What is Economics?

Understanding our changing world

Chapter 1
 Main ideas
After studying this chapter, you 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
between relationships that have a maximum and a minimum.
• Define and calculate the slope of a line.
• Graph relationships among more than two variables.

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 What is economics?

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 Definition of Economics

• Economics: social science that studies choices that

individuals, businesses, governments, and entire societies
make as they cope with scarcity and the incentives that
influence and reconcile those choices.

• Divided into two main parts:

• Microeconomics - study of the choices that individuals
and businesses make, the way these choices interact in
markets and the influence of government.
• Macroeconomics - study of the performance of the
national economy and the global economy.

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 Two Big Economic Questions
Two big questions summarize the scope of economics:
1. What, How, and For Whom to produce?
2. When Is the Pursuit of Self-Interest in the Social Interest?

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 Two Big Economic Questions
1. What, How, and For Whom to produce? How do choices end up
determining what, how and for whom goods and services are
produced?

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 Two Big Economic Questions
What?
• How do choices end up determining the quantities of goods and
services around the world?
FIGURE 1.1 What Six Countries Produce

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 Two Big Economic Questions
How?
• What determines the quantities of factors of production that are
used to produce goods and services?

Goods and services are produced using the following Factors of

Production:
• Land
• Labour
• Capital: e.g. Machines and Buildings.
• Entrepreneurship: Come with ideas about what, how to produce,
makes business decisions and bear the risks that arise from these
decisions

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 Two Big Economic Questions
For Whom?
• Who consumes the goods and services produced depends on
income.

People earn income by selling the services of factors of production

they own:
• Land earns Rent
• Labour earns Wages
• Capital earns Interest
• Entrepreneurships earns Profit

Economics provides some answers to all these questions about what,

how, and for whom goods and services are produced

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 Two Big Economic Questions
2. When Is the Pursuit of Self-Interest in the Social Interest?
Economists take human nature as a given and that people act in self-
interest.

Everyday people make choices that result in what, how and for whom
goods are produced?

The big question: How do we make choices that are in our self-
interest, promote the social interest?
For example with regards to globalisation. Globalisation means the
expansion of international trade, borrowing and lending & investment.
Globalisation is in the self interest of those consumers who buy
low-cost goods produced in other countries and the companies that
sell them, but is it in the self-interest of the low-wage worker and
the worker who lost a job in South Africa, because we import?
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 The Economic way of thinking
How economists think about these questions and go about seeking
answers to these questions.

Six key ideas that define the economic way of thinking (tools):
• A choice is a trade-off. A trade-off is an exchange – giving up
one thing to get something else (e.g. studying vs social media).
• People make rational choices by comparing benefits and
costs.
• Benefit is what you gain from something
• Cost is what you must give up to get something. The
opportunity cost of something is the highest valued alternative
that must be given up to get it. E.g.: Instead of being at a
university you could have taken a job & earn money or used your
school fees to buy things that you like.

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 The Economic way of thinking
• Most choices are ‘how much’ choices made at the margin. Most
choices are not either this or that, they involve choosing how much of
an activity to do.
○ The benefit from an increase in activity is called Marginal Benefit.
○ The opportunity cost of an increase in activity is called the Marginal
Cost.
• Choices respond to incentives (e.g. Tax)
○ The central idea of economics is that we can predict the self-
interested choices that people make by looking at the incentives
they face.
○ People undertake those activities for which marginal benefits
exceeds marginal costs.
○ One of the challenges for economists is to figure out the incentives
that result in self-interested choices being in the social interest.
(Sugar tax)

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 The Economic way of thinking
○ Economists emphasise the crucial role that institutions play in
influencing the incentives that people face as they pursue their
self-interest. (Competition Commission)

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 Economics: A social science
Like all scientists, economists distinguish between positive &
normative statements
• Positive statements: What is. It says what is currently believed
about they way the world operates. It might be right or wrong. A
central task of economists is to test them e.g. using data.
• Normative statements: About what ought to be. It depends on
values and can’t be tested. Policy goals are normative statements.
‘We should cut our use of coal by 50%’ is a normative policy
statement.

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 Example: MCQ question
“Donald Trump is the president of the United States of America.
I would’ve preferred Bernie Sanders instead.” The first
statement is an example of a _________ statement, while the
second statement is an example of a _________ statement.

A. Positive; Positive
B. Normative; Normative
C. Normative; Positive
D. Positive; Normative
E. Negative; Positive
 Economics: A social science
Obstacles and Pitfalls in Economics
• Unscrambling cause and effect: e.g. what causes what?
• E.g. Are computers becoming cheaper because people are buying a
lot of them or are people buying a lot of computers because they
are getting cheaper or Is something else causing both the price of
a computer to fall and the quantity of computers bought to
increase?
• To answer these questions economists create and test economic
models, e.g. in medicine they do experiments.
• But testing an economic model is difficult because we observe the
outcomes of the simultaneous change of many factors.
• To cope with problem e.g. if you want to test how the price of
oranges affects the quantity of oranges bought, you hold other
factors constant like income and test the effect of a change in the
price of oranges on the quantity bought.
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 Economics: A social science
• One assumption/device scientist use to identify cause and effect is
called ceteris paribus.
• Ceteris paribus is a Latin term that means ‘other things being
equal’ or ‘if all other relevant things remain the same’. All attempts
to make scientific progress use this assumption.

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 Economics: A social science
Economists try to avoid fallacies – errors of reasoning that lead to a
wrong conclusion. Two common fallacies:
• Fallacy of composition: Error that what is true for parts is true
for the whole & vice versa,
o e.g. Standing at a soccer match to get a better view works for
one but not for all.
• Post hoc Fallacy: Error that a first event causes the second
event because the first occurs before the second e.g. Shopping &
holidays

• Unravelling cause and effect is a challenge, economists attempt

to this using economic models and data and experiments if
possible.

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 Graphs in Economics
After studying this Appendix, you will be able to:

• Make and interpret a scatter diagram

• Identify linear and non-linear 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

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 Graphs in Economics
A scatter diagram is a graph that plots the value of one variable against the
value of another for a number of different values of each
• E.g. the Price of Oranges and the quantity of Oranges bought are variables,
because they vary
14

12
PRICE OF ORANGES

10

0
0 2 4 6 8 10 12 14
QUANTITY OF ORANGES BOUGHT

• A scatter diagram that shows a clear relationship/pattern between two

variables, tells us that variables have a high correlation.
• When a high correlation is present we can predict one variable from the other.
• Correlation does not imply causation
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 Graphs in Economics
In the previous scatter diagram you can connect the points & you get a graph
14

12
PRICE OF ORANGES

10

0
2 4 6 8 10 12
QUANTITY OF ORANGES BOUGHT

• In this case, as the price goes up, the quantity bought declines, so we have
Negative or Inverse relationship
• In other words the price and quantity bought move in the opposite direction
• A relationship shown by a straight line is called a Linear Relationship
• A nonlinear relationship is a relationship between two variables in
which a change in one variable does not correspond with a constant change
in the other variable.
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 Graphs in Economics
Graph: Price of pens and the quantity of pens produced
14

12

10
PRICE OF PENS

0
4 8 12 16 20 24
QUANTITY OF PENS PRODUCED

• In this case, as the price goes up, the quantity produced increases, so we
have Positive or Direct relationship
• In other words the price and the quantity of pens produced move in the
same direction
• The next slide shows a relationship with a maximum point and also a
relationship with a minimum point
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 Graphs in Economics

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 Graphs in Economics
The slope of a relationship
• We can measure the influence of one variable on another by the
slope of the relationship
• The slope of a relationship is the change in the value of the variable
on the y-axis divided by the change in the value of the variable
measured on the x-axis.
• We use the Greek letter ∆ (delta) to represent ‘change in’.
∆𝑌 = change in the variable on the y-axis and ∆𝑋 = change in the
variable on the x-axis
𝚫𝒀
• Therefore the slope =
𝚫𝑿
• If a large ∆𝑌 is associated with a small ∆𝑋, the slope is large & the
curve is steep
• If a small ∆𝑌 is associated with a large ∆𝑋, the slope is small & the
curve is flat

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 Graphs in Economics

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 Graphs in Economics
Graphing Relationships Among More Than Two Variables

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 Graphs in Economics
Mathematical Equation of a Straight Line
• A relationship shown by a straight line is called a Linear Relationship
• All linear relationships are described by the same general equation.
• The equation that describes a straight-line relationship between x and y
is y = a + bx
• In this equation, a and b are fixed numbers and are called constants.
• The values x and y vary, so these numbers are called variables.
• Because the equation describes a straight line, the equation is called a
linear equation.
• The equation tells us that when the value of x = 0, the value of y is a.
• We call the constant a the y-axis intercept. The reason is that on the
graph the straight line hits the y-axis at a value equal to a.
• The constant b tells us by how much y increases above a as x increases
𝚫𝒀
• The constant b is the slope of the line i.e. b =
𝚫𝑿

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 Graphs in Economics
Example: Finding the slope and equation of the line below

• Find the slope for the graph above

𝜟𝒀 𝒀𝟏 −𝒀𝟎 𝟐−𝟏𝟐 −𝟏𝟎
b= = = = = −𝟏
𝜟𝑿 𝑿𝟏 −𝑿𝟎 𝟏𝟐−𝟐 𝟏𝟎
• Find the equation of the line in the graph above
Equation: y = a – x
To find a, when x = 2, y = 12, using the equation above 12 = a - 2,
therefore a = 14
This implies the equation of the line is: y = 14 – x
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