Chapter 1 – The Nature and Method of Economics
Economics is the study of scarcity and choice
Key concept- opportunity cost:
for a person to get more of one thing...
he/she must forego getting something else
e.g. to get food must pay (give up) money
In economics rational behavior is assumed, e.g. people want more goods for less money Assumption: we all want to increase utility = happiness, satisfaction Rational self-interest not same as selfishness, e.g. one reason for donating to charity is because of derived satisfaction
Key concept- marginal analysis- comparisons of marginal benefits and marginal costs, e.g.: keep eating until full, that is...
until marginal benefit = marginal cost...
i.e. not worth it to pay for more food when already full
Why study economics?
As John Maynard Keynes said “indeed, the world is ruled by little else.” Most practical ideology is found in economics
Economics for citizenship- intelligent participation in a democracy requires a knowledge of fundamental economics
However, from the 2004 “A Fifty College Study” by the American Council of Trustees and Alumni: “One of this study’s most extraordinary findings was that not one college or university among those studied requires a general course in economics”
Understanding of concept of marginal benefits / marginal costs are required for business management Ultimately economics is a social science seeking society’s overall fullest advantages and best interests
Article 1.1 – “The Opportunity Cost of Economics Education” – see end of this chapter
Figure 1.1 – Economic Methodology
Figure 1.1 - economics methodology
observe real-world activity, then...
formulate hypothesis statement, e.g. “seems A happens because of B,” then... test hypothesis by gathering facts, then...
modify and strengthen hypothesis to become a theory
Theoretical economics- the process of deriving economic theories and principles from observation Role of economic theorizing is to arrange facts, interpret them, and generalize from them Economic theories and principles- are statements about behavior of the economy that enable prediction of the probable effects of certain actions
Principle (also called “law”) - a strong, established theory, Model - made from a combination of theories and/or principles, often graphic in form Generalizations - economic theories, principles and models are generalizations, e.g. when personal income goes up people tend to consume more, but some individuals will not Other-things-equal assumption often used - e.g.:
when price of product A goes down ..
people will buy more of A, assuming quality of A has not also gone down Abstractions - simplifications that omit irrelevant facts
Policy economics - economic theory and data ..
formulation of government policies and courses of action .. solve economic problems and achieve economic goals
Economic policy is most often applied by governments after problems arise, but with economic analysis
we can predict problems and apply policy in advance, e.g.:
Federal Reserve Bank (central bank of the U.S.) anticipation of recession .. reduce interest rates ..
increase business investment ..
Note throughout this summary the terms “firms” and “businesses” have the same meaning - private (as opposed to government) profit-seeking organizations
The four steps of economic policy:
1- statement of goal, e.g. maintain full employment
2- determine policy options, e.g. lower taxes or raise amount of government spending 3- implement the policy