Principles of Economics Libby Rittenberg Timothy Tregarthen Chapter 1 in Macro Micro Combo texts Economics The Study of Choice Section 1 Defining Economics A Economics defined the Study of Choice how people choose among the various alternatives available to them involves decisions by individuals about what they will do and thus also involves decisions about what they will not do B Scarce Resources a resource is anything that is used in the production of goods and services resources are scarce the quantity available is not large enough to satisfy all productive uses unlike resources our wants are unlimited as we lack the resources needed to obtain all the things we want we are forced to make choices about what we want most this is what is meant when economists say that we face tradeoffs resources include natural resources human resources e g labor advanced skills entrepreneurship and capital equipment limited resources mean society must make choices goods services G S are produced from scarce resources thus goods services are themselves scarce relative to the demand for them scarcity and value the more limited the supply of a resource good or service the higher the price of the good service the more abundant a resource good or service the lower the price of the good service C Opportunity cost the real cost of something is what you must give up in order to get it is not just the monetary cost cost can be measured in terms of time or effort as well often viewed as the second best option available the best option not chosen what you would have done if you did not do the thing that you did individuals weigh the costs and benefits of an action in determining opportunity cost in their decisions we assume that individuals are rational i e they act in their own self interest D Fundamental Economic Questions also see notes Chap 1 Sect 3G Chap 2 Sect 3E all economies whether market or command control must answer these 3 questions what will be produced how will goods be produced related to technological efficiency related to allocative efficiency a maximization problem involving normative decisions a minimization problem involving positive decisions involves a decision as to which sector will most effectively produce the good public or private sector for whom are goods produced related to equity fairness issues Section 2 The Field of Economics The economic way of thinking includes paying attention paid to the opportunity costs involved in a choice the assumption that individuals behave rationally i e in a manner that maximizes their utility and an emphasis on how choices are made at the margin A How much is a decision at the margin a change in the status quo resulting in a bit more or less of something valued most decisions of interest to economists involve decisions at the margin e g let s say you have 4 hours to study should you spend that time studying economics or another subject if you decide to study economics there is a benefit presumably a better grade in economics there is also a cost you could have devoted that time to another subject supporting a better grade in that subject so your decision involves a tradeoff more of one valued item a good grade in economics might mean less of trade offs are judged by comparing the costs of doing something with the benefits decisions about whether to do or buy a bit more or a bit less of something are marginal decisions the study of such decisions is known as marginal analysis another valued item a good grade in the other class B People usually exploit opportunities to make themselves better off rational people act in their own self interest an incentive is anything that offers a reward to people who change their behavior people respond to incentives e g if the salaries of geologists rise more students will go to school for geology economists are skeptical of attempts to change people s behavior when no change in incentives is involved e g people may drive less because it is the right thing to do vs driving less because gas becomes more expensive responses to incentives however may differ from the anticipated response paradox of thrift people tend to exploit until they are fully exhausted e g geology students flood market C Microeconomics is the field of study that focuses on decisions made by individual decision making units within the economy typically individuals and firms Macroeconomics is the field of study that focuses on the impact of the choices made by individual decision making units on the total also called aggregate level of economic activity Section 3 The Economists Tool Kit A Hypotheses Theories and Models in Economics Terminology constant something whose value does not change variable something whose value can change independent variable a variable that induces a change dependent variable a variable that responds to a change hypothesis an assertion of a relationship between two or more variables this assertion can be tested and could be proven false if it is not possible that a test could prove the assertion false then it is not a hypothesis e g god created the world in six days as no test could prove or disprove this statement it is not a hypothesis theory a hypothesis that has survived not been rejected after widespread testing and is now generally accepted law a theory that has been subjected to even more testing and survived and now receives near universal acceptance model a set of simplifying assumptions about some aspect of the real world B Graphs and their meaning the most basic graph in economics Supply Demand S D looks at product price verses two quantities 1 the quantity of goods services demanded by consumers and 2 the quantity of goods services supplied by producers the graph suggests that one and only one factor affects quantity supplied or demanded and that this factor is product price however we know that this is wrong as a number of variables may influence the quantity supplied or demanded e g income affects demand e g cost of inputs affects supply each point on graph provides two pieces of information specifies one price one quantity Model a simplified representation of a real world situation that is used to study that real world situation models are intended to be as simple as possible while still providing reasonable predictive power models generally assume a perfectly competitive market a set of strict simplifying assumptions see E below the other things equal assumption ceteris paribus is another