1.What is Economics?

1.1 Definition of Economics

Economics is the social science that studies the
choices that we make as we cope with scarcity and
the institutions that have evolved to influence and
reconcile our choices.

1.2 Microeconomics
Microeconomics is the study of choices made by
individuals and businesses, the way these choices
interact, and the influence that governments exert
on them.

1.4 Three Big Microeconomic Questions

Goods and services are the objects that people
value and produce to satisfy wants.
Microeconomics seeks to
understand what determines:
 What goods and services are produced
 How goods and services are produced
 For whom goods and services are produced
The facts about what we produce raise the deeper
question:
What determines the quantities of houses and
apartments, DVD players, and corn that we
produce?
Microeconomics provides some answers to these
questions.

How are Goods and Services Produced?

Factors of production are the resources that
businesses use to produce goods and services.
They are grouped into four categories:
 Land

 Labour

 Capital

 Entrepreneurship
The “gifts of nature” that we use to produce goods
and services are land.
The work time and effort that people devote to
producing goods and services is labour. The
quality of labour depends on human capital, which
is the knowledge and skill that people obtain from
education, on-the-job training, and work
experience.
The tools, instruments, machines, buildings, and
other constructions that are used to produce goods
and services are capital.
The human resource that organizes land, labour,
and capital is entrepreneurship.

The facts about how we produce raise the deeper

question:
What determines the quantities of capital, labour,
and other resources that get used to produce goods
and services?
Microeconomics provides some answers to this
question.

For whom are Goods and Services Produced?

Who gets the goods and services depends on the
incomes that people earn.
Land earns rent.
Labour earns wages.
Capital earns interest.
Entrepreneurship earns profit.

The facts about for whom raise the deeper

question:
What determines earnings and the distribution of
Income that in turn determine who gets the goods
and services produced?
Microeconomics provides some answers to this
question.
 1.5 Three Big Macroeconomic Questions
Macroeconomics focuses on three big questions:
 What determines the standard of living?
 What determines the cost of living?
 Why does our economy fluctuate?
1.5.1 What Determines the Standard of Living?
The standard of living is the level of consumption
that people enjoy on the average and is measured
by average income per person.

Figure 1.1
Figure 1.1 shows income per person per day in a
number of countries and regions.
The United States has one of the highest standards
of living, and the developing nations of Asia and
Africa have the lowest.
Macroeconomics seeks to explain differences in the
standard of living across countries.
Macroeconomics also seeks to explain the rate at
which the standard of living changes.

1.5.2 What Determines the Cost of Living?

The cost of living is the amount of money it takes
to buy the goods and services that a typical family
consumes.
The cost of living in Egypt is the number of Pound
it takes to buy the goods and services that a typical
family consumes.
A rising cost of living is called inflation.
A falling cost of living is called deflation. Inflation
brings a shrinking value of the dollar and deflation
brings a rising value of the dollar.
Macroeconomics seeks to explain the forces that
determine the cost of living and the inflation (or
deflation) rate.

1.5.3 Why Does Our Economy Fluctuate?

The business cycle is the periodic but irregular
upand-down movement in production and jobs in
an economy.
During the 1990s and 2000s, the Canadian
economy enjoyed a prolonged expansion—
production and jobs increased.
Canada’s last recession shrinking production and
jobs occurred in 1991.
Figure 1.2 on the next slide illustrates the phases
and turning points of a business cycle.

Figure 1.2
Economists remain unsure about the sources of
economic fluctuations and about the actions that
might be taken to smooth the economy.
But in your study of macroeconomics, you will learn
what economists have discovered about economic
fluctuations.
 1.6 The Economic Way of Thinking

1.6.1 Choices and Tradeoffs

The economic way of thinking places scarcity and
its implication, choice, at center stage.
You can think about every choice as a tradeoff an
exchange giving up one thing to get something
else.
The classic trade-off is “guns versus butter.” “Guns”
and “butter” stand for any two objects of value.

1.6.2 Microeconomic Tradeoff

The three microeconomic questions become
sharper when we think in terms of trade-off.
“What?” Tradeoffs arise when people choose how
to spend their incomes, when governments choose
how to spend their tax revenues, and when
businesses choose what to produce. “How?”
Tradeoffs arise when businesses choose among
alternative production technologies.
“For Whom?” Tradeoffs arise when choices change
the distribution of buying power across individuals.
Government redistribution of income from the rich
to the poor creates the big trade-off the trade-off
between equality and efficiency.
Standard of Living Tradeoffs arise when we choose
between current consumption and activities that
increase our standard of living.
Activities such as saving and investing, education,
and research increase future production and
consumption possibilities, which increases the
standard of living.
An Output-Inflation Trade-off arises when
policymakers choose how much inflation to endure
in order to maintain a high level of production.
An output-inflation trade-off arises because a
policy action that lowers inflation also lowers output
and a policy action that boosts output increases
inflation.

1.6.3 Opportunity Cost

Thinking about a choice as a tradeoff emphasizes
cost as an opportunity forgone.
The highest-valued alternative that we give up to
get something is the opportunity cost of the
activity chosen.

1.6.4 Margins and Incentives

People make choices at the margin, which means
that they evaluate the consequences of making
incremental changes in the use of their resources.
The benefit from pursuing an incremental increase
in an activity is its marginal benefit.
The opportunity cost of pursuing an incremental
increase in an activity is its marginal cost.
Marginal benefit and marginal cost act as an
incentive an inducement to take a particular action.
For any activity, if marginal benefit exceeds
marginal cost, people have an incentive to do more
of that activity
If marginal cost exceeds marginal benefit, people
have an incentive to do less of that activity.
Economists seek to predict choices by looking at
changes in incentives.