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The Nature and Method of Economics Economics = the social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants The Economic Perspective The economic perspective = the economic way of thinking Scarcity and Choice Since human and property resources are scarce, the goods and services we produce must also be limited. Scarcity limits options and necessitates that we make choices. Opportunity costs = sacrifices like alternative production activities and other goods and services resources for which resources could be used The cost of that which you will get is the value of that which is sacrificed to obtain it. Rational Behavior Economics assumes that human behavior reflects rational self-interest. Allocate their time, energy, and money to maximize well-being. Utility = pleasure, happiness or satisfaction. Look for opportunities that increase utility. Choices will vary greatly among individuals. Rational decisions may change as costs & benefits change. Rational Self-interest enables a person to achieve personal satisfaction, however it may be derived. Marginalism: Benefits and Costs Marginal analysis = comparisons of marginal benefits and marginal costs. Most choices or decisions involve changes in status quo. The decision maker must compare marginal benefits and marginal costs. In a world of scarcity, the decision to obtain the marginal benefit associated with some specific option always includes the marginal cost of forgoing something else. There can be too much of a good thing when we obtain additional amounts of them even though their marginal costs (the value of the forgone options) exceed their marginal benefits. Then alternative goods and services sacrificed that are more valuable at the margin- the place where we consider the very last units of each. Why Study Economics? Prominent economists of the past: Adam Smith, David Ricardo, John Stuart Mill, Karl Marx, and John Maynard Keynes World leaders solicit advice and police suggestions of economists. President benefits from recommendations of his Council of Economic Advisers. Annual Economic Report of the President o Unemployment o Inflation o Economic growth o Taxation o Poverty o International trade o Health care o Pollution o Regulation o Education, etc. Economics for Citizenship Most political problems today have important economic aspects. Professional and Personal Applications

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Improve their analytical skills which are important in workplace. Helps people make sense of everyday activity Enables business managers and executives to increase profit. Helps consumers and workers make better buying and employment decisions. Economics = academic, not vocational, subject. Not primarily a how-to-make-money area of May help to run a business or manage your personal finances, but thats not the primary

study objective. Examines problems and decisions from the social, not personal, point of view. From the viewpoint of societys best interest Economic Methodology Economics relies on the scientific method: o Observation of facts (real world data) o Formulation of possible explanation of case and effect (hypothesis) o Testing experiment by comparing outcomes of specific events to outcome predicted by hypothesis o Acceptance, rejection or modification of hypothesis, based on these comparisons o Continued testing of hypothesis against facts. As favorable results accumulate, the hypothesis theory. A very well tested and widely accepted theory is referred to as a law or principle. Combinations of such laws or principles are incorporated into models= simplified representations of how something works.

Laws, principles, and models enable economists to understand and explain reality and predict various outcomes of particular actions. Theoretical Economics Economists develop models of the behavior of individuals and institutions engaged in the production, exchange, and consumption of goods & services. Gather facts about economic activities & outcomes. Select useful info. and determine which facts are relevant to problem. Economist draws on facts to establish cause-effect hypothesis about economic behavior. Hypotheses tested against real world observation and data. Through this process, the economist tries to discover hypotheses that rise to the level of theories and principles Theoretical economics= process of deriving theories principles to systematically arrange facts, interpret them, and generalize from them. Theories and principles bring order and meaning to facts by arranging them in cause-effect order. Understanding of factual, real-world evidence is required to formulate meaningful hypotheses. Hypotheses tested through gathering & organizing factual data to see if the hypotheses can be verified. Economic theories & principles indicate economic behavior or the economy that enable production of the probable effects of certain actions. Good theories explain & predict well & are supported by facts concerning how individuals and institutions actually behave in producing, exchanging, and consuming goods & services. These facts may change with time, so economists must continually check theories against changing economic environment. Theories, laws, and principles are ingredients of analytical economics= the determining of cause and effect, of action and outcome within economic system. Terminology o Reflects gradation of confidence in generalizations. o Hypothesis needs initial testing. o Theory has been tested bust needs more testing. o Law or principle provides strong predictive accuracy, over & over. Generalizations o Laws, theories, and principles are imprecise b/c economic facts are usually diverse

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Economic principles are expressed as tendencies of typical or average consumers, workers, or business firms. Other-Things-Equal Assumption o Used to construct generalizations o Assume all other variables except those under immediate consideration are held constant for a particular analysis. o Economists test their theories using real-world data, which are generated by the actual operation of the economy. (not controlled)therefore, open to more debate. Abstractions o Abstractions= simplifications that omit irrelevant facts and circumstances. o Economic models dont mirror full complexity of real world. o Economic theories are practical precisely because theyre abstractions. The full scope of economic reality itself is too complex and bewildering to be understood as a whole. Theorizing is highly practical. Graphical Expression o Policy Economics Policy economics recognizes that theories & data can be used to formulate policies= courses of actions based on economic principles and intended to resolve a specific economic problem or further an economic goal. Economic theories are the foundation of economic policy. Economic policy is normally applied to problems after they arise. However, if economic analysis can predict some undesirable event, then it may be possible to avoid or moderate that event through economic policy Economic Policy o Clearly state goal o Determine policy options o Implement & evaluate selected policy Economic Goals o Economic growth o Full employment o Economic efficiency o Price-level stability o Economic freedom o Equitable distribution of income o Economic security o Balance of trade o Some goals complementary. Others conflict and entail tradeoffs, society needs to prioritize objectives. Macroeconomics and Microeconomics

Macroeconomics Macroeconomics= examines whether economy as whole or its basic aggregates. Aggregate= collection of specific economic units treated as if they were one unit Seeks to obtain overview of structure of economy & relationships of major aggregates Think BIG PICTURE Microeconomics Microeconomics= Looks at specific units Observes details of economic unit Many topics and subdivisions of economics are rooted in both macro & micro Positive & Normative Economics Positive economics = focuses on facts and cause & effect relationships. Includes description, theory development, and theoretical economics. (WHAT IS)

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Avoids judgments, tries to est. scientific statements about economic behavior, deals with what economy is actually like Normative economics= incorporates value judgments about what economy should be like or what particular policy actions should be recommended to achieve goal (WHAT OUGHT TO BE) Looks at desirability of certain aspects of economy. Underlies expressions of support for policies.

Pitfalls to Sound Reasoning Biases Cloud thinking & interfere w/ objective analysis.

Loaded Terminology To objectively analyze economic issues, reject/discount such terminology. Definitions Some terms in economics have precise technical definitions that are diff. from those implied from common usage. (ex: investment) Fallacy of Composition Fallacy of Composition =assuming that what is true for 1 indiv. is necessarily true for group Causation Fallacies Post Hoc Fallacy= after this, therefore because of this fallacy Correlation vs. Causation Graphs & Their Meaning Construction of a Graph Horiz. axis- indep. variable Verti. axis- dep. variable Direct & Inverse Relationships Direct (positive) relationship= variables change in same direction Inverse (negative) relationship = variables change in opposite direction Dependent & Independent Variables Independent variable= cause, source Dependent variable= effect, outcome Other Things Equal Presume all other factors to be constant In reality, other things change and when they do, the relationship represented in tables and graphs will change Slope of a Line Slope of straight line= vertical change/horizontal change b/w 2 points Positive slope- direct relationship Negative slope- indirect relationship Depends on way relevant variables are measured Reflects marginal changes in economics Vertical line- infinite slope (unrelated variables) Horizontal line- slope 0 (unrelated variables)

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Vertical Intercept Vertical intercept= point where line meets vertical axis Equation of Linear Relationship y = mx + b Slope of Nonlinear Curve Slope constantly changes. Different at each point To measure slope @ specific point, draw tan line to curve at point. Slope of tan line = slope of curve