1.

What is 'Economics'
Economics is a  social science concerned with the production, distribution and consumption of goods and
services. It studies how individuals, businesses, governments and nations make choices on allocating
resources to satisfy their wants and needs, and tries to determine how these groups should organize and
coordinate efforts to achieve maximum output.

2. Types of Economics
Economics study is generally broken down into two categories.
 Microeconomics - focuses on how individual consumers and producers make their decisions. This
includes a single person, a household, a business or a governmental
organization.  Microeconomics ranges from how these individuals trade with one another to how
prices are affected by the supply and demand of goods. Also studied are the efficiency and costs
associated with producing goods and services, how labor is divided and allocated,
uncertainty,  risk, and strategic  game theory.
 Macroeconomics - studies the overall economy.  This can include a distinct geographical region,
a country, a continent or even the whole world. Topics studied include government  fiscal  and
monetary policy, unemployment rates, growth as reflected by changes in the Gross Domestic
Product (GDP) and  business cycles  that result in expansion, booms, recessions and depressions. 

3. What is 'Opportunity Cost'

Opportunity cost represents the benefits an individual, investor or business misses out on when choosing
one alternative over another. While  financial reports  do not show opportunity cost, business owners can
use it to make educated decisions when they have multiple options before them. 

BREAKING DOWN 'Opportunity Cost'

When assessing the potential profitability of various investments, businesses look for the option that is
likely to  yield  the greatest return. Often, they can determine this by looking at the expected  rate of
return  for an investment vehicle. However, businesses must also consider the opportunity cost of each
option. Assume that, given a set amount of money for investment, a business must choose between
investing funds in securities or using it to purchase new equipment. No matter which option the business
chooses, the potential profit it  gives up by not investing in the other option is the opportunity cost.
Formula for Calculating Opportunity Cost

This is the difference between the expected returns of each option:

Opportunity cost = return of most lucrative option not chosen - return of chosen option

Option A in the above example is to invest in the stock market hoping to generate returns. Option B is to
reinvest the money back into the business expecting newer equipment will increase production efficiency,
leading to lower operational expenses and a higher  profit margin. Assume the expected  return on
investment  in the stock market is 12 percent, and the company expects the equipment update to
generate a 10 percent return. The opportunity cost of choosing the equipment over the stock market is
12 percent - 10 percent, which equals 2 percentage points.

Opportunity cost analysis also plays a crucial role in determining a business's  capital structure. While
both debt and equity require expense to compensate lenders and shareholders for the risk of investment,
each also carries an opportunity cost. Funds used to make payments on loans, for example, are  not
being invested in stocks or bonds, which offer the potential for investment income. The company must
decide if the expansion made by the  leveraging power of debt  will generate greater profits than it could
make through investments.
Because opportunity cost is a forward-looking calculation, the actual rate of return for both options is
unknown. Assume the company in the above example foregoes new equipment and invests in the stock
market instead. If the selected securities decrease in value, the company could end up losing money
rather than enjoying the expected 12 percent  return. For the sake of simplicity, assume the investment
yields a return of 0 percent, meaning the company gets out exactly what it put in. The opportunity cost
of choosing this option is 10% - 0%, or 10%. It is equally possible that, had the company chosen new
equipment, there would be no effect on production efficiency, and profits would remain stable. The
opportunity cost of choosing this option is then 12 percent  rather than the expected 2 percent.

It is important to compare investment options that have a similar risk. Comparing a  Treasury bill, which
is virtually risk-free,  to investment in a highly volatile stock can cause a misleading calculation. Both
options may have expected returns of 5 percent, but the U.S. Government backs the rate of return of the
T-bill, while there is no such guarantee in the stock market. While the opportunity cost of either option is
0 percent, the T-bill is the safer bet when you consider  the relative risk of each investment.

Using Opportunity Costs in Our Daily Lives

When making big decisions like buying a home or  starting a business, you will probably scrupulously
research the pros and cons of your financial decision, but most of our day-to-day choices aren't made
with a full understanding of the potential opportunity costs. If they're cautious about a purchase, most
people just look at their  savings account  and check their balance before spending money. Mostly, we
don't think about the things we must give up when we make those decisions.

However, that kind of thinking could be dangerous. The problem lies when you never look at what else
you could do with your money or buy things blindly without considering the lost opportunities. Buying
takeout for lunch occasionally can be a wise decision, especially if it gets you out of the office when your
boss is throwing a fit. However, buying one cheeseburger every day for the next 25 years could lead to
several missed opportunities. Aside from the potential  health effects, investing that $4.50 on a burger
could add up to just over $52,000 in that time frame, assuming a very doable 5 percent  rate of return.

This is just one simple example, but the core message holds true for a variety of situations. From
choosing whether to invest in "safe"  treasury bonds  or deciding to attend a public college over a private
one to get a degree, there are plenty of things to consider when deciding in your personal-finance life.

While it may sound like overkill to think about opportunity costs every time you want to buy a candy bar
or go on vacation, it's an important tool to use to make the best use of your money.

4. The Scientifi c Methods in the Study of Economics

Economics began as a branch of moral philosophy during the 18th century but has developed
over ti me to become a discipline that emphasizes a scienti fi c approach to understanding how
economies work. As social scienti sts, along with sociologists, psychologists and politi cal
scienti sts, economists employ some scienti fi c methods to the study of how societies allocate
scarce resources to meet their needs and wants

 Testing Hypotheses, Developing Theories

Harvard economist N. Gregory Mankiw, author of “Principles of Economics” and a
former White House adviser, calls the scienti fi c method, which requires the
development and testing of theories, the essence of science. In economics, this means
developing theories about such questi ons as what causes infl ati on, why people save
or consume, and what conditi ons favor increased hiring and investment by firms. To
 explain these and other economic issues, economists develop hypotheses, collect and
analyze data, and formulate theories based on their results. Economists may revise or
refine existi ng theories in response to further examinati on and analysis that
advances previously existi ng knowledge.

 Observati on and Theory

Economists develop their theories about how the worlds of economics and finance
work based on extensive observati on of real-world acti viti es. Mankiw cites as an
example an economist who lives in a country experiencing rapid infl ati on. This
economist may devise a hypothesis of why inflati on increases, then test this
hypothesis by collecti ng and analyzing data from other countries. These data will
include informati on on prices, money supplies, consumer and business acti vity, and
government spending.

 Considerati ons
Although economics relies on observati on and theory like other sciences, economists
face an obstacle that their counterparts in natural sciences such as biology and
chemistry do not have: the lack of laboratory controls. Mankiw points out that while
physicists can repeatedly drop objects from diff erent heights to test the theory of
gravity, economists cannot manipulate nati onal monetary policy to test theories
about infl ati on. Economic researchers must do what they can with the data that the
real world supplies them.

 Soluti on
Because they are unable to conduct controlled laboratory experiments, economists
oft en look to history for lessons and explanati ons about how the economic world
works, according to Mankiw. Analysis of historical events represents another
scienti fi c method by which researchers understand and explain present-day
economics.

 Models
Like other scienti sts, economists use models to convey simplifi ed explanati ons of a
complex world. For economists, these models consist of diagrams and mathemati cal
equati ons that explain such concepts as supply and demand, and gross domesti c
product. Like other fi elds of science, economic models present a simplifi ed version of
reality. Just as an astronomer’s model of the solar system does not fully account for
the complexity of the cosmos, an economist’s model does not include every feature of
a dynamic modern economy. Yet, through their simplicity, economic models help
illustrate how the economic world works.

5. Positive VS Normative Statements in Economics

Positive economics  is objective and fact based, while  normative economics  is subjective and value
based. Positive economic statements must be able to be tested and proved or disproved. Normative
economic statements are opinion based, so they cannot be proved or disproved. In fact, many widely
accepted statements that people hold as fact are actually value based.

Example  of Positive Economics vs  Normative Economics

For example, the statement, "government should provide basic healthcare to all citizens" is a normative
economic statement. There is no way to prove whether government "should" provide healthcare; this
statement is based on opinions about the role of government in individuals' lives, the importance of
healthcare, and who should pay for it.
The statement, "government-provided healthcare increases public expenditures" is a positive economic
statement, as it can be proved or disproved by examining healthcare spending data in countries like
Canada and Britain, where the government provides healthcare.

Disagreements over public policies typically revolve around normative economic statements, and the
disagreements persist because neither side can prove that it is correct or that its opponent is incorrect. A
clear understanding of the difference between positive and normative economics should lead to better
policy making if policies are made based on facts (positive economics), not opinions (normative
economics). Nonetheless, numerous policies on issues ranging from  international trade  to  welfare  are
at least partially based on normative economics.

Or

What are positive statements?

Positive statements are  objective statements  that can be tested, amended or rejected by referring to
the available  evidence. Positive economics deals with  objective explanationand the testing and
rejection of theories. For example:

 A fall in incomes will lead to a rise in demand for own-label supermarket foods
 If the government raises the tax on beer, this will lead to a fall in profits of the brewers.
 The rising price of crude oil on world markets will lead to an increase in cycling to work
 A reduction in income tax will improve the incentives of the unemployed to find work.
 A rise in average temperatures will increase the demand for sun screen products.
 Higher interest rates will reduce house prices
 Cut-price alcohol has increased the demand for alcohol among teenagers
 A car scrappage scheme will lead to fall in the price of second hand cars

What are Normative Statements?

A  value judgement  is a subjective statement of opinion rather than a fact that can be tested by looking
at the available evidence

Normative statements are  subjective statements  – i.e. they carry  value judgments. For example:

 Pollution is the most serious economic problem

 Unemployment is more harmful than inflation

 The congestion charge for drivers of  petrol-guzzling cars   should increase to £25

 The government should  increase the minimum wage   to £7 per hour to reduce poverty.

 The government is right to introduce a  ban on smoking in public places .

 The retirement age should be raised to 70 to combat the effects of our ageing population.
 Resources are best allocated by allowing the market mechanism to work freely
 The government should enforce minimum prices for beers and lagers sold in supermarkets and
off-licences in a bid to control alcohol consumption
Focusing on the evidence is called adopting an  empirical approach  – evidence-based work is becoming
more and more important in shaping different government policies and how much funding to give to
each.