1. Chapter 1 - The Nature of Economics
Learning Objectives
Discuss the difference between microeconomics and macroeconomics
Evaluate the role that rational self-interest plays in economic analysis
Explain why the study of economics is a science
Distinguish between positive and normative economics
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2. Chapter 1 - The Nature of Economics
Defining Economics
Economics
The study of how people allocate their limited resources to satisfy their unlimited wants
The study of how people make choices
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3. Chapter 1 - The Nature of Economics
Defining Economics
Resources
Things used to produce other things to satisfy people’s wants
Wants
What people would buy if their incomes were unlimited
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4. Chapter 1 - The Nature of Economics
Defining Economics
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.
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5. Chapter 1 - The Nature of Economics
Defining Economics
Individuals, businesses, and nations face alternatives, and choices must be made.
Economics studies how these choices are made.
Chapter 1 - The Nature of Economics

6. The Power of Economic Analysis
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 troops should be sent abroad
Incentives
Rewards for engaging in a particular activity
Chapter 1 - The Nature of Economics

7. The Power of Economic Analysis
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, listening to, or reading the news.
Chapter 1 - The Nature of Economics

8. The Power of Economic Analysis
Economic analysis is a way of thinking about all decisions.
Your education, career, financing your home, family
Your involvement in the business world, or in politics as a voter
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9. 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
Decision of a worker to work overtime or not
A family’s choice of having a baby
An individual firm advertising
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10. Microeconomics versus Macroeconomics
The study of the behavior of the economy as a whole
Deals with economy wide phenomena
The national unemployment rate
The rate of growth in the money supply
The national government’s budget deficit
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11. Microeconomics versus Macroeconomics
Macroeconomics deals with aggregates, or totals, such as total output in an economy.
Modern economic theory blends micro and macro concepts.
Chapter 1 - The Nature of Economics

12. The Economic Person: Rational Self-Interest
Economists assume that individuals act as if motivated by self-interest and respond predictably to opportunities for gain.
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13. The Economic Person: Rational Self-Interest
Rationality Assumption
The assumption that people do not intentionally make decisions that would leave them worse off
Chapter 1 - The Nature of Economics

14. The Economic Person: Rational Self-Interest
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?
Chapter 1 - The Nature of Economics

15. The Economic Person: Rational Self-Interest
Responding to incentives
Rationality and the use of incentives
Making choices
Balancing cost and benefits
Chapter 1 - The Nature of Economics

16. The Economic Person: Rational Self-Interest
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
Chapter 1 - The Nature of Economics

17. The Economic Person: Rational Self-Interest
Defining self-interest
The pursuit of one’s goals, does not always mean increasing one’s wealth
Prestige
Friendship
Love
Chapter 1 - The Nature of Economics

18. 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?
Chapter 1 - The Nature of Economics

19. Chapter 1 - The Nature of Economics
Economics as a Science
Models or Theories
Simplified representations of the real world used as the basis for predictions or explanations
A map is the quintessential model
Chapter 1 - The Nature of Economics

20. Chapter 1 - The Nature of Economics
Economics as a Science
Assumptions
The set of circumstances in which a model is applicable
Every model, or theory, must be based on a set of assumptions.
Chapter 1 - The Nature of Economics

21. 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.
Chapter 1 - The Nature of Economics

22. Chapter 1 - The Nature of Economics
Economics as a Science
Ceteris Paribus Assumption
Nothing changes except the factor or factors being studied.
“Other things constant”
“Other things equal”
Chapter 1 - The Nature of Economics

23. Chapter 1 - The Nature of Economics
Economics as a Science
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.
Chapter 1 - The Nature of Economics

24. Chapter 1 - The Nature of Economics
Economics as a Science
Behavioral Economics
Approach to the study of consumer behavior
Emphasizes psychological limitations and complications which may interfere with rational decision making
Chapter 1 - The Nature of Economics

25. Chapter 1 - The Nature of Economics
Economics as a Science
Bounded Rationality
Hypothesis that people are nearly, not fully, rational
They cannot examine every choice available to them
Use simple rules of thumb to sort alternatives
Chapter 1 - The Nature of Economics

26. Positive versus Normative Economics
Positive Economics
Purely descriptive statements or scientific predictions; “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
Chapter 1 - The Nature of Economics

27. 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.
Chapter 1 - The Nature of Economics

28. Summary Discussion of Learning Objectives
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.
Chapter 1 - The Nature of Economics

29. Summary Discussion of Learning Objectives
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.
Chapter 1 - The Nature of Economics

30. Summary Discussion of Learning Objectives
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.
Chapter 1 - The Nature of Economics