics

Individual Choice: The Core of Economics the study of choices individuals make about how to use their scarce resources Choices: decisions about what and what not to do Scarce: not available in sufficient quantities to satisfy unlimited wants Begin with a formal definition of economics, followed by a more concise version that focuses on scarcity and choice. These definitions transition into a brief discussion of resources, how they are scarce, and how decisions involve opportunity costs. Formal Definition of Economics: The social science concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human economic wants. Concise Definition of Economics - Economics is the study of making choice. Choices are necessary because resources are scarce (we can’t always have everything we want). Every economic issue involves, at its most basic level, individual choice—decisions by individuals about what to do and what not to do. In fact, you might say that it isn’t economics if it isn’t about choice. The Economy is a system for coordinating economic activities. In a market economy, markets (made up of individual consumers and producers, largely make the decisions about what, how and for whom to produce.

Opportunity Cost: The Real Cost of Something Is What You Must Give Up to Get It Why all costs are opportunity costs with every choice, an alternative is foregone - money or time spent on one thing can’t be spent on another The sacrifices that are experienced when a choice is made are called opportunity costs. To get more of one thing, you forgo the opportunity to get something else.  Opportunity Cost: The Real Cost of Something is What You Must Give Up to Get It As the previous examples illustrate, decisions made in the face of scarce resources involve bypassing other opportunities and these forgone opportunities have value, or cost. Example: Suppose you purchase a digital camera that costs $100, and you decided not to buy a pair of running shoes that also cost $100. The opportunity cost of buying the camera is $100, plus the forgone enjoyment of the running shoes. Example: Ask the students for an example of an after-school activity they might choose (a sport, club, theatre, etc). By choosing to play tennis (for example), what was the next best activity given up? Suppose it was a spot in the band. The student is giving up the spot in the band, an activity that would have given the student a lot of enjoyment. How could we place on a value on this forgone fun? If you had to pay a fee for the spot in the band, how much would you pay? Start at $5. If you would pay $5 to join the band and have that fun, would you pay $10, $20, $50? Once a student reaches the maximum dollar amount that they would pay to join the band, you have placed a value on the opportunity cost of playing tennis. Basketball star LeBron James chose to skip college and go straight to the NBA from high school when offered a $13 million contract.

Individual Choice: The Core of Economics Economy: a system for coordinating a society’s productive and consumptive activities Market Economy: system in the U.S.; producers and consumers determine what, how and for whom to produce, with little government interference Begin with a formal definition of economics, followed by a more concise version that focuses on scarcity and choice. These definitions transition into a brief discussion of resources, how they are scarce, and how decisions involve opportunity costs. Formal Definition of Economics: The social science concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human economic wants. Concise Definition of Economics - Economics is the study of making choice. Choices are necessary because resources are scarce (we can’t always have everything we want). Every economic issue involves, at its most basic level, individual choice—decisions by individuals about what to do and what not to do. In fact, you might say that it isn’t economics if it isn’t about choice. The Economy is a system for coordinating economic activities. In a market economy, markets (made up of individual consumers and producers, largely make the decisions about what, how and for whom to produce.

Resources Are Scarce Resources (Factors of Production) Land - Labor - Capital - Entrepreneurship - Scarcity and society: societal decisions can be the result of individual choices or they may be better made through community-wide representation Economics exists as a discipline because resources are scarce (that’s why there is scarcity and we have to make choices). What exactly are these resources? Economists divide resources into 4 categories. Resources: labor, land (or natural resources), capital, and entrepreneurial ability (also described as human capital). labor (the effort of workers), land (including timber, water, minerals, and all other resources that come from nature), capital (machinery, buildings, tools, and all other manufactured goods used to make other goods and services) entrepreneurship (risk taking, innovation, and the organization of resources for production). Economic resources are limited/scarce which implies that the goods/services they produce must be limited. Scarcity requires that choices be made. Choices imply that things are given up.   Example: The size of the school parking lot is limited, which means only a certain number of cars can be parked there. If the parking lot were to be expanded, without purchasing more land, what would be sacrificed? Example: A hydroelectric dam  is being planned for a river. Many costly resources will be required to build this dam. Those resources could have been used in other projects. So a bridge over a scenic wild river, or a new highway was sacrificed. By damming the river, we also give up goods and services that could have been generated by the undammed river. Maybe guided whitewater rafting was sacrificed.

Microeconomics Versus Macroeconomics Economic Aggregates Unemployment data, inflation data, gross domestic product Microeconomics: The branch of economics concerned with how individuals make decisions and how these decisions interact. Microeconomics focuses on choices made by individuals, households, or firms—the smaller parts that make up the economy as a whole. Macroeconomics: The branch of economics that studies the overall ups and downs of the economy. Macro focuses on economic aggregates—economic measures such as the unemployment rate, the inflation rate, and gross domestic product—that summarize data across many different markets. Macroeconomics focuses on the bigger picture.

Table 1.1 Microeconomic Versus Macroeconomic Questions Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

A family’s decision about how much income to save. Macro or Micro? ? A family’s decision about how much income to save. The effect of government regulations on auto emissions. The impact of higher national savings on economic growth. ? A firm’s decision about how many workers to hire. 32

Positive Versus Normative Economics Positive economics How much revenue will the tolls yield? How much more revenue would be collected if the toll were raised from $1.00 to $1.50? Normative economics Should the toll be raised? Positive economic: Economic analysis used to answer questions about the way the world works. Statements of “what is” or “what will be”. No value judgments are applied. Positive economic analysis can be tested to determine if it is correct or not. Normative economics. economic analysis that involves saying how the world should work. Statements of “what should be”. These involve value judgments of what is “right”, “wrong”, or “best”. Example of a positive statement: It is 80 degrees outside. This is a statement of what is. Whether it is right or wrong, it is positive because we can go outside and test the temperature using a thermometer and determine if the statement is correct or not. Example of a normative statement: It is too cold outside. This is a value judgment and there is no way to determine if it is right or worng. Someone else can always differ in their judgement about whether it is too cold outside or not.

Positive or Normative Statements? A reduction in the rate of growth of money will reduce the rate of inflation. Society faces a short run tradeoff between inflation and unemployment. The Federal Reserve should reduce the rate of growth of money. ? Society ought to require welfare recipients to look for jobs. Lower tax rate encourage more work and more saving. 32

When and Why Economists Disagree Economists may disagree because they have different values or opinions Economists may disagree because they use different models or methods to conduct their analysis Over time, disputes in economics are resolved by the accumulation of evidence (but this can sometimes take a long time!)