Chapter 1

Economics: The World Around You

Economics, 7th Edition Boyes/Melvin

Why Study Economics?

To answer questions like:
Why do economies go through cycles? Why are some people unemployed while others are able to find jobs? Why do some jobs pay so much more than other jobs? Why do some businesses succeed and others fail?

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Why Study Economics? (Continued)

More questions:
Why do some people have to live on welfare? Why are some nations richer than others? Why is health care so expensive? What determines the prices of things? What is the value of an education?

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What is Economics?
Economics is a social science.
Economists study how individuals make decisions about:
Working and hiring Buying consumer goods and services Producing goods and services for sale Building factories, equipment, and tools Building and buying houses Setting prices and reacting to them Coordinating activities in the economy Importing goods

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What is Economics? (Continued)

Economics is form of applied logic (reasoning).
Economists study the reasoning that drives economic decisions and outcomes. One might think of economics as the study of unintended consequences. Understanding causes and effects is critical to:
understanding the ultimate consequences of economic events and effective and responsible policy making.

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Definition of Economics
Economics is the study of how scarce resources are allocated among unlimited wants.

To understand this definition, we must examine the concepts of scarcity, economic choice, and rational self-interest.

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Human Nature and Reality

People have unlimited wants. People have limited resources to acquire the things they want. As a result, they must make choices. Choices involve pursuing some things while forgoing others.

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Scarcity, Goods and Bads

An item that costs something is called scarce.
Anything with a price on it is called an economic goodthese include goods and services. A free good is a good for which there is no scarcity.

An economic bad is anything you want to get rid of (pollution, disease, garbage)

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Clarifying Concepts
Scarcity means that not enough is available for free. A shortage occurs when not enough is available at the current price. A shortage is a problem of price. Poverty occurs when the goods are scarce, and those who need them do not have the income to obtain them. Poverty is a problem of income.

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Goods to Produce Goods

Resources are the elements needed to produce goods. Resources are also called
factors of production inputs

They are:
Land (includes natural resources) Labor (physical and intellectual services of people) Capital (plant, machinery, equipment used in production)

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Resources in Production
land
rent

Resource Suppliers

labor wages capital

Producers of Goods

interest

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Scarcity and Choice

Scarcity necessitates making choices. Economics is the study of how people choose to use their resources in attempts to satisfy their unlimited wants.

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Rational Self-Interest
Economists believe that people choose options that give them the greatest satisfaction. This means that people:
use all available time and information, weigh the costs and benefits of all available alternatives, and choose the alternative that they believe will bring them the most benefit at the lowest cost. This is the alternative that they believe will bring them the most satisfaction.

This does not mean that people are innately selfish. Self-interest is not greed.

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Limits to Rationality
Depends upon
Information available (and/or its cost) Ability to process the information Your perception of what constitutes your best interests

This leads to the theory of bounded rationality.

In practice, this means that people compare costs and benefits to make a decision.

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Implications
People weigh the costs and benefits of various alternatives, choosing the alternative that makes them best off.
This behavior is called economic decision making.

Costs and benefits are sometimes referred to as negative and positive incentives. Hence incentives matter.

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Positive vs. Normative Economics

Positive Economics
Focuses on what is. Analyzes actual, measurable outcomes. Does not impose value judgments, person feelings or convictions. Positive economics is economics as a science.

Normative Economics
Focuses on what someone thinks ought to be or should be. Makes ethical judgmentsvalue judgments.

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Common Analytical Mistakes (Logical Fallacies)

Fallacy of Composition
The mistaken assumption that what is true of a part is also true of the whole.

Association is not Causation

The mistaken assumption that because two events occur together, one must cause the other. Also given as correlation is not causation.

Violation of Ceteris Paribus

Ceteris Paribus: Latin for all else equal. This occurs when one attempts to analyze the effect of one thing while holding everything else constant, when in fact other things have changed.
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Micro vs. Macro

Microeconomics
Studies the economy at the level of individual consumers, workers, firms, goods, and markets

Macroeconomics
Studies the economy at the aggregate level, at the level of the economy as a whole. Examines total consumer behavior, total employment, total production, total sales, etc.

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