Chapter 1 The Role and Method of Economics

1.1 Economics: A Brief Introduction

1.2 Scarcity
1.3 Opportunity Cost
1.4 Economic Theory
1.5 Useful Tools

1.1 Economics: A Brief Introduction

Why Study Economics?

 develops a disciplined method of thinking

 provides problem-solving tools for both personal and professional life
 sheds light on many social issues such as education, discrimination,
crime, and unemployment

What is Economics?

 economics is the study of the allocation of our limited resources to satisfy our
unlimited wants.
Resources:
- inputs used to produce goods and services.

What is Scarcity?

 scarcity means that our wants exceed our limited resources.

The Economic Problem:

- scarcity forces us to make choices
- choices are costly because we must give up other opportunities that we value

Scarcity → choices → opportunity cost

Macroeconomics:

 the study of the aggregate, or total economy.

 looks at economic problems as they influence the whole of society
 includes topics such as inflation, business cycles, unemployment, and economic
growth.

Microeconomics:

 deals with the smaller units within the economy.

  attempts to understand the decision making behaviour of firms and households and
their interaction in markets for particular goods or services.

The Scope of Economics (Table 1.1)

EXAMPLES OF MICROECONOMIC & MACROECONOMIC CONCERNS

Production Prices Income Employment

Microeconomics Production/Output in Price of Individual Distribution of Income Employment by

Individual Industries and Goods and Services and Wealth Individual Businesses &
Businesses Industries
Price of medical care Wages in the auto
How much steel Price of gasoline industry Jobs in the steel industry
How many offices Food prices Minimum wages Number of employees in
How many cars Apartment rents Executive salaries a firm
Poverty Number of accountants
National Aggregate Price Level National Income Employment and
Production/Output Unemployment in the
Macroeconomics Consumer prices Total wages and salaries Economy
Total Industrial Output Producer Prices Total corporate profits
Gross Domestic Product Rate of Inflation Total number of jobs
Growth of Output Unemployment rate

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1.2 Scarcity

Scarcity:

 exists when human wants exceed available resources

 the scarce resources used in the production of goods and services are:
- labour
- land
- capital
- entrepreneurship

Labour
 physical and mental effort expended by people in the production of goods and
services.
Land
 all natural resources used in the production of goods and services

Capital
 the equipment and structures used to produce goods and services.
 buildings, tools, machines and factories.
 includes human capital: the productive knowledge and skill people receive from
education and training.
Entrepreneurs
 combine labour, land and capital to produce goods and services.
 decide what and how to produce.
 look for ways to improve production techniques, create new products.
 take risks, driven by the chance to make profits.
Goods
 items that we value or desire.

Services
 intangible acts for which people are willing to pay.

1.3 Opportunity Cost

 the value of the best forgone alternative that was not chosen.
 scarcity forces us to make choices
 to get more of anything that is desirable, you must accept less of something else.

Comparative Advantage → Specialization and Trade

 producing a good or service at a lower opportunity cost than other producers.

Comparative Advantage
Example
Production per Shelter ( logs ) Food ( baskets )
day

Colleen 10 10

Ivan 5 8

Production values assume that each person is only

producing that good, so for instance Colleen can
produce 10 logs or 10 baskets of food.
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Advantages of Trade:

 increases wealth by making both parties better off (or they wouldn't trade).
 allows a person or nation to specialize in products that it produces better and trade for
products that others produce better.
 for example, Canada produces wheat, Brazil produces coffee, then they trade

Exercice:
4. Use the concept of opportunity cost to explain the following.
a. More people choose to get graduate degrees when the job market is poor.
b. More people choose to do their own home repairs when the economy is slow and
hourly wages are down.
c. There are more parks in suburban than in urban areas.
d. Convenience stores, which have higher prices than supermarkets, cater to busy
people.
e. Fewer students enroll in classes that meet before 10:00 A.M.

Answer:
4. a.The worse the job market, the lower the opportunity cost of getting a graduate
degree. One of the opportunity costs of going to graduate school is not being able
to work. But if the job market is bad, the salary you can expect to earn is low or
you might be unemployed—so the opportunity cost of going to school is also low.
b. When the economy is slow, the opportunity cost of people’s time is also lower: the
wages they could earn by working longer hours are lower than when the economy
is booming. As a result, the opportunity cost of spending time doing your own
repairs is lower—so more people will decide to do their own repairs.
c. The opportunity cost of parkland is lower in suburban areas. The price per square
foot of land is much higher in urban than in suburban areas. By creating parkland,
you therefore give up the opportunity to make much more money in cities
than in the suburbs.
d. The opportunity cost of time is higher for busy people. Driving long distances to
supermarkets takes time that could be spent doing other things. Therefore, busy
people are more likely to use a nearby convenience store.
e. Before 10:00 A.M. the opportunity cost of time for many students is very high—it
means giving up an extra hour’s sleep. That extra hour is much more valuable
before 10:00 A.M. than later in the day.

1.4 Economic Theory

What Is Ceteris Paribus?

 Latin for “holding everything else constant”.

 means isolating a variable to assess its effect

Example of Ceteris Paribus:

 Hypothesis: if I study harder, I will perform better on a test

 Other variables can affect outcome:
- slept in on day of exam
- studied the wrong material
 Hypothesis true if hold these other variables constant

Correlation vs Causation:

 Correlation: events that usually occur together

- icy roads, reduced speeds, more accidents
 Causation: one event causes another event to occur
- reduced speeds do not cause more accidents; icy roads do
  Positive Analysis:
- an objective, testable statement
- “average income is $30,000”
 Normative Analysis:
- a subjective, non-testable item about what should be
- “incomes should be more equally distributed”

1.5 Useful Tools

Graphing Economic Data

A single economic variable such as GDP or the unemployment rate can come in two basic
forms.
• Cross-sectional data. A number of different observations on one variable all
taken in different places at the same point in time.
• Time-series data. Refers to observations taken on one variable at successive
points in time.

Another way in which data can be presented is in a scatter diagram. It is designed to show the
relation between two different variables, such as the price of eggs and the quantity of eggs
purchased.

Graphing Economic Theories

When we express the relation between two variables, for example the price of eggs and the
quantity of eggs purchased, we are expressing a functional relation.

A functional relation can be expressed:

• in words,

• in a numerical schedule (a table),

• in mathematical equations,

• or in graphs.

Functions

Consider a specific example of a relationship between a family’s annual income, Y, and the
total amount it consumes during that period, C.

To state the expression in general form we use a symbol to express the dependence of one
variable on another. Using f for this purpose, we can write:

C = f(Y)

This is read, “C is a function of Y.” We also say “The amount of consumption expenditure
depends upon the household’s income”.
Graphing Functional Relations

The relationship between two variables may be positive, as with consumption and income, or
negative, as with the price of ice cream and the amount that consumers wish to purchase.

If the graph of these relationships are straight lines, the variables are linearly related to each
other (either positively or negatively).

If the graph of these relationships is not a straight line, then the two variables are related in a
non-linear way.

Four Linear Relationships

Suppose we let X stand for whatever variable is measured

on the horizontal axis and Y stand for whatever variable is
measured on the vertical axis. The slope of a straight line is
then Y/X, where  (the Greek letter “delta”) stands for
“the change in.”
Slide 2-14
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 Four Nonlinear Relationships

Nonlinear relations are much more common than linear ones.

Figure (i) shows an increasingly positively sloped relation
between X and Y. Figure (ii) shows a decreasingly negative
relationship between X and Y.

Slide 2-15
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