The Scope and Method of Economics

1. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair


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Prepared by: Fernando Quijano Prepared by: Fernando Quijano
and Yvonn Quijanoand Yvonn Quijano
The Scope and Method of The Scope and Method of
EconomicsEconomics

2. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Study of EconomicsThe Study of Economics
•EconomicsEconomics is the study of is the study of
how individuals and societies how individuals and societies
choose to use the scarce choose to use the scarce
resources that nature and resources that nature and
previous generations have previous generations have
provided.provided.

3. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Why Study Economics?Why Study Economics?
•Probably the most important reason Probably the most important reason
for studying economics is for studying economics is to learn to learn
a way of thinking.a way of thinking.
•Three fundamental concepts:Three fundamental concepts:
•Opportunity costOpportunity cost
•MarginalismMarginalism, and, and
•Efficient marketsEfficient markets

4. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Opportunity CostOpportunity Cost
•Opportunity costOpportunity cost is the best is the best
alternative that we forgo, or give alternative that we forgo, or give
up, when we make a choice or a up, when we make a choice or a
decision.decision.
•Opportunity costs arise because Opportunity costs arise because
time and resources are scarce. time and resources are scarce.
Nearly all decisions involve trade-Nearly all decisions involve trade-
offs.offs.

5. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
MarginalismMarginalism
•In weighing the costs and benefits of a decision, In weighing the costs and benefits of a decision,
it is important to weigh only the costs and it is important to weigh only the costs and
benefits that arise from the decision.benefits that arise from the decision.
•For example, when deciding whether to produce For example, when deciding whether to produce
additional output, a firm considers only the additional output, a firm considers only the
additionaladditional (or marginal cost), not the sunk cost. (or marginal cost), not the sunk cost.
•Sunk costsSunk costs are costs that cannot be avoided, are costs that cannot be avoided,
regardless of what is done in the future, because regardless of what is done in the future, because
they have already been incurred.they have already been incurred.

6. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Efficient MarketsEfficient Markets
•An An efficient marketefficient market is one in which is one in which
profit opportunities are eliminated profit opportunities are eliminated
almost instantaneously.almost instantaneously.
•There is no free lunch! Profit There is no free lunch! Profit
opportunities are rare because, at opportunities are rare because, at
any one time, there are many any one time, there are many
people searching for them.people searching for them.

7. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
More Reasons to Study EconomicsMore Reasons to Study Economics
•Economics involves the study of societal and Economics involves the study of societal and
global affairs concerning resource allocation.global affairs concerning resource allocation.
•Economics is helpful to us as voters. Voting Economics is helpful to us as voters. Voting
decisions require a basic understanding of decisions require a basic understanding of
economics.economics.
•Money and financial systems are an important Money and financial systems are an important
component of the economic system, but are not component of the economic system, but are not
the most fundamental issue in economics.the most fundamental issue in economics.

8. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Scope of EconomicsThe Scope of Economics
•MicroeconomicsMicroeconomics is the branch of economics is the branch of economics
that examines the functioning of individual that examines the functioning of individual
industries and the behavior of individual industries and the behavior of individual
decision-making units—that is, business firms decision-making units—that is, business firms
and households.and households.
•MacroeconomicsMacroeconomics is the branch of economics is the branch of economics
that examines the economic behavior of that examines the economic behavior of
aggregatesaggregates— income, output, employment, and — income, output, employment, and
so on—on a national scale.so on—on a national scale.

9. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Diverse Fields of EconomicsThe Diverse Fields of Economics
Examples of microeconomic and macroeconomic concernsExamples of microeconomic and macroeconomic concerns
ProductionProduction PricesPrices IncomeIncome EmploymentEmployment
MicroeconomicsMicroeconomics Production/Output Production/Output
in Individual in Individual
Industries and Industries and
BusinessesBusinesses

How much steelHow much steel
How many officesHow many offices
How many carsHow many cars
Price of Individual Price of Individual
Goods and ServicesGoods and Services

Price of medical Price of medical
carecare
Price of gasolinePrice of gasoline
Food pricesFood prices
Apartment rentsApartment rents
Distribution of Distribution of
Income and Income and
WealthWealth

Wages in the auto Wages in the auto
industryindustry
Minimum wagesMinimum wages
Executive salariesExecutive salaries
PovertyPoverty
Employment by Employment by
Individual Individual
Businesses & Businesses &
IndustriesIndustries
Jobs in the steel Jobs in the steel
industryindustry
Number of Number of
employees in a employees in a
firmfirm
MacroeconomicsMacroeconomics National National
Production/OutputProduction/Output

Total Industrial Total Industrial
OutputOutput
Gross Domestic Gross Domestic
ProductProduct
Growth of OutputGrowth of Output
Aggregate Price Aggregate Price
LevelLevel

Consumer pricesConsumer prices
Producer PricesProducer Prices
Rate of InflationRate of Inflation
National IncomeNational Income
Total wages and Total wages and
salaries salaries
Total corporate Total corporate
profitsprofits
Employment and Employment and
Unemployment in Unemployment in
the the EconomyEconomy

Total number of Total number of
jobsjobs
Unemployment Unemployment
raterate

10. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Method of EconomicsThe Method of Economics
•Normative economicsNormative economics, , also called policy also called policy
economics, analyzes outcomes of economic economics, analyzes outcomes of economic
behavior, evaluates them as good or bad, and behavior, evaluates them as good or bad, and
may prescribe courses of action.may prescribe courses of action.
•Positive economicsPositive economics studies economic studies economic
behavior without making judgments. It behavior without making judgments. It
describes what exists and how it works.describes what exists and how it works.

11. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Method of EconomicsThe Method of Economics
•Positive economics includes:Positive economics includes:
•Descriptive economicsDescriptive economics, which involves the , which involves the
compilation of data that describe phenomena and compilation of data that describe phenomena and
facts.facts.
•Economic theoryEconomic theory that involves building models of that involves building models of
behavior. A theory is a statement or set of related behavior. A theory is a statement or set of related
statements about cause and effect, action and statements about cause and effect, action and
reaction.reaction.
•Empirical economicsEmpirical economics refers to the collection refers to the collection
and use of data to test economic theories.and use of data to test economic theories.

12. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Theories and ModelsTheories and Models
•A A theorytheory is a general statement of cause and is a general statement of cause and
effect, action and reaction. Theories involve effect, action and reaction. Theories involve
models, and models involve variables.models, and models involve variables.
•A A modelmodel is a formal statement of a theory. is a formal statement of a theory.
Models are descriptions of the relationship Models are descriptions of the relationship
between two or more variables.between two or more variables.
•Ockham’s razorOckham’s razor is the principle that irrelevant is the principle that irrelevant
detail should be cut away. Models are detail should be cut away. Models are
simplifications, not complications, of reality.simplifications, not complications, of reality.

13. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Theories and ModelsTheories and Models
•A A variablevariable is a measure that can change from is a measure that can change from
observation to observation.observation to observation.
•Using the Using the ceteris paribus, ceteris paribus, or or all else equal, all else equal,
assumptionassumption, economists study the relationship , economists study the relationship
between two variables while the values of other between two variables while the values of other
variables are held unchanged.variables are held unchanged.
•The ceteris paribus device is part of the process The ceteris paribus device is part of the process
of abstraction used to focus only on key of abstraction used to focus only on key
relationships.relationships.

14. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Theories and ModelsTheories and Models
•In formulating theories and models we must In formulating theories and models we must
avoid two pitfalls:avoid two pitfalls:
•The The Post Hoc FallacyPost Hoc Fallacy: It is erroneous to believe that : It is erroneous to believe that
if event A happened before event B, then A caused B.if event A happened before event B, then A caused B.
•The The Fallacy of CompositionFallacy of Composition: It is erroneous to : It is erroneous to
believe that what is true for a part is also true for the believe that what is true for a part is also true for the
whole. Theories that seem to work well when applied whole. Theories that seem to work well when applied
to individuals often break down when they are applied to individuals often break down when they are applied
to the whole. to the whole.

15. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Economic PolicyEconomic Policy
Criteria for judging economic outcomes:Criteria for judging economic outcomes:
•EfficiencyEfficiency, or allocative efficiency. An efficient , or allocative efficiency. An efficient
economy is one that produces what people want at economy is one that produces what people want at
the least possible costthe least possible cost..
•EquityEquity, or , or fairness of economic outcomes.fairness of economic outcomes.
•GrowthGrowth, or , or an increase in the total output of an an increase in the total output of an
economy.economy.
•StabilityStability, or the condition in which output is steady , or the condition in which output is steady
or growing, with low inflation and full employment or growing, with low inflation and full employment
of resources. of resources.

16. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
How to Read and Understand GraphsHow to Read and Understand Graphs
•Each point on the Cartesian Each point on the Cartesian
plane is a combination of plane is a combination of
(X,Y) values.(X,Y) values.
•The relationship between X The relationship between X
and Y is causal. For a given and Y is causal. For a given
value of X, there is a value of X, there is a
corresponding value of Y, or corresponding value of Y, or
X causes Y.X causes Y.

17. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Reading Between the LinesReading Between the Lines
•A A lineline is a continuous string is a continuous string
of points, or sets of (X,Y) of points, or sets of (X,Y)
values on the Cartesian values on the Cartesian
plane.plane.
•The relationship between X The relationship between X
and Y on this graph is and Y on this graph is
negative. An increase in the negative. An increase in the
value of X leads to a value of X leads to a
decreasedecrease in the value of Y, in the value of Y,
and vice versa.and vice versa.

18. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Positive and Negative RelationshipsPositive and Negative Relationships
A A downward-slopingdownward-sloping
line describes a line describes a
negative relationship negative relationship
between X and Y.between X and Y.
An An upward-slopingupward-sloping line line
describes a positive describes a positive
relationship between X relationship between X
andand Y.Y.

19. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Components of a LineThe Components of a Line
•The algebraic expression of The algebraic expression of
this line is as follows:this line is as follows:
Y = a + bX
where:where:
Y = dependent variabledependent variable
X = independent variableindependent variable
a = Y-interceptY-intercept, or value of, or value of
YY when when XX = 0. = 0.
b = slopeslope of the line, or the of the line, or the
rate of change in rate of change in YY
given a change in given a change in XX..
+ = positive relationshippositive relationship
between between XX and and YY
b=
D
D
Y
X
Y Y
X X
=
-
-
1 0
1 0

20. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Different Slope ValuesDifferent Slope Values
b= =
5
1 0
05. b=- =-
7
1 0
07.
b= =
0
1 0
0 b= =¥
1 0
0

21. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Strength of the Relationship BetweenStrength of the Relationship Between
X and YX and Y
•This line is This line is relatively flatrelatively flat. .
Changes in the value of X have Changes in the value of X have
only a small influence on the only a small influence on the
value of Y.value of Y.
•This line is This line is relatively steeprelatively steep. .
Changes in the value of X have a Changes in the value of X have a
greater influence on the value of greater influence on the value of
Y.Y.

22. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Difference Between a Line and a CurveThe Difference Between a Line and a Curve
Equal increments in Equal increments in
XX lead to diminished lead to diminished
increases in increases in YY..
Equal increments in Equal increments in
XX lead to constant lead to constant
increases in increases in YY..

23. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
Interpreting the Slope of a CurveInterpreting the Slope of a Curve
•Graph A hasGraph A has
a positive and a positive and
decreasing decreasing
slope. slope.
•Graph B hasGraph B has
a negative a negative
slope, then a slope, then a
positive slope. positive slope.
•Graph C shows Graph C shows
a negative and a negative and
increasing increasing
relationship relationship
between between XX and and
YY. .
•Graph D Graph D
shows a shows a
negative and negative and
decreasing decreasing
slope. slope.