CHAPTER ONE THE NATURE AND METHOD OF ECONOMICS CHAPTER OVERVIEW This chapter begins with a discussion of the meaning and importance of economics. In this first chapter, however, we will not plunge into problems and issues; instead we consider some important preliminaries. We first look at the economic perspective—how economists think about problems. Next, we state some of the benefits of studying economics. Then, we examine the specific methods economists use to examine economic behavior and the economy, distinguishing between macroeconomics and microeconomics. Finally, the problems, limitations, and pitfalls that hinder sound economic reasoning are examined. . LECTURE NOTES I. Definition of Economics A. The social science concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human materials wants. B. Human wants are unlimited, but the means to satisfy the wants are limited. II. The Economic Perspective A. Scarcity and choice 1. Resources can only be used for one purpose at a time. 2. Scarcity requires that choices be made. 3. The cost of any good, service, or activity is the value of what must be given up to obtain it. (opportunity cost). B. Rational Behavior 1. Rational self-interest entails making decisions to achieve maximum fulfillment of goals. 2. Different preferences and circumstances lead to different choices. 3. Rational self-interest is not the same as selfishness. C. Marginalism: benefits and costs 1. Most decisions concern a change in current conditions; therefore the economic perspective is largely focused on marginal analysis. 2. Each option considered weighs the marginal benefit against the marginal cost. 3. Whether the decision is personal or one made by business or government, the principle is the same. 4. The marginal cost of an action should not exceed its marginal benefits. 5. There is ―no free lunch‖ and there can be ―too much of a good thing.‖ III. Why Study Economics? A. Economics for citizenship. 1. Most political problems have an economic aspect, whether it is balancing the budget, fighting over the tax structure, welfare reform, international trade, or concern for the environment. 2. Both the voters and the elected officials can fulfill their role more effectively if they have an understanding of economic principles. B. Professional and personal applications 1. The study of economics helps to develop an individual’s analytical skills and allows students to better predict the logical consequences of their actions. 2. Economic principles enable business managers to make more intelligent decisions. 3. Economics can help individuals make better buying decisions, better employment choices, and better financial investments. 4. Economics is however, mainly an academic, not a vocational subject. Its primary objective is to examine problems and decisions from a social rather than personal point of view. It is not a series of ―how to make money‖ examples. IV. Economic Methodology A. Economists use the scientific method to establish theories, laws, and principles. 1. The scientific method consists of: a. The observation of facts (real data). b. The formulations of explanations of cause and effect relationships (hypotheses) based upon the facts. c. The testing of the hypotheses. d. The acceptance, reject, or modification of the hypotheses. The determination of a theory, law, principle, or model. 2. Theoretical economics: The systematic arranging of facts, interpretation of the facts, making generalizations. 3. Principles are used to explain and/or predict the behavior of individuals and institutions.
Terminology—Principles, laws, theories, and models are all terms that refer to generalizations about economic behavior. They are used synonymously in the text, with custom or convenience governing the choice in each particular case. 5. Generalization—Economic principles are expressed as the tendencies of the typical or average consumer, worker, or...