Lecture 1. What is Economics?

• Economics, Scarcity and Choices

• Microeconomics and Macroeconomics

• Positive Economics and Normative Economics

• Why study Economics

• The method of Economics

Economics, Scarcity, and Choice

• A good definition of economics– Study of choice under conditions of

scarcity

• Scarcity– Situation in which the amount of

something available is insufficient to satisfy the desire for it (Human beings have unlimited wants and needs in general)

Scarcity and Individual Choice

• Two basic limitations for individuals– Scarce time– Scarce spending power

• Limitations force each of us to make choices• The scarcity of resources—and the choices it

forces us to make—is the source of all of the problems studied in economics

• Examples: Dating & Getting A in this class

Microeconomics

• Study of behavior of individual households, firms, and governments

• Choices they make• Interaction in specific markets

• Focuses on individual parts of an economy, rather than the whole

• Examples: How many management trainee jobs will open up for college

graduates? How would U.S. phone companies be affected by a tax on imported

cell phones?

Macroeconomics

• Study of the economy as a whole• Focuses on big picture and ignores fine

details• Examples: Instead of focusing on the production of carrots, it looks at GDP. Instead of focusing on the employment of management trainees, it

considers total employment (or unemployment rate) in the economy. Instead of asking why credit card loans carry high interest rate than

home mortgage loans, it asks what makes interest rates in general rise or fall.

Why Economists Disagree

• Two economists asked whether the States should eliminate all government-imposed barriers to trading with the rest of the world. The first economist says, ‘Yes.’ but the other says, ‘No’.– The two economists may disagree about what will happen if

trade barriers were eliminated. In this case, the disagreement is positive.

– Both economists might agree that opening up international trade would benefit most Americans, but harm some of them.

• The first economist might put more emphasis on benefits to the overall economy

• The second economist might put more emphasis on preventing harm to a particular group.

In this case, the disagreement is normative.

Positive Economics

• Study of how economy works

• Accuracy of positive statements can be tested and quantified.

• Examples: An decrease in the personal income tax will increase the growth rate of the economy.

Normative Economics

• Use Value Judgment to study what should be

• Normative statements cannot be proved or disproved by the facts alone

• Example: The goal of any country’s economic policy should be to increase the well-being of its poorest, most vulnerable citizens.

The Methods of Economics

• Model. What is a model?– A Model is an Abstract representation of

reality.– A Model should be as simple as possible to

accomplish its purpose.– A model should contain the right amount of

details.

Drive from Ames to Chicago

Drive from Chicago O’Hare International Airport to Hilton Tower Chicago

Assumptions and Conclusions

• Simplifying assumptions• Way of making a model simpler without affecting

any of its important conclusions• Example: When we study the behavior of

consumers, we assume that there are only two goods to choose from.

• Critical assumptions• Affect conclusions of a model in important ways• Example: When we study the behavior of business

firms, we assume that firms try to earn the highest possible profit.

Why Study Economics

• To Understand the World Better

• To Achieve Social Change

• To Help prepare for Other Careers

• To become an Economist– Median annual wage and salary earnings of

economists were $72,780 in May 2004. Check out http://stats.bls.gov/oco/ocos055.htm

How to Study Economics

• Economics must be studied actively, not passively

• What does active studying mean?– Closing the book periodically and reproducing what

you have learned– Reading with a pencil in your hand and a blank sheet

of paper in front of you– Listing the steps in each logical argument– Retracing the cause-and-effect steps in each model– Drawing the graphs that represent the model– Thinking about the basic principles of economics and

how they relate to what you are learning

Appendix: Tables and Graphs

Advertising ($1,000s per Month)

Sales ($1,000s per Month)

2 46 3 49 6 58 7 61

11 73 12 76

Table A.1 Advertising and Sales at Len & Harry’s

Appendix: Tables and Graphs

Advertising ($1,000 per Month)

Sales ($1,000 per

Month

1

A

2 3 4 5 6 7 8 9 10 11 12

404649

58

76

B

CD

EF

61

73

Measuring the Slope of a Curve

1

A

2 3 4 5 6 7 8 9

40

43

46

49

54

B

CD53

H

Advertising ($1,000 per Month)

Sales ($1,000 per

Month 2. is the slope of the straight line tangent to the curve at point B.

3. Along the tangent line, when advertising increases from 0 to 3 units (ΔX = 3)

1. The slope of this curve at point B . . .

4. sales increase from 43 to 49 units (ΔY= 6). So the curve's slope at point B is = 6/3 = 2.

Straight Lines with Different Slopes and Vertical Intercepts

0

Y

X

a

b > 0

b < 0

b = 0

(a)

Straight Lines with Different Slopes and Vertical Intercepts

0

Y

X

a < 0

a = 0

a > 0

(b)

Shifts in the Graph of Advertising and Sales

6

58

C''

C'

C

July

September

June

64

Advertising ($1,000 per Month)

Sales ($1,000 per

Month

Shifts of Curved Lines and Straight Lines

An increase in Z causes an increase in Y at any value of X

Y

X

C

(a)

C'