Study Guide for Economics 1A: What is Economics?

Objectives of Chapter 1

• After studying this chapter, students will be able to:

  • Define economics and distinguish between microeconomics and macroeconomics.

  • Explain the two big questions of economics.

  • Explain the key ideas that define the economic way of thinking.

  • Explain how economists go about their work as social scientists.

  • Distinguish between linear and nonlinear relationships and relationships that have a maximum and a minimum.

  • Define and calculate the slope of a line.

  • Graph relationships among more than two variables.

Definition of Economics

• Scarcity:

  • All economic questions arise because we want more than we can get.

  • Our inability to satisfy all our wants is referred to as scarcity.

• Choices and Incentives:

  • Due to scarcity, we must make choices.

  • The choices we make depend on the incentives we face.

  • Incentive: A reward that encourages an action or a penalty that discourages it.

Key Definitions

• Economics: The social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices.

• Economics divides into two main parts:

  • Microeconomics:

  • Studies choices that individuals and businesses make, how those choices interact in markets, and the influence of governments.

  • Macroeconomics:

  • Studies the performance of national and global economies.

Two Big Economic Questions

• The two big questions summarize the scope of economics:

  • How do choices determine what, how, and for whom goods and services get produced?

  • When do choices made in the pursuit of self-interest also promote the social interest?

Breakdown of Economic Questions

What, How, and For Whom?

• What:

  • The production of goods and services changes over time.

  • Various factors determine the quantities and types of items we produce.

• How:

  • Goods and services are produced using productive resources called factors of production.

Factors of Production

1. Land:

   • Refers to the natural resources used in production.

2. Labour:

   • Represents the work time and effort devoted to producing goods and services.

   • The quality of labor is linked to human capital, defined as the knowledge and skills acquired through education, training, and work experience.

3. Capital:

   • Tools, instruments, machines, buildings, and structures used in production.

4. Entrepreneurship:

   • The human resource that organizes land, labor, and capital.

For Whom?

• Distribution of goods and services depends on the incomes earned:

  • Land earns rent.

  • Labour earns wages.

  • Capital earns interest.

  • Entrepreneurship earns profit.

The Pursuit of Self-Interest and Social Interest

Self-Interest vs. Social Interest

• Daily, millions of people make choices impacting the production of goods and services.

• Key questions include:

  • Are the right things produced in appropriate quantities?

  • Are our factors of production optimally utilized?

  • Do goods and services reach those who benefit most?

• Choices in self-interest may align with societal interest.

• An outcome serves social interest if it efficiently uses resources and distributes goods fairly.

Discussion Topics

• Examples generating discussion on self-interest versus social interest include:

  • Globalisation

  • Climate change

  • Financial instability

  • Water, power, and food shortages

  • Unemployment

The Economic Way of

Thinking

Choices and Trade-offs

• Due to scarcity, we must make choices, selecting among alternatives.

• Every choice represents a trade-off, giving up one thing for another.

• Example of a classic trade-off: "guns versus roses".

What, How, and For Whom Trade-offs

• What Trade-offs:

  • Depends on choices of individuals, governments, and businesses.

• How Trade-offs:

  • Dependent on business decisions in production.

• For Whom Trade-offs:

  • Relies on distribution of buying power, highlighting the trade-off between equality and efficiency.

Choices Bring Change

• The range and quality of goods and services today is vastly greater than in previous generations.

• Our economic conditions continue to improve due to trade-offs in choices made:

  • Saving more increases capital and production capability.

  • Investing in education improves labor productivity.

  • Allocating effort to research and development fosters future production advancements.

Economic Concepts

Opportunity Cost

• Opportunity Cost: The highest-valued alternative forgone to pursue an action.

• Example: Choosing between chocolate, ice cream, and jelly babies reveals that choosing ice cream gives up chocolates as the next best alternative.

Choosing at the Margin

• Arrange preferences to decide how to allocate time (e.g., studying versus socializing):

  • Marginal Benefit: Benefit from increasing an activity.

  • Marginal Cost: Cost of increasing an activity.

Responding to Incentives

• Choices respond to incentives:

  • If marginal benefit exceeds marginal cost, there’s an incentive to increase activity.

  • If marginal cost exceeds marginal benefit, the incentive is to decrease activity.

  • Incentives reconcile self-interest and social interest.

Human Nature, Incentives and Institutions

• Economists view human nature as innate, focusing on self-interested behaviors.

• Self-interested actions can serve the overall social interest.

• Institutions creating incentives foster actions beneficial to social interests, emphasizing private property and voluntary exchanges.

Economics as a Social Science

• Economists differentiate:

  • Positive Statements: Testable against facts (what is).

  • Normative Statements: Not testable (what ought to be).

Economic Modelling, Graphs, and Equations

Observation and Measurement

• Understanding the economy requires observing and measuring economic behavior.

Model Building

• Economic models are descriptions focusing only on features essential for analysis.

Testing Models

• Models are tested by comparing predictions to facts to see agreement.

Ceteris Paribus

• Ceteris Paribus: Latin for "other things being equal"; isolates factors of interest in analysis.

Graphs in Economics

• Types of Relationships in Graphs:

  • Variables that move in the same direction.

  • Variables that move in opposite directions.

  • Variables that have a maximum or minimum.

  • Variables that are unrelated.

Slope of Relationships

• The slope is defined as: $rac{∆y}{∆x}$.

• Positive Slope: Indicates a direct relationship.

• Negative Slope: Indicates an inverse relationship.

Curved Lines

• For curved lines—slope can be assessed at a point or across an arc.

Graphing Multiple Variables

• Understanding and graphing interactions among more than two variables is essential.

In-class Activity: From Linear Equation to Economic Graph

Example Equation: $Consumption = 100 + 0.99(Income)$

• Symbol Meaning:

  • $Y$: Dependent Variable (Consumption)

  • $X$: Independent Variable (Income)

  • $a$: Intercept (100)

  • $b$: Slope (0.99)

Calculation of Points for Graphing

• Income (X) and Consumption (Y) Points:

  • 0: 100

  • 100: 199

  • 200: 298

Graph Representation

• Plot points on a graph with:

  • Horizontal Axis (X): Income

  • Vertical Axis (Y): Consumption

Interpreting the Graph

• Intercept (a = 100): Consumption when income = 0.

• Slope: For every R1 increase in income, consumption increases by 99 cents.

• Economic modeling conveys narratives influenced by data that affect lives.