Because resources are scarce and human wants are unlimited, people cannot have everything they want. Economics is the study of how individuals choose to use their scarce resources in an attempt to satisfy their unlimited wants.
Households, firms, governments, and the rest of the world are the four economic actors in the economy. Households act both as consumers who demand the goods and services produced and as resource owners who supply resources to firms and government. Everybody owns at least one productive resource: his or her own labor. Firms supply goods and services to consumers by hiring resources to produce them. The government provides some goods and services, such as national defense, that tend not to be produced by private firms. The government also makes and enforces rules to be followed by other economic actors. The rest of the world includes foreign households, firms, and governments.
Buyers and sellers come together to carry out exchange in markets. Some markets -- farmers' markets, for example -- are physical places with specific geographic locations. Other markets are less concrete and consist of communications by individuals thousands of miles apart. For example, people can order books from a book club through the mail.
Economics is broken down into two parts: microeconomics and macroeconomics. Microeconomics concerns the economic behavior of individual decision makers, such as the consumer, the worker, and the manager of a firm. Macroeconomics examines the economic system as a whole and tries to explain unemployment, inflation, and economic growth.
It is very rare for people to have to make all-or-nothing decisions. Instead, decisions usually involve choices between the status quo and something else. One chooses among having apple pie for dessert, cake for dessert, or no dessert at all. A decision is made on the basis of a comparison of the extra (marginal) benefits and the extra (marginal) costs of the contemplated change. When marginal benefits exceed marginal costs, the individual makes the change.
Rational choice takes time and information. A choice can be a poor one if a decision maker lacks good information. The collection and assimilation of information take time and use up resources. Rational individuals collect information from a variety of sources as long as the expected marginal benefit of doing so exceeds the expected marginal cost.
Economic analysis follows the scientific method, which can be broken down into four steps. First, the relevant variables must be identified and defined. Second, the assumptions that specify the conditions under which the theory applies must be identified. In economics, it is common to employ the assumption of ceteris paribus, which means "other things held constant." For example, when we say that a higher price for a good causes fewer units of the good to be sold, we hold income and tastes, among other things, constant. Third, hypotheses about the relations among variables are stated. These generally take the form of if-then statements. Fourth, the hypotheses are tested.
Economists distinguish between positive economic statements and normative economic statements. Positive economic statements are associated with economic theory and involve facts or predictions that are testable. Normative economic statements involve value judgments and opinions. The statement "Tariffs on imported steel will increase employment in the U.S. steel industry" is an example of a positive statement. "Higher tariffs should be placed on imported steel" is an example of a normative statement.
A question that is often of interest in economics is whether one variable has a positive, or direct, effect on another variable or an inverse, or negative, effect. Exhibit 1 shows a line that represents a consumption function. The independent variable is income and the dependent variable is consumption expenditures. The graph represents the assumption that as a family's income increases, its consumption spending also increases. Hence, there is a direct, or positive, relation between a family's income and the amount the family spends.
A negative, or inverse, relation is illustrated in Exhibit 2. Here the independent variable is hours of practice and the dependent variable is one's golf score. The more one practices, the lower the golf score will be.
The slope of a line is the amount the vertical variable changes for a given increase in the horizontal variable. The slope of an upward-sloping line is positive; the slope of a downward-sloping line is negative. The slope of a straight line is constant, but the slope of a curved line changes at every point. To find the slope of a curved line at a point, draw a straight line tangent to the point. The slope of this line is the slope of the curved line at that point. Make sure that you understand the graphs that are used in the appendix in the textbook.
Question to Think About: Does the percentage of income spent on consumption goods vary with age?
Question to Think About: Do you think all ancient Greeks would have made the same decision that Achilles made?
|Scarce resources||Other-things-constant assumption|
|Labor||Positive economic statement|
|Capital||Normative economic statement|
|Human capital||Association-causation fallacy|
|Entrepreneurial ability||Fallacy of composition|
|Product market||Independent variable|
|Resource market||Positive, or direct, relation|
|Microeconomics||Negative, or inverse, relation|
|Economic theory, or economic model||Ray|
|1.||Economics; scarce; unlimited||9.||marginal|
|1. True||10. False|
|2. True||11. False|
|3. False||12. True|
|4. False||13. False|
|5. False||14. True|
|6. False||15. False|
|7. False||16. False|
|8. True||17. True|
|9. True||18. False|
10. False: Decisions are based on marginal
benefits and marginal costs.
12. True: A theory is good not because it predicts accurately all the time but because it predicts better than other theories.
C. Multiple Choice
1. e 6.   e 11. b 16. a 2. a 7.   b 12. b 17. d 3. d 8.   d 13. a 18. a 4. d 9.   c 14. c 19. b 5. d 10. c 15. c 20. e
D. Discussion Questions