Principles of Microeconomics - Attributed

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AttributedtoLibbyRittenbergandTimothyTregarthen Saylor.orgSaylorURL:http://www.saylor.org/books/ 1

This document is attributed to Libby Rittenberg andTim Tregarthen


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AbouttheAuthors

LibbyRittenberg

LibbyRittenberghasbeenaProfessorofEconomicsatColoradoCollegein

ColoradoSpringssince1989.Sheteachesprinciplesofeconomics,

intermediatemacroeconomictheory,comparativeeconomicsystems,and

internationalpoliticaleconomy.ShereceivedherB.A.ineconomics-

mathematicsandSpanishfromSimmonsCollegeandherPh.D.in

economicsfromRutgersUniversity.

PriortojoiningthefacultyatColoradoCollege,

shetaughtatLafayetteCollegeandatthe

RutgersUniversityGraduateSchoolof

Management.SheservedasaFulbrightScholar

inIstanbul,Turkey,andasaresearch

economistatMathematica,Inc.inPrinceton,NewJersey.Dr.Rittenbergspecializesintheinternationallyorientedareasof

economics,withnumerousarticlesinjournalsandbooksoncomparative

anddevelopmenteconomics.Muchofherworkfocusesontransition

issuesandontheTurkisheconomy.

Shehasbeenveryinvolvedinstudyabroadeducationandhasdirected

programsincentralEuropeandTurkey.

TimTregarthen


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ThereisonewordthatcapturestheessenceofDr.TimothyTregarthen

inspiring.Timwasfirstdiagnosedwithmultiplesclerosis(MS)in1975.

Yet,hecontinuedaremarkableacademiccareerofteachingandresearch.

In1996,hepublishedthefirsteditionofhisprinciplesofeconomics

textbooktogreatacclaim,anditbecamewidelyusedincollegesaround

thecountry.Thatsameyear,MSmadehimwheelchair-bound.Thedisease

forcedhisretirementfromteachingattheUniversityofColoradoat

ColoradoSpringsin1998.Helosttheuseofhisarmsin2001andhasbeen

quadriplegiceversince.In2002,Timsdoctorexpectedhimtodie.

HewasplacedinthePikesPeakHospiceprogramandwastwicegivenhis

lastritesbyhispriest.UCCSChancellorShockley-Zalabaksays,Ireally

thoughtthatTimwoulddieinhospice.Thatswhatthedoctorstoldme,

andIreallybelievedthat.Irememberonedaytheycalledmeandtoldme

totrytocomeseehim.Theydidn'texpecthimtolivethroughthenight.

Notonlydidhelivethroughthenight,butheeventuallyrecoveredtothe

pointthathemovedfromhospicetoalong-termcarefacility.There,he

neverlethisdiseasegethimdown.Infact,heturnedbacktohisloveof

writingandteachingforinspiration.Heobtainedavoice-activated

computer,recruitedacoauthor,LibbyRittenbergofColoradoCollege,and

turnedhisattentiontorevisinghisprinciplesofeconomicsbook.Flat

WorldKnowledgeishonoredtopublishanew,firsteditionrelaunchof

thiswonderfulbook,andproudtobringTimsincredibletalentsasa

teacherbacktolifeforfuturegenerationsofstudentstolearnfrom.

Inadditiontocompletingtherewriteofhistextbook,Timrecently

completedanautobiographyaboutthethirty-twoyearshehashadMS,

titledSuffering,Faith,andWildflowers.Heisnearingcompletionofanovel,


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CoolLuck,basedonthelifeofafriend.Itisthestoryofayoungcouple

facingthehusbandsdiagnosisofALSLouGehrigsdisease.Remarkably,

in2007,hewasabletoreturntotheclassroomatUCCS,wherehehad

taughteconomicsfortwenty-sevenyears.InJanuaryof2009,Timmarried

DinoraMontenegro(nowDinoraTregarthen);thecouplelivesinSan

Gabriel,California.

PerhapsTimsapproachtolifeisbestsummedupbyanobservationby

UCCSEnglishProfessorThomasNaperierkowski:Oneoftheremarkable

thingsis,heck,Icanwakeupwithaheadacheandbeaprettygrouchy

character,butgivenhisphysicaltrials,whichhefaceseveryminuteofhis

lifethesedays,Iveneverseenhimgrouchy,Iveneverseenhimcranky.

Carryon,Tim.

Acknowledgments

Theauthorswouldliketothanktothefollowingindividualswhoreviewed

thetextandwhosecontributionswereinvaluableinshapingthefinal

product:

CarlosAguilar ElPasoCommunityCollege

JeffAnkrom WittenbergUniversity

LeeAshSkagitValleyCommunityCollege

RandallBennett GonzagaUniversity

JosephCalhoun FloridaStateUniversity

RichardCantrell WesternKentuckyUniversity


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GreggDavisFlatheadValleyCommunityCollege

KevinDunagan OaktonCommunityCollege

MonaElShazly ColumbiaCollege

JoseEsteban PalomarCollege

MauritaFawls PortlandCommunityCollege

FredFoldvary SantaClaraUniversity

RichardFowles UniversityofUtah

DorisGeide-Stevenson WeberStateUniversity

SarmilaGhoshUniversityofScranton,KaniaSchoolofManagement

DavidGordonIllinoisValleyCommunityCollege

ClintonGreene UniversityofMissouri-St.Louis

JamesHolcomb UniversityofTexasatElPaso

PhilHolleran MitchellCommunityCollege

YuHsingSoutheasternLouisianaUniversity

ThomasHyclak LehighUniversity

BruceJohnson CentreCollege

JamesKahiga GeorgiaPerimeterCollege

AndrewKohen JamesMadisonUniversity

MonacoKristenCaliforniaStateUniversityLongBeach

MarkMaier GlendaleCommunityCollege

DavidMcClough BowlingGreenStateUniversity


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AnnMcPherren HuntingtonUniversity

JohnMinNorthernVirginiaCommunityCollege

ShahriarMostashariCampbellUniversity,Lundy-FettermanSchoolofBusiness

FrancisMummery FullertonCollege

RobertMurphy BostonCollege

KathrynNantz FairfieldUniversity

PaulOkelloTarrantCountyCollege-SouthCampus

NicholasPeppes St.LouisCommunityCollege

RamooRatha DiabloValleyCollege

TeresaRiley YoungstownStateUniversity

MichaelRobinson MountHolyokeCollege

AnirbanSengupta TexasA&MUniversity

JohnSolow TheUniversityofIowa

JohnSomersPortlandCommunityCollege

CharlesStaelin SmithCollege

RichardStratton TheUniversityofAkron

KayE.Strong

BowlingGreenState

UniversityFirelands

DellaSue MaristCollege

JohnVahaly UniversityofLouisville

RobertWhaples WakeForestUniversity


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MarkWheelerWesternMichiganUniversity

LeslieWolfson ThePingrySchool

SourusheZandvakili UniversityofCincinnati

Wewouldliketoextendaspecialthankyoutothefollowinginstructors

whoclasstestedthetextintheircourses:

JohnathanMillman UniversityofMassachusettsBoston

JohnMin NorthernVirginiaCommunityCollege

KristenMonaco CaliforniaStateUniversityLongBeach

SteveSkinner WesternConnecticutStateUniversity

RichardStratton UniversityofAkron

Preface

GreekphilosopherHeraclitissaidover2500yearsagothatNothing

enduresbutchange.Forecastingisatrickybusiness,butthissentiment

strikesusasbeingassafeabetasonecanmake.Changerapidchange

underliesallourlives.Aswewerecompletingthistextbook,theworld

enteredaperiodofmarkedeconomicuncertaintythatledmanystudents,

andindeedpeoplefromallwalksoflife,totuneintoeconomiceventsas

neverbeforetotrytounderstandtheeconomicworldaroundthem.So,

whileweaseconomistshavethepublicsattention,weseeanopportunity

toshareeconomicsprinciplesandtheeconomicwayofthinkinginaway

thatemphasizestheirrelevancetotodaysworld.Weuseapplicationsfrom

sports,politics,campuslife,currentevents,andotherfamiliarsettingsto

illustratethelinksbetweentheoreticalprinciplesandcommon


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experiences.Becauseoftheincreasinglyglobalnatureofeconomicactivity,

wealsorecognizetheneedforaclearandconsistentinternationalfocus

throughoutaneconomicstext.Inaddition,wehavetriedtoprovidea

senseoftheintellectualexcitementofthefieldandanappreciationforthe

gainsithasmade,aswellasanawarenessofthechallengesthatlieahead.

Toensurestudentsrealizethateconomicsisaunifieddisciplineandnota

bewilderingarrayofseeminglyunrelatedtopics,wedevelopthe

presentationofmicroeconomicsandofmacroeconomicsaround

integratingthemes.

Theintegratingthemeformicroeconomicsisthemarginaldecisionrule,a

simpleapproachtochoicesthatmaximizethevalueofsomeobjective.

Followingitspresentationinanearlymicroeconomicschapter,the

marginaldecisionrulebecomesanintegratingdevicethroughoutthe

discussionofmicroeconomics.Insteadofahodgepodgeofrulesfor

differentmarketconditions,wegiveasinglerulethatcanbeapplied

withinanymarketsetting.

Theintegratingthemeformacroeconomicsisthemodelofaggregate

demandandaggregatesupply.Followingitspresentationinanearly

macroeconomicschapter,thismodelallowsustolookatbothshort-run

andlong-runconceptsandtoaddressavarietyofpolicyissuesand

debates.

Recognizingthatacourseineconomicsmayseemdauntingtosome

students,wehavetriedtomakethewritingclearandengaging.Clarity

comesinpartfromtheintuitivepresentationstyle,butwehavealso

integratedanumberofpedagogicalfeaturesthatwebelievemakelearning


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economicconceptsandprincipleseasierandmorefun.Thesefeaturesare

verystudent-focused.

Thechaptersthemselvesarewrittenusingamodularformat.In

particular,chaptersgenerallyconsistofthreemaincontentsectionsthat

breakdownaparticulartopicintomanageableparts.Eachcontentsection

containsnotonlyanexpositionofthematerialathandbutalsolearning

objectives,summaries,examples,andproblems.Eachchapteris

introducedwithastorytomotivatethematerialandeachchapterends

withawrap-upandadditionalproblems.Ourgoalistoencourageactive

learningbyincludingmanyexamplesandmanyproblemsofdifferent

types.

Atourofthefeaturesavailableforeachchaptermaygiveabettersenseof

whatwemean:

StartUpChapterintroductionssetthestageforeachchapterwithanexamplethatwehopewillmotivatereaderstostudythematerialthat

follows.Theseessays,ontopicssuchasthevalueofacollegedegreeinthe

labormarketorhowpolicymakersreactedtoaparticulareconomic

recession,lendthemselvestothetypeofanalysisexplainedinthechapter.

Weoftenrefertotheseexampleslaterinthetexttodemonstratethelink

betweentheoryandreality.

LearningObjectivesThesesuccinctstatementsareguidestothecontentofeachsection.Instructorscanusethemasasnapshotoftheimportant

pointsofthesection.Aftercompletingthesection,studentscanreturnto

thelearningobjectivestocheckiftheyhavemasteredthematerial.

HeadsUp!Thesenotesthroughoutthetextwarnofcommonerrorsandexplainhowtoavoidmakingthem.Afterourcombinedteaching


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experienceofmorethanfiftyyears,wehaveseenthesamemistakesmade

bymanystudents.Thisfeatureprovidesadditionalclarificationandshows

studentshowtonavigatepossiblytreacherouswaters.

KeyTakeawaysThesestatementsreviewthemainpointscoveredineachcontentsection.

KeyTermsDefinedwithinthetext,studentscanreviewthemincontext,aprocessthatenhanceslearning.

TryIt!questionsTheseproblems,whichappearattheendofeachcontentsectionandwhichareansweredcompletelyinthetext,give

studentstheopportunitytobeactivelearners.Theyaredesignedtogive

studentsaclearsignalastowhethertheyunderstandthematerialbefore

theygoontothenexttopic.

CasesinPointTheseessaysincludedattheendofeachcontentsectionillustratetheinfluenceofeconomicforcesonrealissuesandrealpeople.

Unlikeothertextsthatuseboxedfeaturestopresentinterestingnew

materialornewspaperarticles,wehavewritteneachcaseourselvesto

integratethemmoreclearlywiththerestofthetext.

SummaryInafewparagraphs,theinformationpresentedinthechapterispulledtogetherinawaythatallowsforaquickreviewofthematerial.

End-of-chapterconceptandnumericalproblemsThesearebountifulandareintendedtocheckunderstanding,topromotediscussionoftheissues

raisedinthechapter,andtoengagestudentsincriticalthinkingaboutthe

material.Includedarenotonlygeneralreviewquestionstotestbasic

understandingbutalsoexamplesdrawnfromthenewsandfromresultsof

economicsresearch.Somehavestudentsworkingwithreal-worlddata.

ChapterquizzesEachchapteralsoincludesonline,supplementarymultiplechoicequestionsthatprovidestudentswithfeedbackonboth

correctandincorrectresponses.Theseprovideyetanotherwayfor

studentstotestthemselvesonthematerial.


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AdditionalMaterialforInstructors

TheauthorshavebeenpersonallyinvolvedinthegenerationofahugeTest

Bankthatincludesmultiplechoice,true/false,andshortessaysquestions.

Thesequestionsarescoredintermsoflevelofdifficultyandinclude

multiplewaysoftestingthematerial.

TheSolutionsManual,withwhichtheauthorswerealsoinvolved,contains

answersforallconceptandnumericalproblemsfoundattheendofeach

textchapter.

ThePowerPointSlidesincludealltheexhibitscontainedinthetexttoallow

easeofuseinclass.

Wehopethatuserswillfindthistextanengagingandenjoyablewayof

becomingacquaintedwitheconomicsprinciplesandthatmasteryofthe

materialwillleadtolookingattheworldinadeeperandmoremeaningful

way.Wewelcomeallfeedback.

LibbyRittenberg

TimothyTregarthen


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Chapter1

Economics:TheStudyofChoice

StartUp:EconomicsintheNews

2008seemedtobetheyearofeconomicnews.Fromtheworstfinancial

crisissincetheGreatDepressiontothepossibilityofaglobalrecession,to

gyratinggasolineandfoodprices,andtoplunginghousingprices,

economicquestionsweretheprimaryfactorsinthepresidentialcampaign

of2008anddominatedthenewsgenerally.

Whatcausesthepricesofsomegoodtorisewhilethepricesofsomeother

goodsfall?Pricedeterminationisoneofthethingsthatwewillstudyin

thisbook.Wewillalsoconsiderfactorsthatleadaneconomytofallintoa

recessionandtheattemptstolimitit.

Whiletheinvestigationoftheseproblemssurelyfallswithintheprovince

ofeconomics,economicsencompassesafarbroaderrangeofissues.

Ultimately,economicsisthestudyofchoice.Becausechoicesrangeover

everyimaginableaspectofhumanexperience,sodoeseconomics.

Economistshaveinvestigatedthenatureoffamilylife,thearts,education,

crime,sports,jobcreationthelistisvirtuallyendlessbecausesomuchof

ourlivesinvolvesmakingchoices.

Howdoindividualsmakechoices:Wouldyoulikebettergrades?More

timetorelax?Moretimewatchingmovies?Gettingbettergradesprobably

requiresmoretimestudying,andperhapslessrelaxationand

entertainment.Notonlymustwemakechoicesasindividuals,wemust


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makechoicesasasociety.Dowewantacleanerenvironment?Faster

economicgrowth?Bothmaybedesirable,buteffortstocleanupthe

environmentmayconflictwithfastereconomicgrowth.Societymustmake

choices.

Economicsisdefinedlessbythesubjectseconomistsinvestigatethanby

thewayinwhicheconomistsinvestigatethem.Economistshaveawayof

lookingattheworldthatdiffersfromthewayscholarsinotherdisciplines

lookattheworld.Itistheeconomicwayofthinking;thischapter

introducesthatwayofthinking.

1.1DefiningEconomics

LEARNINGOBJECTIVES

1. Defineeconomics.2. Explaintheconceptsofscarcityandopportunitycostandhowthey

relatetothedefinitionofeconomics.

3. Understandthethreefundamentaleconomicquestions:Whatshouldbeproduced?Howshouldgoodsandservicesbeproduced?For

whomshouldgoodsandservicesbeproduced?

Economicsisasocialsciencethatexamineshowpeoplechooseamongthe

alternativesavailabletothem.Itissocialbecauseitinvolvespeopleand

theirbehavior.Itisasciencebecauseituses,asmuchaspossible,a

scientificapproachinitsinvestigationofchoices.

Scarcity,Choice,andCost


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Allchoicesmeanthatonealternativeisselectedoveranother.Selecting

amongalternativesinvolvesthreeideascentraltoeconomics:scarcity,

choice,andopportunitycost.

Scarcity

Ourresourcesarelimited.Atanyonetime,wehaveonlysomuchland,so

manyfactories,somuchoil,somanypeople.Butourwants,ourdesiresfor

thethingsthatwecanproducewiththoseresources,areunlimited.We

wouldalwayslikemoreandbetterhousing,moreandbettereducation

moreandbetterofpracticallyeverything.

Ifourresourceswerealsounlimited,wecouldsayyestoeachofour

wantsandtherewouldbenoeconomics.Becauseourresourcesare

limited,wecannotsayyestoeverything.Tosayyestoonethingrequires

thatwesaynotoanother.Whetherwelikeitornot,wemustmake

choices.

Ourunlimitedwantsarecontinuallycollidingwiththelimitsofour

resources,forcingustopicksomeactivitiesandtorejectothers.Scarcityis

theconditionofhavingtochooseamongalternatives.Ascarcegoodisone

forwhichthechoiceofonealternativerequiresthatanotherbegivenup.

Consideraparcelofland.Theparcelpresentsuswithseveralalternative

uses.Wecouldbuildahouseonit.Wecouldputagasstationonit.We

couldcreateasmallparkonit.Wecouldleavethelandundevelopedin

ordertobeabletomakeadecisionlaterastohowitshouldbeused.


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Supposewehavedecidedthelandshouldbeusedforhousing.Shoulditbe

alargeandexpensivehouseorseveralmodestones?Supposeitistobea

largeandexpensivehouse.Whoshouldliveinthehouse?IftheLeeslivein

it,theNguyenscannot.Therearealternativeusesofthelandbothinthe

senseofthetypeofuseandalsointhesenseofwhogetstouseit.Thefact

thatlandisscarcemeansthatsocietymustmakechoicesconcerningits

use.

Virtuallyeverythingisscarce.Considertheairwebreathe,whichis

availableinhugequantityatnochargetous.Coulditpossiblybescarce?

Thetestofwhetherairisscarceiswhetherithasalternativeuses.What

usescanwemakeoftheair?Webreatheit.Wepolluteitwhenwedrive

ourcars,heatourhouses,oroperateourfactories.Ineffect,oneuseofthe

airisasagarbagedump.Wecertainlyneedtheairtobreathe.Butjustas

certainly,wechoosetodumpgarbageinit.Thosetwousesareclearly

alternativestoeachother.Themoregarbagewedumpintheair,theless

desirableandhealthyitwillbetobreathe.Ifwedecidewewantto

breathecleanerair,wemustlimittheactivitiesthatgeneratepollution.Air

isascarcegoodbecauseithasalternativeuses.

Notallgoods,however,confrontuswithsuchchoices.Afreegoodisone

forwhichthechoiceofoneusedoesnotrequirethatwegiveupanother.

Oneexampleofafreegoodisgravity.Thefactthatgravityisholdingyou

totheearthdoesnotmeanthatyourneighborisforcedtodriftupinto

space!Onepersonsuseofgravityisnotanalternativetoanotherpersons

use.


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Therearenotmanyfreegoods.Outerspace,forexample,wasafreegood

whentheonlyusewemadeofitwastogazeatit.Butnow,ouruseof

spacehasreachedthepointwhereoneusecanbeanalternativeto

another.Conflictshavealreadyarisenovertheallocationoforbitalslots

forcommunicationssatellites.Thus,evenpartsofouterspacearescarce.

Spacewillsurelybecomemorescarceaswefindnewwaystouseit.

Scarcitycharacterizesvirtuallyeverything.Consequently,thescopeof

economicsiswideindeed.

ScarcityandtheFundamentalEconomicQuestions

Thechoicesweconfrontasaresultofscarcityraisethreesetsofissues.

Everyeconomymustanswerthefollowingquestions:

1. Whatshouldbeproduced?Usingtheeconomysscarceresourcestoproduceonethingrequiresgivingupanother.Producingbettereducation,

forexample,mayrequirecuttingbackonotherservices,suchashealth

care.Adecisiontopreserveawildernessarearequiresgivingupother

usesoftheland.Everysocietymustdecidewhatitwillproducewithits

scarceresources.

2. Howshouldgoodsandservicesbeproduced?Thereareallsortsofchoicestobemadeindetermininghowgoodsandservicesshouldbe

produced.Shouldafirmemployafewskilledoralotofunskilledworkers?

Shoulditproduceinitsowncountryorshouldituseforeignplants?

Shouldmanufacturingfirmsuseneworrecycledrawmaterialstomake

theirproducts?

3. Forwhomshouldgoodsandservicesbeproduced?Ifagoodorserviceisproduced,adecisionmustbemadeaboutwhowillgetit.Adecisionto

haveonepersonorgroupreceiveagoodorserviceusuallymeansitwill


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notbeavailabletosomeoneelse.Forexample,representativesofthe

poorestnationsonearthoftencomplainthatenergyconsumptionper

personintheUnitedStatesis17timesgreaterthanenergyconsumption

perpersonintheworlds62poorestcountries.Criticsarguethatthe

worldsenergyshouldbemoreevenlyallocated.Shouldit?Thatisafor

whomquestion.

Everyeconomymustdeterminewhatshouldbeproduced,howitshould

beproduced,andforwhomitshouldbeproduced.Weshallreturntothese

questionsagainandagain.

OpportunityCost

Itiswithinthecontextofscarcitythateconomistsdefinewhatisperhaps

themostimportantconceptinallofeconomics,theconceptofopportunity

cost.Opportunitycostisthevalueofthebestalternativeforgoneinmaking

anychoice.

Theopportunitycosttoyouofreadingtheremainderofthischapterwill

bethevalueofthebestotherusetowhichyoucouldhaveputyourtime.If

youchoosetospend$20onapottedplant,youhavesimultaneously

chosentogiveupthebenefitsofspendingthe$20onpizzasora

paperbackbookoranightatthemovies.Ifthebookisthemostvaluableof

thosealternatives,thentheopportunitycostoftheplantisthevalueofthe

enjoymentyouotherwiseexpectedtoreceivefromthebook.

Theconceptofopportunitycostmustnotbeconfusedwiththepurchase

priceofanitem.Considerthecostofacollegeoruniversityeducation.That

includesthevalueofthebestalternativeuseofmoneyspentfortuition,


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fees,andbooks.Butthemostimportantcostofacollegeeducationisthe

valueoftheforgonealternativeusesoftimespentstudyingandattending

classinsteadofusingthetimeinsomeotherendeavor.Studentssacrifice

thattimeinhopesofevengreaterearningsinthefutureorbecausethey

placeavalueontheopportunitytolearn.Orconsiderthecostofgoingto

thedoctor.Partofthatcostisthevalueofthebestalternativeuseofthe

moneyrequiredtoseethedoctor.But,thecostalsoincludesthevalueof

thebestalternativeuseofthetimerequiredtoseethedoctor.The

essentialthingtoseeintheconceptofopportunitycostisfoundinthe

nameoftheconcept.Opportunitycostisthevalueofthebestopportunity

forgoneinaparticularchoice.Itisnotsimplytheamountspentonthat

choice.

Theconceptsofscarcity,choice,andopportunitycostareattheheartof

economics.Agoodisscarceifthechoiceofonealternativerequiresthat

anotherbegivenup.Theexistenceofalternativeusesforcesustomake

choices.Theopportunitycostofanychoiceisthevalueofthebest

alternativeforgoneinmakingit.

KEYTAKEAWAYS

Economicsisasocialsciencethatexamineshowpeoplechooseamongthealternativesavailabletothem.

Scarcityimpliesthatwemustgiveuponealternativeinselectinganother.Agoodthatisnotscarceisafreegood.

Thethreefundamentaleconomicquestionsare:Whatshouldbeproduced?Howshouldgoodsandservicesbeproduced?Forwhom

shouldgoodsandservicesbeproduced?


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Everychoicehasanopportunitycostandopportunitycostsaffectthechoicespeoplemake.Theopportunitycostofanychoiceisthevalue

ofthebestalternativethathadtobeforgoneinmakingthatchoice.

TRYIT!

Identifytheelementsofscarcity,choice,andopportunitycostineach

ofthefollowing:

1. TheEnvironmentalProtectionAgencyisconsideringanorderthata500-acreareaontheoutskirtsofalargecitybepreservedinits

naturalstate,becausetheareaishometoarodentthatisconsidered

anendangeredspecies.Developershadplannedtobuildahousing

developmentontheland.

2. Themanagerofanautomobileassemblyplantisconsideringwhethertoproducecarsorsportutilityvehicles(SUVs)nextmonth.Assume

thatthequantitiesoflaborandothermaterialsrequiredwouldbethe

sameforeithertypeofproduction.

3. Ayoungmanwhowenttoworkasanursesaideaftergraduatingfromhighschoolleaveshisjobtogotocollege,wherehewillobtain

trainingasaregisterednurse.

CaseinPoint:TheRisingCostofEnergyOilisanexhaustibleresource.Theoilweburntodaywillnotbeavailable

foruseinthefuture.Partoftheopportunitycostofourconsumptionofgoodssuchasgasolinethatareproducedfromoilincludesthevalue

peopleinthefuturemighthaveplacedonoilweusetoday.


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Itappearsthatthecostofouruseofoilmayberising.Wehavebeenusing

lightcrude,theoilfoundinthegroundindepositsthatcanbereadily

tapped.Aslightcrudebecomesmorescarce,theworldmayneedtoturnto

so-calledheavycrude,thecrudeoilthatisfoundinthesandysoilof

placessuchasCanadaandVenezuela.Thatoilexistsinsuchabundance

thatitpropelsVenezuelatothetopoftheworldlistofavailableoil.Saudi

Arabiamovestothesecondposition;Canadaisthird.

Thedifficultywiththeoilmixedinthesandisthatextractingitisfarmore

costlythanlightcrude,bothintermsoftheexpendituresrequiredandin

termsoftheenvironmentaldamagethatminingitcreates.Northern

Alberta,inCanada,boastsaFlorida-sizedareawhosesandysoilsarerich

incrudeoil.Someofthatoilis1,200feetunderground.Extractingit

requirespumpingsteamintotheoilysandandthenpumpingupthe

resultantoilysyrup.Thatsyrupisthenplacedintohuge,industrial-sized

washingmachinesthatseparatecrudeoil.Whatisleftoveristoxicandwill

beplacedinhugelakesthatarebeingcreatedbydiggingpitsintheground

200feetdeep.Theoilproducedfromthesesandshasbecomeimportant

AlbertaisthelargestforeignsupplierofoiltotheUnitedStates.

Sandsthatareclosertothesurfaceareremovedbybulldozersandgiant

cranes;theforestoveritisclearedaway.Theoilysandisthenhauledoffin

two-storydumptruckswhich,whenfilled,weighmorethanaBoeing747.

TotalSA,aFrenchcompany,isleadingtheracetodevelopCanadasoil.

JeanLuc-Guiziou,thepresidentofTotalSAsCanadianoperations,says

thattheextraordinarilycostlyprocessofextractingheavycrudeis

somethingtheworldisgoingtohavetogetusedto.Thelightcrude

undiscoveredtodayisgettingscarcerandscarcer,hetoldTheWallStreet


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Journal.Wehavetoaccepttherealityofgeoscience,whichisthatthenext

generationofoilresourceswillbeheavier.

Already,TotalSAhasclear-cutthousandsofacresofforestlandinorderto

gainaccesstotheoilysandbelow.Theprocessofextractingheavycrude

oilcoststhecompany$25abarrelcomparedtothe$6perbarrelcostof

extractingandrefininglightcrude.Extractingheavycrudegeneratesthree

timesasmuchgreenhousegasperbarrelasdoeslightcrude.By2015,Fort

McMurray,thesmall(population61,000)townthathasbecomethe

headquartersofNorthernAlbertascrudeoilboom,willemitmore

greenhousegasthantheentirecountryofDenmark(population5.4

million).CanadawillexceeditsgreenhousegasquotasetbytheKyoto

Accordsaninternationaltreatyaimedatlimitingglobalwarming

largelyasaresultofdevelopingitsheavycrudedeposits.

Nooneevenconsideredtheextractionofheavycrudewhenlightcrude

wascheap.Inthelate1990s,oilcostjust$12perbarrel,anddepositsof

heavycrudesuchasthoseinCanadaattractedlittleattention.Bymid-

2006,oilsoldformorethan$70perbarrel,andCanadasheavycrudewas

suddenlyahotcommodity.Itmovedfrombeingjustaninteresting

experimentinnorthernCanadatoreallythisisthefuturesourceofoil

supply,GregStringhamoftheCanadianAssociationofPetroleum

ProducerstoldAlJazeera.

Albertasenergyminister,GregMelchin,defendstheprovincesdecisionto

proceedwiththeexploitationofitsoilysand.Thereisacosttoit,butthe

benefitsaresubstantiallygreater,heinsists.


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Noteveryoneagrees.GeorgePoitras,amemberoftheMikisewCreetribe,

livesdownstreamfromtheoilsandsdevelopment.Youseealotofthe

landdugup,alotoftheborealforeststruckdownanditsupsetting,itfills

mewithrage,hesays.DianaGibsonoftheParklandInstitute,an

environmentaladvocacygroup,saysthatyoucanseetheenvironmental

damagegeneratedbytheextractionofoilsandsaroundFortMcMurray

fromthemoon.Whatwearegoingtobehavingisdestructionofvery,

veryvaluableecosystems,andpermanentpollution,shesays.

Sources:AlbertasHeavyOilBurden,AlJazeeraEnglish,March17,2008

(seeenglish.aljazeera.net);andRussellGold,AsPricesSurge,OilGiants

TurnSludgeintoGold,TheWallStreetJournalOnline,March27,2006,A1.

ANSWERSTOTRYIT!PROBLEMS

1. The500-acreareaisscarcebecauseithasalternativeuses:preservationinitsnaturalstateorasiteforhomes.Achoicemustbe

madebetweentheseuses.Theopportunitycostofpreservingthe

landinitsnaturalstateistheforgonevalueofthelandasahousing

development.Theopportunitycostofusingthelandasahousing

developmentistheforgonevalueofpreservingtheland.

2. Thescarceresourcesaretheplantandthelaborattheplant.ThemanagermustchoosebetweenproducingcarsandproducingSUVs.

Theopportunitycostofproducingcarsistheprofitthatcouldbe

earnedfromproducingSUVs;theopportunitycostofproducingSUVs

istheprofitthatcouldbeearnedfromproducingcars.

3. Themancandevotehistimetohiscurrentcareerortoaneducation;histimeisascarceresource.Hemustchoosebetweenthese

alternatives.Theopportunitycostofcontinuingasanursesaideis

theforgonebenefitheexpectsfromtrainingasaregisterednurse;the


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opportunitycostofgoingtocollegeistheforgoneincomehecould

haveearnedworkingfull-timeasanursesaide.

1.2TheFieldofEconomics

LEARNINGOBJECTIVES

1. Explainthedistinguishingcharacteristicsoftheeconomicwayofthinking.

2. Distinguishbetweenmicroeconomicsandmacroeconomics.Wehaveexaminedthebasicconceptsofscarcity,choice,andopportunity

costineconomics.Inthissection,wewilllookateconomicsasafieldof

study.Webeginwiththecharacteristicsthatdistinguisheconomicsfrom

othersocialsciences.

TheEconomicWayofThinking

Economistsstudychoicesthatscarcityrequiresustomake.Thisfactisnot

whatdistinguisheseconomicsfromothersocialsciences;allsocial

scientistsareinterestedinchoices.Ananthropologistmightstudythe

choicesofancientpeoples;apoliticalscientistmightstudythechoicesof

legislatures;apsychologistmightstudyhowpeoplechooseamate;a

sociologistmightstudythefactorsthathaveledtoariseinsingle-parent

households.Economistsstudysuchquestionsaswell.Whatisitaboutthe

studyofchoicesbyeconomiststhatmakeseconomicsdifferentfromthese

othersocialsciences?


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Threefeaturesdistinguishtheeconomicapproachtochoicefromthe

approachestakeninothersocialsciences:

1. Economistsgivespecialemphasistotheroleofopportunitycostsintheiranalysisofchoices.

2. Economistsassumethatindividualsmakechoicesthatseektomaximizethevalueofsomeobjective,andthattheydefinetheirobjectivesinterms

oftheirownself-interest.

3. Individualsmaximizebydecidingwhethertodoalittlemoreoralittlelessofsomething.Economistsarguethatindividualspayattentiontothe

consequencesofsmallchangesinthelevelsoftheactivitiestheypursue.

Theemphasiseconomistsplaceonopportunitycost,theideathatpeople

makechoicesthatmaximizethevalueofobjectivesthatservetheirself-

interest,andafocusontheeffectsofsmallchangesareideasofgreat

power.Theyconstitutethecoreofeconomicthinking.Thenextthree

sectionsexaminetheseideasingreaterdetail.

OpportunityCostsAreImportant

Ifdoingonethingrequiresgivingupanother,thentheexpectedbenefitsof

thealternativeswefacewillaffecttheoneswechoose.Economistsargue

thatanunderstandingofopportunitycostiscrucialtotheexaminationof

choices.

Asthesetofavailablealternativeschanges,weexpectthatthechoices

individualsmakewillchange.Arainydaycouldchangetheopportunity

costofreadingagoodbook;wemightexpectmorereadingtogetdonein

badthaningoodweather.Ahighincomecanmakeitverycostlytotakea


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dayoff;wemightexpecthighlypaidindividualstoworkmorehoursthan

thosewhoarenotpaidaswell.Ifindividualsaremaximizingtheirlevelof

satisfactionandfirmsaremaximizingprofits,thenachangeinthesetof

alternativestheyfacemayaffecttheirchoicesinapredictableway.

Theemphasisonopportunitycostsisanemphasisontheexaminationof

alternatives.Onebenefitoftheeconomicwayofthinkingisthatitpushes

ustothinkaboutthevalueofalternativesineachprobleminvolving

choice.

IndividualsMaximizeinPursuingSelf-Interest

Whatmotivatespeopleastheymakechoices?Perhapsmorethananything

else,itistheeconomistsanswertothisquestionthatdistinguishes

economicsfromotherfields.

Economistsassumethatindividualsmakechoicesthattheyexpectwill

createthemaximumvalueofsomeobjective,giventheconstraintstheyface.Furthermore,economistsassumethatpeoplesobjectiveswillbe

thosethatservetheirownself-interest.

Economistsassume,forexample,thattheownersofbusinessfirmsseekto

maximizeprofit.Giventheassumedgoalofprofitmaximization,

economistscanpredicthowfirmsinanindustrywillrespondtochangesin

themarketsinwhichtheyoperate.AslaborcostsintheUnitedStatesrise,forexample,economistsarenotsurprisedtoseefirmsmovingsomeof

theirmanufacturingoperationsoverseas.


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Similarly,economistsassumethatmaximizingbehaviorisatworkwhen

theyexaminethebehaviorofconsumers.Instudyingconsumers,

economistsassumethatindividualconsumersmakechoicesaimedat

maximizingtheirlevelofsatisfaction.Inthenextchapter,wewilllookat

theresultsoftheshiftfromskiingtosnowboarding;thatisashiftthat

reflectsthepursuitofself-interestbyconsumersandbymanufacturers.

Inassumingthatpeoplepursuetheirself-interest,economistsarenot

assumingpeopleareselfish.Peopleclearlygainsatisfactionbyhelping

others,assuggestedbythelargecharitablecontributionspeoplemake.

Pursuingonesownself-interestmeanspursuingthethingsthatgiveone

satisfaction.Itneednotimplygreedorselfishness.

ChoicesAreMadeattheMargin

Economistsarguethatmostchoicesaremadeatthemargin.

Themarginisthecurrentlevelofanactivity.Thinkofitastheedgefrom

whichachoiceistobemade.Achoiceatthemarginisadecisiontodoalittlemoreoralittlelessofsomething.

Assessingchoicesatthemargincanleadtoextremelyusefulinsights.

Consider,forexample,theproblemofcurtailingwaterconsumptionwhen

theamountofwateravailablefallsshortoftheamountpeoplenowuse.

Economistsarguethatonewaytoinducepeopletoconservewateristo

raiseitsprice.Acommonresponsetothisrecommendationisthatahigherpricewouldhavenoeffectonwaterconsumption,becausewaterisa

necessity.Manypeopleassertthatpricesdonotaffectwaterconsumption

becausepeopleneedwater.


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Butchoicesinwaterconsumption,likevirtuallyallchoices,aremadeatthe

margin.Individualsdonotmakechoicesaboutwhethertheyshouldor

shouldnotconsumewater.Rather,theydecidewhethertoconsumealittle

moreoralittlelesswater.HouseholdwaterconsumptionintheUnited

Statestotalsabout105gallonsperpersonperday.Thinkofthatstarting

pointastheedgefromwhichachoiceatthemargininwaterconsumption

ismade.Couldahigherpricecauseyoutouselesswaterbrushingyour

teeth,takeshortershowers,orwateryourlawnless?Couldahigherprice

causepeopletoreducetheiruse,say,to104gallonsperpersonperday?

To103?Whenweexaminethechoicetoconsumewateratthemargin,the

notionthatahigherpricewouldreduceconsumptionseemsmuchmore

plausible.Pricesaffectourconsumptionofwaterbecausechoicesinwater

consumption,likeotherchoices,aremadeatthemargin.

Theelementsofopportunitycost,maximization,andchoicesatthemargin

canbefoundineachoftwobroadareasofeconomicanalysis:

microeconomicsandmacroeconomics.Youreconomicscourse,for

example,maybedesignatedasamicroorasamacrocourse.Wewill

lookatthesetwoareasofeconomicthoughtinthenextsection.

MicroeconomicsandMacroeconomics

Thefieldofeconomicsistypicallydividedintotwobroadrealms:

microeconomicsandmacroeconomics.Itisimportanttoseethe

distinctionsbetweenthesebroadareasofstudy.

Microeconomicsisthebranchofeconomicsthatfocusesonthechoices

madebyindividualdecision-makingunitsintheeconomytypically

consumersandfirmsandtheimpactsthosechoiceshaveonindividual


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markets.Macroeconomicsisthebranchofeconomicsthatfocusesonthe

impactofchoicesonthetotal,oraggregate,levelofeconomicactivity.

Whydoticketstothebestconcertscostsomuch?Howdoesthethreatof

globalwarmingaffectrealestatepricesincoastalareas?Whydowomen

endupdoingmostofthehousework?Whydoseniorcitizensgetdiscounts

onpublictransitsystems?Thesequestionsaregenerallyregardedas

microeconomicbecausetheyfocusonindividualunitsormarketsinthe

economy.

Isthetotallevelofeconomicactivityrisingorfalling?Istherateof

inflationincreasingordecreasing?Whatishappeningtothe

unemploymentrate?Thesearequestionsthatdealwithaggregates,or

totals,intheeconomy;theyareproblemsofmacroeconomics.The

questionaboutthelevelofeconomicactivity,forexample,referstothe

totalvalueofallgoodsandservicesproducedintheeconomy.Inflationisa

measureoftherateofchangeintheaveragepricelevelfortheentire

economy;itisamacroeconomicproblem.Thetotallevelsofemployment

andunemploymentintheeconomyrepresenttheaggregateofalllabor

markets;unemploymentisalsoatopicofmacroeconomics.

Bothmicroeconomicsandmacroeconomicsgiveattentiontoindividual

markets.Butinmicroeconomicsthatattentionisanendinitself;in

macroeconomicsitisaimedatexplainingthemovementofmajor

economicaggregatestheleveloftotaloutput,thelevelofemployment,

andthepricelevel.

Wehavenowexaminedthecharacteristicsthatdefinetheeconomicwayof

thinkingandthetwobranchesofthiswayofthinking:microeconomics


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andmacroeconomics.Inthenextsection,wewillhavealookatwhatone

candowithtrainingineconomics.

PuttingEconomicstoWork

Economicsisonewayoflookingattheworld.Becausetheeconomicway

ofthinkinghasprovenquiteuseful,trainingineconomicscanbeputto

workinawiderangeoffields.One,ofcourse,isinworkasaneconomist.

Undergraduateworkineconomicscanbeappliedtoothercareersaswell.

CareersinEconomics

Economistsworkinthreetypesoforganizations.About58%ofeconomists

workforgovernmentagencies.[1]Theremainderworkforbusinessfirms

orincollegesanduniversities.

Economistsworkingforbusinessfirmsandgovernmentagencies

sometimesforecasteconomicactivitytoassisttheiremployersinplanning.

Theyalsoapplyeconomicanalysistotheactivitiesofthefirmsoragencies

forwhichtheyworkorconsult.Economistsemployedatcollegesand

universitiesteachandconductresearch.

Perusethewebsiteofyourcollegeoruniversityseconomicsdepartment.

Chancesarethedepartmentwilldiscussthewidevarietyofoccupations

thattheireconomicsmajorsenter.Unlikeengineeringandaccountingmajors,economicsandothersocialsciencemajorstendtobedistributed

overabroadrangeofoccupations.

ApplyingEconomicstoOtherFields


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Supposethatyouareconsideringsomethingotherthanacareerin

economics.Wouldchoosingtostudyeconomicshelpyou?

Theevidencesuggestsitmay.Suppose,forexample,thatyouare

consideringlawschool.Thestudyoflawrequireskeenanalyticalskills;

studyingeconomicssharpenssuchskills.Economistshavetraditionally

arguedthatundergraduateworkineconomicsservesasexcellent

preparationforlawschool.EconomistMichaelNieswiadomyofthe

UniversityofNorthTexascollecteddataonLawSchoolAdmittanceTest

(LSAT)scoresforundergraduatemajorslistedby2,200ormorestudents

takingthetestin2003.Table1.1"LSATScoresandUndergraduate

Majors"givesthescores,aswellastherankingforeachofthesemajors,in

2003andintwopreviousyearsinwhichtherankingswerecompiled.In

rankingsforallthreeyears,economicsmajorsrecordedthehighestscores.

Table 1.1 LSAT Scores and Undergraduate Majors

MajorfieldLSATaverage20032004

20032004Rank

19941995Rank

19911992Rank

Economics 156.6 1 1 1

Engineering 155.4 2 4 2

History 155.0 3 2 3

English 154.3 4 3 4

Finance 152.6 5 6 5

Politicalscience 152.1 6 9 9

Psychology 152.1 7 7 8

Accounting 151.1 8 8 6


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MajorfieldLSATaverage20032004

20032004Rank

19941995Rank

19911992Rank

Communications 150.5 9 10 10

Sociology 150.2 10 12 13

Bus.Administration 149.6 11 13 12

CriminalJustice 144.7 12 14 14

HerearetheaverageLSATscoresandrankingsforthe12undergraduate

majorswithmorethan2200studentstakingthetesttoenterlawschoolin

the20032004academicyear.

Source:MichaelNieswiadomy,LSATScoresofEconomicsMajors:2003

2004ClassUpdate,JournalofEconomicEducation,37(2)(Spring2006):

244247andMichaelNieswiadomy,LSATScoresofEconomics

MajorsJournalofEconomicEducation,29(4)(Fall1998):377379.

Didthestrongperformancebyeconomics,engineering,andhistorymajors

meanthattraininginthosefieldssharpensanalyticalskillstestedinthe

LSAT,orthatstudentswithgoodanalyticalskillsaremorelikelytomajor

inthem?Bothfactorswereprobablyatwork.Economicsclearlyattracts

studentswithgoodanalyticalskillsandstudyingeconomicshelps

developthoseskills.

Economicsmajorsshineinotherareasaswell.AccordingtotheBureauof

LaborStatisticsOccupationalOutlookHandbook,astrongbackgroundin

economictheory,mathematics,andstatisticsprovidesthebasisfor

competingforthebestjobopportunities,particularlyresearchassistant


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positions,inabroadrangeoffields.Manygraduateswithbachelors

degreeswillfindgoodjobsinindustryandbusinessasmanagementor

salestraineesorasadministrativeassistants.Becauseeconomistsare

concernedwithunderstandingandinterpretingfinancialmatters,among

othersubjects,theywillalsobeattractedtoandqualifiedforjobsas

financialmanagers,financialanalysts,underwriters,actuaries,securities

andfinancialservicessalesworkers,creditanalysts,loanandbudget

officers,andurbanandregionalplanners.

Table1.2"AverageYearlySalaryOffers,May2006andOccupational

Outlook20042014,SelectedMajors/Occupations"showsaverageyearly

salaryoffersforbachelordegreecandidatesforMay2006andtheoutlook

forrelatedoccupationsto2014.

Table1.2AverageYearlySalaryOffers,May2006andOccupational

Outlook20042014,SelectedMajors/Occupations

Undergraduatemajor

Average$

OfferMay,2006

Projected%Changein

TotalEmploymentinOccupation20042014

ComputerEngineering $54,200 10.1

Electrical/ElectronicEngineering 54,053 11.8

ComputerScience 50,892 25.6

Accounting 46,188 22.4

EconomicsandFinance 45,058 12.4

ManagementInformationSystems 44,755 25.9

LogisticsandMaterialsManagement 43,426 13.2


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Undergraduatemajor

Average$OfferMay,2006

Projected%ChangeinTotalEmploymentinOccupation20042014

BusinessAdministration 40,976 17.0

EnvironmentalSciences(includingforestryandconservationscience) 39,750 6.3

OtherBusinessMajors(e.g.,Marketing) 37,446 20.8

HumanResources(incl.LaborRelations) 36,256 15.9

GeologyandGeologicalSciences 35,034 8.3

Sociology 33,752 4.7

PoliticalScience/Government 33,151 7.3

LiberalArts&Sciences(generalstudies) 32,627 na

PublicRelations 32,623 21.7

SpecialEducation 31,817 23.3

ElementaryEducation 31,778 18.2

ForeignLanguages 31,364 na

Letters(incl.English) 31,204 20.4

OtherSocialSciences

(IncludingCriminalJusticeandHistory) 30,788 12.3

Psychology 30,308 9.9

Pre-elementaryEducation 27,550 22.4

SocialWork 25,865 19.6


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Undergraduatemajor

Average$OfferMay,2006

Projected%ChangeinTotalEmploymentinOccupation20042014

VisualandPerformingArts 21,726 15.2

Sources:NationalAssociationofCollegesandEmployers,SalarySurvey,

Spring2006http://naceweb.org;BureauofLaborStatistics,20062007

editionoftheOccupationalOutlookHandbook;OccupationalEmployment,

Training,andEarnings:EducationalLevelReport(May,2006)

URL:http://data.bls.gov/oep/noeted/empoptd.jsp(note:na=not

reported;thatis,nospecificoccupationwasreportedinBLSreport;Other

businessmajors,Othersocialsciences,Socialwork(includingSociology),andEnvironmentalSciencesareweightedaveragesofvariousdisciplines,

calculatedbyauthors.)

Oneschoiceofamajor,orminor,isnotlikelytobebasedsolelyon

considerationsofpotentialearningsortheprospectoflandingaspotin

lawschool.Youwillalsoconsideryourinterestsandabilitiesinmakinga

decisionaboutwhethertopursuefurtherstudyineconomics.And,of

course,youwillconsidertheexpectedbenefitsofalternativecoursesof

study.Whatisyouropportunitycostofpursuingstudyofeconomics?Does

studyingmoreeconomicsserveyourinterestsandwilldoingsomaximize

yoursatisfactionlevel?Theseconsiderationsmaybeonyourmindasyou

begintostudyeconomicsatthecollegelevelandobviouslystudentswill

makemanydifferentchoices.But,shouldyoudecidetopursueamajoror

minorineconomics,youshouldknowthatabackgroundinthisfieldis

likelytoserveyouwellinawiderangeofcareers.

KEYTAKEAWAYS


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Economistsfocusontheopportunitycostsofchoices,theyassumethatindividualsmakechoicesinawaythatmaximizesthevalueofan

objectivedefinedintermsoftheirownself-interest,andtheyassume

thatindividualsmakethosechoicesatthemargin. Economicsisdividedintotwobroadareas:microeconomicsand

macroeconomics.

Awiderangeofcareeropportunitiesisopentoeconomicsmajors.Empiricalevidencesuggeststhatstudentswhoenterthejobmarket

withamajorineconomicstendtoearnmorethandostudentsin

mostothermajors.Further,economicsmajorsdoparticularlywellon

theLSAT.

TRYIT!

TheDepartmentofAgricultureestimatedthattheexpendituresa

middle-income,husbandwifefamilyofthreewouldincurtoraiseone

additionalchildfrombirthin2005toage17wouldbe$250,530.In

whatwaydoesthisestimateillustratetheeconomicwayofthinking?

WouldtheDepartmentsestimatebeanexampleofmicroeconomic

orofmacroeconomicanalysis?Why?

CaseinPoint:TheFinancialPayoffto

StudyingEconomicsCollegeeconomicsprofessorshavelongarguedthatstudyingeconomicsis

goodpreparationforavarietyofcareers.Arecentstudysuggeststheyare

rightandthatstudyingeconomicsisevenlikelytomakestudentsmore

prosperous.Studentswhomajorineconomicsbutdidnotpursuegraduate

workarelikelytoearnmorethanstudentsinvirtuallyeveryothercollege

major.Studentswhomajorineconomicsandthengoontolawschoolor


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anMBAprogramarelikelytoearnmorethanstudentswhoapproach

thoseareasofstudyhavingmajoredinmostotherareas.

EconomistsDanA.Black,SethSanders,andLowellTaylorusedthe1993

NationalSurveyofCollegeGraduates,whichincludedmorethan86,000

college-educatedworkersbetweentheagesof25and55thataskedwhat

fieldtheyhadmajoredin.Theythencontrolledforvariablessuchas

gender,race,andethnicity.Theyfoundthatstudentswhohadnotdone

graduateworkandhadmajoredineconomicsearnedmorethanstudents

inanyothermajorexceptengineering.Specifically,economicsmajors

earnedabout13%morethanothersocialsciencesmajors,11%morethan

businessadministrationmajors,andaboutthesameasnaturalscienceand

accountingmajors.Theeconomicsmajorsintheirsurvey,likethosewho

majoredinothersocialsciencesandbusinessadministrationandunlike

thosewhomajoredinengineeringoraccounting,werespreadoutovera

widerangeofoccupationsbutwithmanyinmanagementpositions.

Basedonthesurveytheyused,over40%ofeconomicsmajorswentonto

earngraduatedegrees,manyinlawandbusiness.Economicsmajors

rankedfirstintermsofwages,ascomparedtootherlawschoolgraduates

withthe12mostcommonpre-lawmajors(includingsuchmajorsas

businessadministration,finance,English,history,psychology,andpolitical

science).MBAgraduateswhohadmajoredineconomicsearnedmorethan

thosewhohadmajoredinanyotherfieldexceptchemicalengineering.

Specifically,undergraduateeconomicsmajorswithMBAsearnedabout

15%morethanthosewhohadmajoredinotherdisciplinesrepresentedin

thesurvey,includingbusiness-relatedmajors.


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Itisremarkablethatallofthebusiness-relatedmajorsgeneratedsalaries

muchlowerthanthoseearnedbyeconomicsmajorswithanMBA.One

couldarguethatthisreflectsself-selection;thatstudentswhomajorin

economicsaresimplybrighter.But,studentswhomajorinphysicshave

highSATscores,yetthey,too,earnedwagesthatwereabout20%lower

thanMBAstudentswhohadmajoredineconomics.Thisfindinglends

somecredencetothenotionthatthemarketplacerewardstraininginthe

economicwayofthinking.

Source:DanA.Black,SethSanders,andLowellTaylor,TheEconomic

RewardforStudyingEconomics,EconomicInquiry,41(3),July2003,365

377.

ANSWERTOTRYIT!PROBLEM

Theinformationgivensuggestsoneelementoftheeconomicwayof

thinking:assessingthechoiceatthemargin.Theestimatereflectsthe

costofonemorechildforafamilythatalreadyhasone.Itisnotclear

fromtheinformationgivenhowclosetheestimateofcostcomesto

theeconomicconceptofopportunitycost.TheDepartmentof

Agriculturesestimateincludedsuchcostsashousing,food,

transportation,clothing,healthcare,childcare,andeducation.An

economistwouldaddthevalueofthebestalternativeuseofthe

additionaltimethatwillberequiredforthechild.Ifthecoupleis

lookingfarahead,itmaywanttoconsidertheopportunitycostof

sendingachildtocollege.And,ifitislookingveryfarahead,itmay

wanttoconsiderthefactthatnearlyhalfofallparentsovertheageof

50supportatleastonechildovertheageof21.Thisisaproblemin

microeconomicanalysis,becauseitfocusesonthechoicesof

individualhouseholds.


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[1]BureauofLaborStatisticsOccupationalOutlookathttp://www.bls.gov/oco/.

1.3TheEconomistsToolKit

LEARNINGOBJECTIVES

1. Explainhoweconomiststesthypotheses,developeconomictheories,andusemodelsintheiranalyses.

2. Explainhowtheall-other-thingsunchanged(ceterisparibus)problemandthefallacyoffalsecauseaffectthetestingofeconomic

hypothesesandhoweconomiststrytoovercometheseproblems.3. Distinguishbetweennormativeandpositivestatements.

Economicsdiffersfromothersocialsciencesbecauseofitsemphasison

opportunitycost,theassumptionofmaximizationintermsofonesown

self-interest,andtheanalysisofchoicesatthemargin.Butcertainlymuch

ofthebasicmethodologyofeconomicsandmanyofitsdifficultiesare

commontoeverysocialscienceindeed,toeveryscience.Thissectionexplorestheapplicationofthescientificmethodtoeconomics.

Researchersoftenexaminerelationshipsbetweenvariables.Avariableis

somethingwhosevaluecanchange.Bycontrast,aconstantissomething

whosevaluedoesnotchange.Thespeedatwhichacaristravelingisan

exampleofavariable.Thenumberofminutesinanhourisanexampleofa

constant.

Researchisgenerallyconductedwithinaframeworkcalled

thescientificmethod,asystematicsetofproceduresthroughwhich

knowledgeiscreated.Inthescientificmethod,hypothesesaresuggested


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andthentested.Ahypothesisisanassertionofarelationshipbetweentwo

ormorevariablesthatcouldbeproventobefalse.Astatementisnota

hypothesisifnoconceivabletestcouldshowittobefalse.Thestatement

Plantslikesunshineisnotahypothesis;thereisnowaytotestwhether

plantslikesunshineornot,soitisimpossibletoprovethestatementfalse.

ThestatementIncreasedsolarradiationincreasestherateofplant

growthisahypothesis;experimentscouldbedonetoshowthe

relationshipbetweensolarradiationandplantgrowth.Ifsolarradiation

wereshowntobeunrelatedtoplantgrowthortoretardplantgrowth,

thenthehypothesiswouldbedemonstratedtobefalse.

Ifatestrevealsthataparticularhypothesisisfalse,thenthehypothesisis

rejectedormodified.Inthecaseofthehypothesisaboutsolarradiation

andplantgrowth,wewouldprobablyfindthatmoresunlightincreases

plantgrowthoversomerangebutthattoomuchcanactuallyretardplant

growth.Suchresultswouldleadustomodifyourhypothesisaboutthe

relationshipbetweensolarradiationandplantgrowth.

Ifthetestsofahypothesisyieldresultsconsistentwithit,thenfurther

testsareconducted.Ahypothesisthathasnotbeenrejectedafter

widespreadtestingandthatwinsgeneralacceptanceiscommonlycalled

atheory.Atheorythathasbeensubjectedtoevenmoretestingandthat

haswonvirtuallyuniversalacceptancebecomesalaw.Wewillexamine

twoeconomiclawsinthenexttwochapters.

Evenahypothesisthathasachievedthestatusofalawcannotbeproven

true.Thereisalwaysapossibilitythatsomeonemayfindacasethat

invalidatesthehypothesis.Thatpossibilitymeansthatnothingin

economics,orinanyothersocialscience,orinanyscience,canever


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beproventrue.Wecanhavegreatconfidenceinaparticularproposition,

butitisalwaysamistaketoassertthatitisproven.

ModelsinEconomics

Allscientificthoughtinvolvessimplificationsofreality.Therealworldis

fartoocomplexforthehumanmindorthemostpowerfulcomputerto

consider.Scientistsusemodelsinstead.Amodelisasetofsimplifying

assumptionsaboutsomeaspectoftherealworld.Modelsarealwaysbased

onassumedconditionsthataresimplerthanthoseoftherealworld,

assumptionsthatarenecessarilyfalse.Amodeloftherealworld

cannotbetherealworld.

WewillencounteraneconomicmodelinChapter2"ConfrontingScarcity:

ChoicesinProduction".Forthatmodel,wewillassumethataneconomy

canproduceonlytwogoods.Thenwewillexplorethemodelofdemand

andsupply.Oneoftheassumptionswewillmakethereisthatallthegoods

producedbyfirmsinaparticularmarketareidentical.Ofcourse,real

economiesandrealmarketsarenotthatsimple.Realityisneverassimple

asamodel;onepointofamodelistosimplifytheworldtoimproveour

understandingofit.

Economistsoftenusegraphstorepresenteconomicmodels.Theappendix

tothischapterprovidesaquick,refreshercourse,ifyouthinkyouneed

one,onunderstanding,building,andusinggraphs.

Modelsineconomicsalsohelpustogeneratehypothesesaboutthereal

world.Inthenextsection,wewillexaminesomeoftheproblemswe

encounterintestingthosehypotheses.


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TestingHypothesesinEconomics

Hereisahypothesissuggestedbythemodelofdemandandsupply:an

increaseinthepriceofgasolinewillreducethequantityofgasoline

consumersdemand.Howmightwetestsuchahypothesis?

Economiststrytotesthypothesessuchasthisonebyobservingactual

behaviorandusingempirical(thatis,real-world)data.Theaverageretail

priceofgasolineintheUnitedStatesrosefromanaverageof$2.12per

gallononMay22,2005to$2.88pergallononMay22,2006.Thenumber

ofgallonsofgasolineconsumedbyU.S.motoristsrose0.3%duringthat

period.

Thesmallincreaseinthequantityofgasolineconsumedbymotoristsasits

priceroseisinconsistentwiththehypothesisthatanincreasedpricewill

leadtoanreductioninthequantitydemanded.Doesthatmeanthatwe

shoulddismisstheoriginalhypothesis?Onthecontrary,wemustbe

cautiousinassessingthisevidence.Severalproblemsexistininterpreting

anysetofeconomicdata.Oneproblemisthatseveralthingsmaybe

changingatonce;anotheristhattheinitialeventmaybeunrelatedtothe

eventthatfollows.Thenexttwosectionsexaminetheseproblemsindetail.

TheAll-Other-Things-UnchangedProblem

Thehypothesisthatanincreaseinthepriceofgasolineproducesa

reductioninthequantitydemandedbyconsumerscarrieswithitthe

assumptionthattherearenootherchangesthatmightalsoaffect

consumerdemand.Abetterstatementofthehypothesiswouldbe:An


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increaseinthepriceofgasolinewillreducethequantityconsumers

demand,ceterisparibus.CeterisparibusisaLatinphrasethatmeansall

otherthingsunchanged.

ButthingschangedbetweenMay2005andMay2006.Economicactivity

andincomesrosebothintheUnitedStatesandinmanyothercountries,

particularlyChina,andpeoplewithhigherincomesarelikelytobuymore

gasoline.Employmentroseaswell,andpeoplewithjobsusemoregasoline

astheydrivetowork.PopulationintheUnitedStatesgrewduringthe

period.Inshort,manythingshappenedduringtheperiod,allofwhich

tendedtoincreasethequantityofgasolinepeoplepurchased.

OurobservationofthegasolinemarketbetweenMay2005andMay2006

didnotofferaconclusivetestofthehypothesisthatanincreaseinthe

priceofgasolinewouldleadtoareductioninthequantitydemandedby

consumers.Otherthingschangedandaffectedgasolineconsumption.Such

problemsarelikelytoaffectanyanalysisofeconomicevents.Wecannot

asktheworldtostandstillwhileweconductexperimentsineconomic

phenomena.Economistsemployavarietyofstatisticalmethodstoallow

themtoisolatetheimpactofsingleeventssuchaspricechanges,butthey

canneverbecertainthattheyhaveaccuratelyisolatedtheimpactofa

singleeventinaworldinwhichvirtuallyeverythingischangingallthe

time.

Inlaboratorysciencessuchaschemistryandbiology,itisrelativelyeasyto

conductexperimentsinwhichonlyselectedthingschangeandallother

factorsareheldconstant.Theeconomistslaboratoryistherealworld;

thus,economistsdonotgenerallyhavetheluxuryofconductingcontrolled

experiments.


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TheFallacyofFalseCause

Hypothesesineconomicstypicallyspecifyarelationshipinwhichachange

inonevariablecausesanothertochange.Wecallthevariablethat

respondstothechangethedependentvariable;thevariablethatinducesa

changeiscalledtheindependentvariable.Sometimesthefactthattwo

variablesmovetogethercansuggestthefalseconclusionthatoneofthe

variableshasactedasanindependentvariablethathascausedthechange

weobserveinthedependentvariable.

Considerthefollowinghypothesis:Peoplewearingshortscausewarm

weather.Certainly,weobservethatmorepeoplewearshortswhenthe

weatheriswarm.Presumably,though,itisthewarmweatherthatcauses

peopletowearshortsratherthanthewearingofshortsthatcauseswarm

weather;itwouldbeincorrecttoinferfromthisthatpeoplecausewarm

weatherbywearingshorts.

Reachingtheincorrectconclusionthatoneeventcausesanotherbecause

thetwoeventstendtooccurtogetheriscalledthefallacyoffalsecause.

Theaccompanyingessayonbaldnessandheartdiseasesuggestsan

exampleofthisfallacy.

Becauseofthedangerofthefallacyoffalsecause,economistsusespecial

statisticalteststhataredesignedtodeterminewhetherchangesinone

thingactuallydocausechangesobservedinanother.Giventheinabilityto

performcontrolledexperiments,however,thesetestsdonotalwaysoffer

convincingevidencethatpersuadesalleconomiststhatonethingdoes,in

fact,causechangesinanother.


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InthecaseofgasolinepricesandconsumptionbetweenMay2005and

May2006,thereisgoodtheoreticalreasontobelievethepriceincrease

shouldleadtoareductioninthequantityconsumersdemand.And

economistshavetestedthehypothesisaboutpriceandthequantity

demandedquiteextensively.Theyhavedevelopedelaboratestatistical

testsaimedatrulingoutproblemsofthefallacyoffalsecause.Whilewe

cannotprovethatanincreaseinpricewill,ceterisparibus,leadtoa

reductioninthequantityconsumersdemand,wecanhaveconsiderable

confidenceintheproposition.

NormativeandPositiveStatements

Twokindsofassertionsineconomicscanbesubjectedtotesting.Wehave

alreadyexaminedone,thehypothesis.Anothertestableassertionisa

statementoffact,suchasItisrainingoutsideorMicrosoftisthelargest

producerofoperatingsystemsforpersonalcomputersintheworld.Like

hypotheses,suchassertionscanbedemonstratedtobefalse.Unlike

hypotheses,theycanalsobeshowntobecorrect.Astatementoffactora

hypothesisisapositivestatement.

Althoughpeopleoftendisagreeaboutpositivestatements,such

disagreementscanultimatelyberesolvedthroughinvestigation.Thereis

anothercategoryofassertions,however,forwhichinvestigationcannever

resolvedifferences.Anormativestatementisonethatmakesavalue

judgment.Suchajudgmentistheopinionofthespeaker;noonecan

provethatthestatementisorisnotcorrect.Herearesomeexamplesof

normativestatementsineconomics:Weoughttodomoretohelpthe

poor.PeopleintheUnitedStatesshouldsavemore.Corporateprofits


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aretoohigh.Thestatementsarebasedonthevaluesofthepersonwho

makesthem.Theycannotbeprovenfalse.

Becausepeoplehavedifferentvalues,normativestatementsoftenprovoke

disagreement.Aneconomistwhosevaluesleadhimorhertoconcludethat

weshouldprovidemorehelpforthepoorwilldisagreewithonewhose

valuesleadtoaconclusionthatweshouldnot.Becausenotestexistsfor

thesevalues,thesetwoeconomistswillcontinuetodisagree,unlessone

persuadestheothertoadoptadifferentsetofvalues.Manyofthe

disagreementsamongeconomistsarebasedonsuchdifferencesinvalues

andthereforeareunlikelytoberesolved.

KEYTAKEAWAYS

Economiststrytoemploythescientificmethodintheirresearch. Scientistscannotproveahypothesistobetrue;theycanonlyfailto

proveitfalse.

Economists,likeothersocialscientistsandscientists,usemodelstoassistthemintheiranalyses.

Twoproblemsinherentintestsofhypothesesineconomicsaretheall-other-things-unchangedproblemandthefallacyoffalsecause.

Positivestatementsarefactualandcanbetested.Normativestatementsarevaluejudgmentsthatcannotbetested.Manyofthe

disagreementsamongeconomistsstemfromdifferencesinvalues.

TRYIT!LookagainatthedatainTable1.1"LSATScoresandUndergraduate

Majors".Nowconsiderthehypothesis:Majoringineconomicswill

resultinahigherLSATscore.Arethedatagivenconsistentwiththis


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hypothesis?Dothedataprovethatthishypothesisiscorrect?What

fallacymightbeinvolvedinacceptingthehypothesis?

CaseinPoint:DoesBaldnessCauseHeart

Disease?Awebsitecalledembarrassingproblems.comreceivedthefollowingemail:

DearDr.Margaret,

Iseemtobegoingbald.Accordingtoyourwebsite,thismeansImmorelikelytohaveaheartattack.IfItakeadrugtopreventhairloss,

willitreducemyriskofaheartattack?

WhatdidDr.Margaretanswer?Mostimportantly,shedidnotrecommend

thatthequestionertakedrugstotreathisbaldness,becausedoctorsdonot

thinkthatthebaldnesscausestheheartdisease.Amorelikelyexplanation

fortheassociationbetweenbaldnessandheartdiseaseisthatboth

conditionsareaffectedbyanunderlyingfactor.Whilenotingthatmore

researchneedstobedone,onehypothesisthatDr.Margaretoffersisthat

highertestosteronelevelsmightbetriggeringboththehairlossandthe

heartdisease.Thegoodnewsforpeoplewithearlybalding(whichisreally

wheretheassociationwithincreasedriskofheartdiseasehasbeen

observed)isthattheyhaveasignalthatmightleadthemtobechecked

earlyonforheartdisease.

Source:http://www.embarrassingproblems.com/problems/problempage

230701.htm.


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ANSWERTOTRYIT!PROBLEM

Thedataareconsistentwiththehypothesis,butitisneverpossibleto

provethatahypothesisiscorrect.Acceptingthehypothesiscould

involvethefallacyoffalsecause;studentswhomajorineconomics

mayalreadyhavetheanalyticalskillsneededtodowellontheexam.

1.4ReviewandPractice

SummaryChoicesareforcedonusbyscarcity;economistsstudythechoicesthat

peoplemake.Scarcegoodsarethoseforwhichthechoiceofone

alternativerequiresgivingupanother.Theopportunitycostofanychoice

isthevalueofthebestalternativeforgoneinmakingthatchoice.

Somekeychoicesassessedbyeconomistsincludewhattoproduce,howto

produceit,andforwhomitshouldbeproduced.Economicsis

distinguishedfromotheracademicdisciplinesthatalsostudychoicesby

anemphasisonthecentralimportanceofopportunitycostsinevaluating

choices,theassumptionofmaximizingbehaviorthatservestheinterestsof

individualdecisionmakers,andafocusonevaluatingchoicesatthe

margin.

Economicanalysesmaybeaimedatexplainingindividualchoiceorchoices

inanindividualmarket;suchinvestigationsarelargelythefocusof

microeconomics.Theanalysisoftheimpactofthoseindividualchoiceson

suchaggregatesastotaloutput,thelevelofemployment,andtheprice

levelistheconcernofmacroeconomics.

Workingwithintheframeworkofthescientificmethod,economists

formulatehypothesesandthentestthem.Thesetestscanonlyrefutea

hypothesis;hypothesesinsciencecannotbeproved.Ahypothesisthathas


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beenwidelytestedoftencomestoberegardedasatheory;onethathas

wonvirtuallyuniversalacceptanceisalaw.Becauseofthecomplexityof

therealworld,economistsrelyonmodelsthatrestonaseriesof

simplifyingassumptions.Themodelsareusedtogeneratehypotheses

abouttheeconomythatcanbetestedusingreal-worlddata.

Statementsoffactandhypothesesarepositivestatements.Normative

statements,unlikepositivestatements,cannotbetestedandprovidea

sourceforpotentialdisagreement.

PROBLEMS

1. Whydoesthefactthatsomethingisscarcerequirethatwemakechoices?

2. Doesthefactthatsomethingisabundantmeanitisnotscarceintheeconomicsense?Whyorwhynot?

3. Insomecountries,suchasCubaandNorthKorea,thegovernmentmakesmostofthedecisionsaboutwhatwillbeproduced,howitwill

beproduced,andforwhom.Doesthefactthatthesechoicesare

madebythegovernmenteliminatescarcityinthesecountries?Why

orwhynot?

4. Explainwhatismeantbytheopportunitycostofachoice.5. Whatistheapproximatedollarcostofthetuitionandotherfees

associatedwiththeeconomicscourseyouaretaking?Doesthisdollar

costfullyreflecttheopportunitycosttoyouoftakingthecourse?

6. IntheCaseinPointessayTheRisingCostofEnergy,whatwouldbesomeofthethingsthatwouldbeincludedinanestimateofthe

opportunitycostofpreservingpartofnorthernAlbertaCanadaby

prohibitingheavycrudeoilextraction?Doyouthinkthatthe

increasedextractionrepresentsthebestuseoftheland?Whyorwhy

not?


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7.Indicatewhethereachofthefollowingisatopicofmicroeconomicsormacroeconomics:

1. Theimpactofhigheroilpricesontheproductionofsteel2. Theincreaseddemandinthelast15yearsforexoticdietary

supplements

3. ThesurgeinaggregateeconomicactivitythathitmuchofAsialateintheearly2000s

4. ThesharpincreasesinU.S.employmentandtotaloutputthatoccurredbetween2003and2007

5. Theimpactofpreservationofwildernessareasontheloggingindustryandonthepriceoflumber

8.Determinewhethereachofthefollowingraisesawhat,how,orforwhomissue.Arethestatementsnormativeor

positive?

1. Arequirementthataluminumusedincarsbemadefrom

recycledmaterialswillraisethepriceofautomobiles.

2. Thefederalgovernmentdoesnotspendenoughforchildren.3. Anincreaseinpoliceresourcesprovidedtotheinnercitywill

lowerthecrimerate.

4. Automationdestroysjobs.5. Effortstoimprovetheenvironmenttendtoreduce

productionandemployment.

6. Japanesefirmsshouldbemorewillingtohireadditionalworkerswhenproductionrisesandtolayoffworkerswhen

productionfalls.


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7. Accesstohealthcareshouldnotbelimitedbyincome.

9. Yourtimeisascarceresource.Whatifthequantityoftimewereincreased,sayto48hoursperday,andeveryonestilllivedasmanydaysasbefore.Wouldtimestillbescarce?

10.Mostcollegestudentsareunderage25.Givetwoexplanationsforthisonebasedonthebenefitspeopleofdifferentagesarelikelyto

receivefromhighereducationandonebasedontheopportunity

costsofacollegeeducationtostudentsofdifferentages.

11.Somemunicipalwatercompanieschargecustomersaflatfeeeachmonth,regardlessoftheamountofwatertheyconsume.Othersmeterwateruseandchargeaccordingtothequantityofwater

customersuse.Comparethewaythetwosystemsaffectthecostof

wateruseatthemargin.

12.Howmightyoutesteachofthefollowinghypotheses?Suggestsomeproblemsthatmightariseineachtestdueto

theceterisparibus(all-other-things-unchanged)problemandthefallacyoffalsecause.

1. Reducingthequantityofheroinavailablewillincreasetotalspendingonheroinandincreasethecrimerate.

2. Higherincomesmakepeoplehappier.3. Higherincomesmakepeoplelivelonger.

13.Manymodelsinphysicsandinchemistryassumetheexistenceofaperfectvacuum(thatis,aspaceentirelyemptyofmatter).Yetwe

knowthataperfectvacuumcannotexist.Aresuchmodelsvalid?Why

aremodelsbasedonassumptionsthatareessentiallyincorrect?


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14.Supposeyouwereaskedtotestthepropositionthatpublishingstudentsteacherevaluationscausesgradeinflation.Whatevidence

mightyouwanttoconsider?Howwouldtheinabilitytocarryout

controlledexperimentsmakeyouranalysismoredifficult?15.ReferringtotheCaseinPointBaldnessandHeartDisease,explain

thepossiblefallacyoffalsecauseinconcludingthatbaldnessmakesa

personmorelikelytohaveheartdisease.

16.In2005theFoodandDrugAdministrationorderedthatVioxxandotherpopulardrugsfortreatingthepainofarthritisbewithdrawn

fromthemarket.Theorderresultedfromafindingthatpeopletaking

thedrugshadanincreasedriskofcardiovascularproblems.Someresearcherscriticizedthegovernmentsaction,arguingthat

concludingthatthedrugscausedthecardiovascularproblems

representedanexampleofthefallacyoffalsecause.Canyouthinkof

anyreasonwhythismightbethecase?


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Chapter2ConfrontingScarcity:ChoicesinProduction

StartUp:TighteningSecurityattheWorlds

Airports

Doyouwantsaferairtravelornot?Whilethatquestionisseldomaskedso

bluntly,anypersonwhotravelsbyaircantellyouthatourcollective

answerhasbeenyes,andithasbeenaccompaniedbyincreasesin

securityanditsassociatedcostsatairportsallovertheworld.Why?In

short,9/11.TerroristshijackedfourU.S.commercialairlinerson

September11,2001,andthetragicresultsthatfollowedledtoasharp

tighteninginairportsecurity.

Inanefforttopreventsimilardisasters,airportsecurityofficialsscrutinize

luggageandpassengersmorecarefullythaneverbefore.Inthemonths

following9/11,delaysofasmuchasthreehourswerecommonasagents

triedtoassurethatnoweaponsorbombscouldbesmuggledontoanother

plane.

Whattoproduce?isafundamentaleconomicquestion.Everyeconomy

mustanswerthisquestion.Shoulditproducemoreeducation,better

healthcare,improvedtransportation,acleanerenvironment?Thereare

limitstowhatanationcanproduce;decidingtoproducemoreofonething

inevitablymeansproducinglessofsomethingelse.Individualsinmuchof

theworld,afterthetragedyof9/11,clearlywerewillingtogiveuptime,

andafairamountofindividualprivacy,inanefforttoobtaingreater

security.Nationsandindividualcitiesalsodevotedadditionalresourcesto


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policeandotherformsofprotectioninanefforttopreventtragediessuch

as9/11.Peopleallovertheworldchosetoproducelessofothergoodsin

ordertodevotemoreresourcestotheproductionofgreatersecurity.And,

asofearly2009,thechoicetodevotemoreresourcestosecurityhadpaid

off;therehadbeennosimilarhijackingsintheUnitedStates.

Inthischapterweuseourfirstmodel,theproductionpossibilitiesmodel,

toexaminethenatureofchoicestoproducemoreofsomegoodsandless

ofothers.Asitsnamesuggests,theproductionpossibilitiesmodelshows

thegoodsandservicesthataneconomyiscapableofproducingits

possibilitiesgiventhefactorsofproductionandthetechnologyithas

available.Themodelspecifieswhatitmeanstouseresourcesfullyand

efficientlyandsuggestssomeimportantimplicationsforinternational

trade.Wecanalsousethemodeltoillustrateeconomicgrowth,aprocess

thatexpandsthesetofproductionpossibilitiesavailabletoaneconomy.

Wethenturntoanexaminationofthetypeofeconomicsysteminwhich

choicesaremade.Aneconomicsystemisthesetofrulesthatdefinehowan

economysresourcesaretobeownedandhowdecisionsabouttheiruse

aretobemade.Wewillseethateconomicsystemsdifferintermsofhow

theyanswerthefundamentaleconomicquestions.Manyoftheworlds

economicsystems,includingthesystemsthatprevailinNorthAmerica,

Europe,andmuchofAsiaandCentralandSouthAmerica,relyon

individualsoperatinginamarketeconomytomakethosechoices.Other

economicsystems,includingthoseofCubaandNorthKoreatodayand

historicallythoseoftheformerSovietUnion,Sovietbloccountries,and

China,relyorreliedongovernmenttomakethesechoices.Different

economicsystemsresultindifferentsetsofchoicesandthusdifferent

outcomes;thefactthatmarketeconomiesgenerallyoutperformtheothers


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whenitcomestoprovidingmoreofthethingsthatpeoplewanthelpsto

explainthedramaticshiftfromgovernment-dominatedtowardmarket-

dominatedeconomicsystemsthathasoccurredthroughouttheworldin

thepast25years.Thechapterconcludeswithanexaminationoftheroleof

governmentinaneconomythatrelieschieflyonmarketstoallocategoods

andservices.

2.1FactorsofProduction

LEARNINGOBJECTIVES1. Definethethreefactorsofproductionlabor,capital,andnatural

resources.

2. Explaintheroleoftechnologyandentrepreneursintheutilizationoftheeconomysfactorsofproduction.

Choicesconcerningwhatgoodsandservicestoproducearechoicesabout

aneconomysuseofitsfactorsofproduction,theresourcesavailabletoitfortheproductionofgoodsandservices.Thevalue,orsatisfaction,that

peoplederivefromthegoodsandservicestheyconsumeandtheactivities

theypursueiscalledutility.Ultimately,then,aneconomysfactorsof

productioncreateutility;theyservetheinterestsofpeople.

Thefactorsofproductioninaneconomyareitslabor,capital,andnatural

resources.Laboristhehumaneffortthatcanbeappliedtotheproduction

ofgoodsandservices.Peoplewhoareemployedorwouldliketobeare

consideredpartofthelaboravailabletotheeconomy.Capitalisafactorof

productionthathasbeenproducedforuseintheproductionofother

goodsandservices.Officebuildings,machinery,andtoolsareexamplesof


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capital.Naturalresourcesaretheresourcesofnaturethatcanbeusedfor

theproductionofgoodsandservices.

Inthenextthreesections,wewilltakeacloserlookatthefactorsof

productionweusetoproducethegoodsandservicesweconsume.The

threebasicbuildingblocksoflabor,capital,andnaturalresourcesmaybe

usedindifferentwaystoproducedifferentgoodsandservices,butthey

stilllieatthecoreofproduction.Wewillthenlookattherolesplayedby

technologyandentrepreneursinputtingthesefactorsofproductionto

work.Aseconomistsbegantograpplewiththeproblemsofscarcity,

choice,andopportunitycosttwocenturiesago,theyfocusedonthese

concepts,justastheyarelikelytodotwocenturieshence.

Labor

Laborishumaneffortthatcanbeappliedtoproduction.Peoplewhowork

torepairtires,pilotairplanes,teachchildren,orenforcelawsareallpartof

theeconomyslabor.Peoplewhowouldliketoworkbuthavenotfound

employmentwhoareunemployedarealsoconsideredpartofthelabor

availabletotheeconomy.

Insomecontexts,itisusefultodistinguishtwoformsoflabor.Thefirstis

thehumanequivalentofanaturalresource.Itisthenaturalabilityan

untrained,uneducatedpersonbringstoaparticularproductionprocess.

Butmostworkersbringfarmore.Theskillsaworkerhasasaresultof

education,training,orexperiencethatcanbeusedinproductionare

calledhumancapital.Studentswhoareattendingacollegeoruniversity

areacquiringhumancapital.Workerswhoaregainingskillsthrough


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experienceorthroughtrainingareacquiringhumancapital.Childrenwho

arelearningtoreadareacquiringhumancapital.

Theamountoflaboravailabletoaneconomycanbeincreasedintwo

ways.Oneistoincreasethetotalquantityoflabor,eitherbyincreasingthe

numberofpeopleavailabletoworkorbyincreasingtheaveragenumber

ofhoursofworkperweek.Theotheristoincreasetheamountofhuman

capitalpossessedbyworkers.

Capital

Longago,whenthefirsthumanbeingswalkedtheearth,theyproduced

foodbypickingleavesorfruitoffaplantorbycatchingananimaland

eatingit.Weknowthatveryearlyon,however,theybeganshapingstones

intotools,apparentlyforuseinbutcheringanimals.Thosetoolswerethe

firstcapitalbecausetheywereproducedforuseinproducingother

goodsfoodandclothing.

Modernversionsofthefirststonetoolsincludesaws,meatcleavers,hooks,

andgrinders;allareusedinbutcheringanimals.Toolssuchashammers,

screwdrivers,andwrenchesarealsocapital.Transportationequipment,

suchascarsandtrucks,iscapital.Facilitiessuchasroads,bridges,ports,

andairportsarecapital.Buildings,too,arecapital;theyhelpustoproduce

goodsandservices.

Capitaldoesnotconsistsolelyofphysicalobjects.Thescoreforanew

symphonyiscapitalbecauseitwillbeusedtoproduceconcerts.Computer

softwareusedbybusinessfirmsorgovernmentagenciestoproducegoods


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andservicesiscapital.Capitalmaythusincludephysicalgoodsand

intellectualdiscoveries.Anyresourceiscapitalifitsatisfiestwocriteria:

1. Theresourcemusthavebeenproduced.2. Theresourcecanbeusedtoproduceothergoodsandservices.

Onethingthatisnotconsideredcapitalismoney.Afirmcannotusemoney

directlytoproduceothergoods,somoneydoesnotsatisfythesecond

criterionforcapital.Firmscan,however,usemoneytoacquirecapital.

Moneyisaformoffinancialcapital.Financialcapitalincludesmoneyand

otherpaperassets(suchasstocksandbonds)thatrepresentclaimson

futurepayments.Thesefinancialassetsarenotcapital,buttheycanbe

useddirectlyorindirectlytopurchasefactorsofproductionorgoodsand

services.

NaturalResources

Therearetwoessentialcharacteristicsofnaturalresources.Thefirstis

thattheyarefoundinnaturethatnohumanefforthasbeenusedtomake

oralterthem.Thesecondisthattheycanbeusedfortheproductionof

goodsandservices.Thatrequiresknowledge;wemustknowhowtouse

thethingswefindinnaturebeforetheybecomeresources.

Consideroil.Oilinthegroundisanaturalresourcebecauseitisfound(not

manufactured)andcanbeusedtoproducegoodsandservices.However,

250yearsagooilwasanuisance,notanaturalresource.Pennsylvania

farmersintheeighteenthcenturywhofoundoiloozingupthroughtheir

soilweredismayed,notdelighted.Nooneknewwhatcouldbedonewith

theoil.Itwasnotuntilthemid-nineteenthcenturythatamethodwas


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foundforrefiningoilintokerosenethatcouldbeusedtogenerateenergy,

transformingoilintoanaturalresource.Oilisnowusedtomakeallsorts

ofthings,includingclothing,drugs,gasoline,andplastic.Itbecamea

naturalresourcebecausepeoplediscoveredandimplementedawaytouse

it.

Definingsomethingasanaturalresourceonlyifitcanbeusedtoproduce

goodsandservicesdoesnotmeanthatatreehasvalueonlyforitswoodor

thatamountainhasvalueonlyforitsminerals.Ifpeoplegainutilityfrom

theexistenceofabeautifulwildernessarea,thenthatwildernessprovides

aservice.Thewildernessisthusanaturalresource.

Thenaturalresourcesavailabletouscanbeexpandedinthreeways.One

isthediscoveryofnewnaturalresources,suchasthediscoveryofa

depositoforecontainingtitanium.Thesecondisthediscoveryofnewuses

forresources,ashappenedwhennewtechniquesallowedoiltobeputto

productiveuseorsandtobeusedinmanufacturingcomputerchips.The

thirdisthediscoveryofnewwaystoextractnaturalresourcesinorderto

usethem.Newmethodsofdiscoveringandmappingoildepositshave

increasedtheworldssupplyofthisimportantnaturalresource.

TechnologyandtheEntrepreneur

Goodsandservicesareproducedusingthefactorsofproductionavailable

totheeconomy.Twothingsplayacrucialroleinputtingthesefactorsof

productiontowork.Thefirstistechnology,theknowledgethatcanbe

appliedtotheproductionofgoodsandservices.Thesecondisan

individualwhoplaysakeyroleinamarketeconomy:theentrepreneur.

Anentrepreneurisapersonwho,operatingwithinthecontextofamarket


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economy,seekstoearnprofitsbyfindingnewwaystoorganizefacto

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