fundamentals of economics

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Topic 1
Fundamentals of Economics

Introduction and Goals of the Firm
• Key Concepts
• Summary
• Practice Quiz
• Online Exercises

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What will you learn
in this chapter?
You will be acquainted
with the foundation of
the economic way of
thinking
* Return to previous slide
while in slide show mode

3. 3
What are the 3 building
blocks in the economic
way of thinking?
•scarcity & choice
•model building
•pitfalls of economic
reasoning

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What is the
economic problem?
Providing for people’s
wants and needs in a
world of scarcity

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What is meant by
scarcity?
The condition in which
wants are forever greater
than the available supply
of time, goods, and
resources

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What does scarcity
force us to do?
It forces us to
make choices

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What are resources?
The basic categories
of inputs used to
produce goods and
services

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What are the three
categories of
resources?
Land
Labor
Capital

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What is a
land resource?
A shorthand expression
for any natural resource
provided by nature

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What is labor?
The mental and physical
capacity of workers to
produce goods and services

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What is capital?
The physical plants,
machinery, and
equipment used to
produce other goods

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What is
financial capital?
The money used to
purchase capital

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What is
entrepreneurship?
The creative ability of
individuals to seek profits
by combining resources
to produce innovative
products.

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LandLand
LaborLabor
CapitalCapital
Entrepreneurship organizes
resources to produce goods
and services
Entrepreneurship organizes
resources to produce goods
and services

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What is economics?
The study of how
society chooses to
allocate its scarce
resources to the
production of goods
and services in order to
satisfy unlimited wants

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What is
macroeconomics?
The branch of economics
that studies decision-
making for the economy
as a whole

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What is
microeconomics?
The branch of economics
that studies decision-
making by a single
individual, household,
firm, industry, or level of
government

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What is the purpose of
an economic model?
To forecast or predict
the results of various
changes in variables

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What is the
scientific method?
•Problem identification
•Model development
•Testing a theory

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Identify the problemIdentify the problem
Develop a model based
on simplified assumptions
Develop a model based
on simplified assumptions
Collect data and
test the model
Collect data and
test the model

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What are the two
common pitfalls in
understanding how
the economy works?
•failing to understand the
ceteris paribus assumption
•confusing association with
causation

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What assumption is
always made when
testing a model?
ceteris paribus

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What is
ceteris paribus?
A Latin phrase that
means that while certain
variables can change,
“all other things remain
unchanged”

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What is the difference
between association
and causation?
We cannot always assume
that when one event
follows another, the first
caused the second

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Why do some
economists disagree?
The answer lies in
understanding the
difference between
positive and normative
economics

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What is
positive economics?
An analysis limited
to statements
that are verifiable

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What is
normative economics?
An analysis based on
value judgement

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Key Concepts

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•What are the three building blocks in the economic way of thinking?
•What is the economic problem?
•What is meant by scarcity?
•What are resources?
•What are the three categories of resources?
•What is entrepreneurship?
•What is economics?
•What is macroeconomics?
•What is microeconomics?

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•What is the scientific method?
•What are the two common pitfalls in understanding how the economy works?
•Why do some economists disagree?
•What assumption is always made when
testing a model?
•What is ceteris paribus?
•What is the purpose of model building?
•What is positive economics?
•What is normative economics?

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Summary

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Scarcity is the fundamental
economic problem that human
wants exceed the availability to time,
goods, and resources. Individuals
and society therefore can never
have everything they desire.

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Resources are factors of
production classified as land,
labor, and capital.
Entrepreneurship is a special
type of labor. An entrepreneur
combines resources to produce
innovative products.

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Economics is the study of how
individuals and society choose to
allocate scarce resources in order
to satisfy unlimited wants. Faced
with unlimited wants and scarce
resources, we must make choices
among alternatives.

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Unlimited
wants
Scarcity
Society
Chooses
Resources

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Macroeconomics applies an
economy wide perspective that
focuses on such issues as inflation,
unemployment, and the growth rate
of the economy.

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Microeconomics examines
individual decision-making units
within an economy.
Microeconomics studies such
topics as a consumer’s response
to changes in the price of coffee
and the reasons for changes in the
market price of personal
computers.

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Models are simplified descriptions
of reality used to understand and
predict economic events. An
economic model can be stated
verbally or in a table, graph, or
equation. If the evidence is not
consistent with the model, the
model is rejected.

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Identify
the
problem
Develop
a model based
on assumptions
Collect data
and test
the model

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Ceteris paribus holds “all other
factors unchanged” that might
affect a particular relationship. If
this assumption is violated, a
model cannot be tested. Another
reasoning pitfall is to think
association means causation.

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Positive economics uses testable
statements. Often a positive
argument is expressed as an “if-the”
statement.
Normative economics is based on
value judgments or opinions and
uses words such as good, bad,
ought to, and ought not to.

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Practice Quiz

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1. Scarcity exists
a. when people consume beyond
their needs.
b. only in rich nations.
c. in all countries in the world.
d. only in poor nations.
C. No matter what economic system
a country has, it is always faced
with the problem of scarcity.

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2. Which of the following would eliminate
scarcity as an economic problem?
a. Moderation of people’s competitive
instincts.
b. Discovery of large new energy
reserves.
c. Resumption of steady productivity
growth.
d. None of the above.
e. All of the above.
D. Because it is impossible to
provide everyone with everything
they want, we will always have
scarcity.

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3. Which of the following is not a
resource?
a. Land.
b. Labor.
c. Money.
d. Capital.
C. Money is not a resource because it
has no intrinsic value. Money that is
used to make an investment is called
financial capital.

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4. Economics is the study of
a. how to make money.
b. how to operate a business.
c. people making choices because of
the problem of scarcity.
d. none of the above.
C. Economics is the study of how people
must decide among alternatives to meet
their wants and needs in this world of
scarcity.

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5. Microeconomics approaches the
study of economics from the
viewpoint of
a. individuals or specific markets.
b. the operation of the Federal
Reserve.
c. economy wide effects
d. the national economy.
A. Microeconomics is the study of the
decision- making process for
individuals, business owners, and
government.

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6. A review of the performance of the
U.S. economy during the 1990’s is
primarily the concern of
a. macroeconomics.
b. microeconomics.
c. both macroeconomics and
microeconomics.
d. neither macroeconomics nor
microeconomics.
A. Macroeconomics is the study of
the economy as a whole.

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7. An economic theory claims that a rise I
gasoline prices will cause gasoline
purchases to fall, ceteris paribus. The
phrase “ceteris paribus” means that
a. other relevant factors like consumer
incomes must be held constant.
b. the gasoline prices must first be
adjusted for inflation.
c. the theory is widely accepted, but
cannot be accurately tested.
d. consumers need for gasoline
remains the same regardless of
price.A. Anytime price changes we always
make the assumption that nothing
else changes.

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8. An economist notices that sunspot
activity is high just prior to recessions
and concludes that sunspots cause
recessions. The economist has
a. confused association with and
causation.
b. misunderstood the ceteris paribus
assumption.
c. Used normative economics to
answer a positive question.
d. built an untestable model.
A. Just because one action follows
another, does not mean that the first
caused the second.

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9. Which of the following is a statement
of positive economics?
a. The income tax system collects a
lower percentage of the incomes of
the poor.
b. A reduction in the tax rates of the
rich makes the tax system more fair.
c. Taxes ought to be raised to finance
health care.
d. All of the above are primarily
statements of positive economics.
A. Positive economic statements are
testable by facts and explain the world as
it is without making value judgements.

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10. Which of the following is a statement of
positive economics?
a. An unemployment rate of greater than
8 percent is good because prices will
fall.
b. An unemployment rate of 7% is a
serious problem.
c. If the overall unemployment rate is 7%,
black unemployment rates will average
15%.
d. Unemployment is a more severe
problem than inflation.
C. Other answers are based on a value
judgement between
black and white
unemployment rates.

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11. Which of the following is a
statement of normative economics?
a. A minimum wage is good because
it raises wages for the working
poor.
b. The minimum wage is supported
by unions.
c. The minimum wage reduces jobs
for unskilled workers.
d. The minimum wage encourages
firms to substitute capital for labor
A. Even though the minimum wage
reduces jobs for some working poor,
it is a value judgement that the
minimum wage is beneficial overall.

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12. Select the normative statement that
completes the following sentence: If
the minimum wage is raised rapidly,
then
a. inflation increases.
b. workers will gain their rightful
share of total income.
c. profits will fall.
d. unemployment will rise.
B. To say that workers have right
to a certain part of total income
entails a value judgement.

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Online Exercises

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Exercise 1
Does the Internet raise or lower the cost of
making friends?
As you consider this question, visit a virtual
meeting place: the American Intercultural
Student Exchange (http://www.aise.com). Or
you may wish to participate in a live chat with
other people on the Internet—if so, visit
Yahoo! (http://chat.yahoo.com). Explain how
scarcity relates to the Internet.

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Exercise 2
Visit World Factbook
(http://www.odci.gov/cia/publications/factbook/inde
x.html) and follow these steps:
1. Select the United States.
2. Note the land area and population in the United
States.
3. Compute the land area per person by dividing
the land area of the United States by its population
size.
4. Select Japan. Repeat steps 2 and 3 for Japan.
5. How does the scarcity of land influence land-use
choices? Would you find as many golf courses
inJapan as in the United States? Explain.

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Exercise 3
If water is inexpensive and readily available,
why does the demand for bottled water, which
can cost more than $2 for a 12-ounce bottle,
remain strong? Why are consumers willing to
pay such a steep price for bottled water? For
references, visit the Evian water Web site at
http://www.evian.com.

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Exercise 4
Visit the White House home page—
http://www.whitehouse .gov/. Look under
Current News. Choose a topic you think
pertains to economics. Does the subject
matter pertain to macroeconomics or
microeconomics? Is the analysis primarily
normative or positive?

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END