1. Chapter 1 The Nature of Economics

2. Introduction
Nearly half of the babies born in Hong Kong Hospitals today have mothers who are classified as tourists visiting from the Chinese mainland.
How can fundamental principles of economics explain patterns of social behavior such as this?
You will explore this question in Chapter One.

3. Learning Objectives
Discuss the difference between microeconomics and macroeconomics
Evaluate the role that rational self-interest plays in economic analysis
Explain why economics is a science
Distinguish between positive and normative economics 3

4. Chapter Outline The Power of Economic Analysis Defining Economics
The Three Basic Economic Questions and Two Opposing Answers
The Economic Approach: Systematic Decisions
Economics as a Science
Positive versus Normative Economics 5

5. Did You Know That ... Economics is a rapidly growing college major?
During the past 10 years, the number of students majoring in economics at U.S. colleges has increased by 40%?
Economics majors typically earn more than students who major in management, chemistry, or psychology? 7

6. The Power of Economic Analysis
Incentives
Rewards for engaging in a particular activity
The nature of self-interested responses to incentives is the starting point for economic analysis

7. The Power of Economic Analysis (cont'd)
The economic way of thinking is a framework to analyze solutions to economic problems
How much time to study
Choosing which courses to take
Whether the U.S. government should encourage or discourage immigration 9

8. The Power of Economic Analysis (cont'd)
The economic way of thinking gives you the power to reach informed conclusions about what is happening in the world
Economic analysis helps you make better decisions, and increases your understanding when watching or reading the news on the Web

9. The Power of Economic Analysis (cont'd)
Economic analysis is a way of thinking about all decisions
These decisions could be about:
Your education, career, or financing your home
Your involvement in the business world
How you cast your ballot as a voter 10

10. Defining Economics Economics
The study of how people allocate their limited resources to satisfy their unlimited wants
The study of how people make choices 11

11. Defining Economics (cont'd)
Resources
Things used to produce other things to satisfy people’s wants
Wants
What people would buy if their incomes were unlimited 12

12. Defining Economics (cont'd)
With limited income (resources), people must make choices to satisfy their wants
We never have enough of everything, including time, to satisfy our every desire 13

13. Defining Economics (cont'd)
Individuals, businesses, and nations face alternatives, and choices must be made
Economics studies how these choices are made

14. Microeconomics versus Macroeconomics
The study of decision making undertaken by individuals (or households) and by firms
Like looking though a microscope to focus on the smaller parts of the economy
The effects of changes in gasoline prices
A family’s choice of having a baby
An individual firm’s decision to advertise 14

15. Microeconomics versus Macroeconomics (cont'd)
The study of the behavior of the economy as a whole
Deals with economywide phenomena
The national unemployment rate
The rate of inflation
The yearly output of goods and services in a nation 15

16. Microeconomics versus Macroeconomics (cont'd)
Macroeconomics deals with aggregates, or totals—such as total output in an economy
Modern economic theory blends micro and macro concepts

17. The Three Basic Economic Questions and Two Opposing Answers
Economic System
The institutional mechanism through which resources are utilized to satisfy human wants 17

18. The Three Basic Economic Questions and Two Opposing Answers (cont’d)
Three economic questions:
What and how much will be produced?
How will items be produced?
For whom will items be produced? 17

19. The Three Basic Economic Questions and Two Opposing Answers (cont’d)
Two opposing answers in the form of economic systems:
Centralized command and control (central planning): Authority that makes all economic decisions
Price system (market system): Decentralized decision making process in which prices are terms (signals) under which people agree to make exchanges 17

20. Policy Example: The Federal Government Directs New California Train Tracks
Centralized command and control was used to make decisions regarding a high-speed rail project in California.
Railway construction began in the least-populated areas, in order to provide service immediately for areas that were considered to be “underserved”. 17

21. The Three Basic Economic Questions and Two Opposing Answers (cont’d)
Economic systems of the world’s nations (e.g., U.S.) are mixed systems that incorporate aspects of both centralized command and control and a decentralized price system 17

22. International Policy Example: Cuba Experiments with Mixing It Up
Cuba is undergoing a transition in which 600,000 former employees of the public sector will now be employed in the private sector.
These workers will be paid wages determined by the price system. 17

23. The Economic Approach: Systematic Decisions
Economists assume that individuals act as if motivated by self-interest and respond predictably to opportunities for gain 17

24. The Economic Approach: Systematic Decisions (cont’d)
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”
—Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 16

25. The Economic Approach: Systematic Decisions (cont’d)
Rationality Assumption
The assumption that people do not intentionally make decisions that would leave themselves worse off

26. The Economic Approach: Systematic Decisions (cont’d)
Questions
Does the fact that some people make apparently irrational choices invalidate the rationality assumption in economics?
Can economic models be applied to situations in which behavior is at odds with what we expect from rational people?

27. Example: Hello, Bank Robber, I’ll Remember You
How can the rationality assumption help prevent bank robberies?
Some banks now follow a policy of having a teller, guard, or branch manager greet every person entering the bank.
A high probability of being recognized and remembered should deter potential bank robbers.

28. The Economic Approach: Systematic Decisions (cont’d)
Responding to incentives
Rationality and the use of incentives
Positive incentives
Negative incentives
Making choices
Balancing cost and benefits

29. The Economic Approach: Systematic Decisions (cont’d)
Some examples of incentives
Responding to positive incentives
Schoolchildren getting gold stars, working to have a “better life” for yourself
Responding to negative incentives
Penalties, punishments, using credit cards to avoid check overdrafts

30. The Economic Approach: Systematic Decisions (cont’d)
Defining self-interest
The pursuit of one’s goals, does not always mean increasing one’s wealth
Prestige
Friendship
Love

31. Example: The Perceived Value of Gifts
Often the recipient of the gift places a value on it far less than the market value.
Should we substitute gift certificates for physical gifts?

32. Economics as a Science (cont’d)
Economics is a social science that employs the same kinds of methods used in other sciences, such as biology
Economics uses models to explain economic phenomena in the real world

33. Economics as a Science (cont'd)
Models or Theories
Simplified representations of the real world used as the basis for predictions or explanations
Should capture only the essential relationships that are sufficient to analyze a problem
Cannot be faulted as unrealistic simply because they do not capture all details of the real world
A map is the quintessential model

34. Economics as a Science (cont'd)
Assumptions
The set of circumstances in which a model is applicable
Every model, or theory, must be based on a set of assumptions

35. Example: Getting Directions
A map is a simplifying model of reality.
The degree of simplification varies across maps; some contain more detail than others.
Economic models attempt to focus on what is relevant to the problem at hand and omit what is not.

36. Economics as a Science (cont'd)
Ceteris Paribus Assumption [KAY-ter-us PEAR-uh-bus]
Nothing changes except the factor or factors being studied.
“Other things constant”
“Other things equal”

37. Economics as a Science (cont'd)
Economics is an empirical science
Real-world data is used to evaluate the usefulness of a model
Models are useful if they predict economic phenomena
Economic models predict how people react, not how they think

38. What if economic theories were based on what people say they would do, rather than on what they actually do?
Economists seek to predict what people will do when faced with certain incentives
When surveyed for a poll, many people will say that tax breaks have no effect on their charitable donations
Yet, we find that charitable giving does respond to tax incentives
In this instance, an accurate prediction would need to be based on what people actually do

39. Economics as a Science (cont'd)
Behavioral Economics
Approach to the study of consumer behavior
Emphasizes psychological limitations and complications which may interfere with rational decision making
Proponents believe that it is “unrealistic” to assume:
Unbounded selfishness
Unbounded willpower
Unbounded rationality

40. Economics as a Science (cont'd)
Bounded Rationality
Hypothesis that people are nearly, not fully, rational
They cannot examine every choice available to them
They appear to use rules of thumb to sort alternatives

41. Positive versus Normative Economics
Positive Economics
Purely descriptive statements or scientific predictions, such as: “If A, then B.”
A statement of what is
Normative Economics
Analysis involving value judgments; relates to whether things are good or bad.
A statement of what ought to be

42. You Are There: Why So Many Firms Are Incorporating Outside the United States
In recent years, an increasing number of U.S. family-owned companies or partnerships have chosen to incorporate in other countries.
The fact that the U.S. corporate tax rate is the second highest in the world has given firms an incentive to establish their corporate identity outside U.S. borders.

43. Mothers from mainland China are responding to incentives:
Issues & Applications: Why So Many Tourists Have Been Giving Birth in Hong Kong (cont’d)
The increase in “tourist births” is consistent with the rationality assumption.
Mothers from mainland China are responding to incentives:
The quality of care is better in Hong Kong.
A child born in Hong Kong receives the benefit of 12 years of publicly provided education and subsidized health care.
Mothers who give birth in Hong Kong are exempt from China’s one-child policy.

44. Issues & Applications: Why So Many Tourists Have Been Giving Birth in Hong Kong (cont’d)
How does Hong Kong benefit from providing these benefits for tourist mothers?
There has been a decline in the birth rate among Hong Kong residents.
Without immigration, the population would begin to decline.
By allowing mothers to give birth and then to remain in Hong Kong, the government pursues a policy of rational self-interest.

45. Summary Discussion of Learning Objectives
Microeconomics versus macroeconomics
Economics is the study of how individuals make choices to satisfy wants
Microeconomics is the study of decision making by individual households and individual firms
Macroeconomics is the study of nationwide phenomena, such as inflation and unemployment levels

46. Summary Discussion of Learning Objectives (cont'd)
Self-interest in economic analysis
Rational self-interest is the assumption that individuals behave in a reasonable (rational) way in making choices to further their interests

47. Summary Discussion of Learning Objectives (cont'd)
Economics as a science
Economists use models, or theories, that are simplified representations of the real world to analyze and make predictions about the real world

48. Summary Discussion of Learning Objectives (cont'd)
The difference between positive and normative economics
Positive economics deals with what is, whereas normative economics deals with what ought to be
Positive statements are of the “if…then” variety, while normative ask what “should, or could” be

49. Appendix A: Reading and Working with Graphs
Independent Variable
A variable whose value is determined independently of, or outside, the equation under study
Dependent Variable
A variable whose value changes according to changes in the value of one or more independent variable

50. Appendix A: Direct and Inverse Relationship
Direct Relationship
A relationship between two variables that is positive, meaning that an increase in one variable is associated with an increase in the other and a decrease in one variable is associated with a decrease in the other
Inverse Relationship
A relationship between two variables that is negative, meaning that an increase in one variable is associated with a decrease in the other and a decrease in one variable is associated with an increase in the other

51. Table A-1 Gas Mileage as a Function of Driving Speed

52. Figure A-1 Direct and Inverse Relationships

53. Appendix A: Constructing a Graph
Number Line
A line that can be divided into segments of equal length, each associated with a number
y Axis
The vertical axis in a graph
x Axis
The horizontal axis in a graph
Origin
The intersection of the y axis and the x axis in a graph

54. Figure A-2 Horizontal Number Line

55. Figure A-3 Vertical Number Line

56. Figure A-4 A Set of Coordinate Axes

57. Table A-2 T-Shirts Purchased

58. Figure A-5 Graphing the Relationship Between T-Shirts Purchased and Price

59. Figure A-6 Connecting the Observation Points

60. Figure A-7 A Positively Sloped Curve

61. Appendix A: The Slope of a Line (A Linear Curve)
The change in the y value divided by the corresponding change in the x value of a curve
The “incline” of the curve
“Rise” over “run”

62. Figure A-8 Figuring Positive Slope

63. Figure A-9 Figuring Negative Slope

64. Figure A-10 The Slope of a Nonlinear Curve