to accompanyto accompany

Exploring EconomicsExploring Economics33rdrd Edition Edition

by Robert L. Sextonby Robert L. SextonCopyright © Copyright © 20052005 Thomson Learning, Inc. Thomson Learning, Inc.

Thomson Learning™ is a trademark used herein under license.Thomson Learning™ is a trademark used herein under license.

ALL RIGHTS RESERVED. Instructors of classes adopting ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICSEXPLORING ECONOMICS, 3rd, 3rd Edition Edition by Robert L. Sexton as an assigned textbook may by Robert L. Sexton as an assigned textbook may

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Printed in the United States of America Printed in the United States of America ISBN 0-324-26086-5ISBN 0-324-26086-5

A Lecture PresentationA Lecture Presentation

The Role and Method The Role and Method of Economicsof Economics

Chapter 1Chapter 1

1.1 Economics: A Brief Introduction1.1 Economics: A Brief IntroductionMany issues in our lives are at least partly economic in Many issues in our lives are at least partly economic in

character: character: Why do 10 AM classes fill up faster than 8 AM classes during Why do 10 AM classes fill up faster than 8 AM classes during

registration?registration? Why is it difficult to find a cab after a play on a rainy night in Why is it difficult to find a cab after a play on a rainy night in

in New York City? in New York City? Why is it hard to find an apartment in cities like, San Why is it hard to find an apartment in cities like, San

Francisco, Berkeley and New York?Francisco, Berkeley and New York? Why is teenage unemployment higher than adult Why is teenage unemployment higher than adult

unemployment?unemployment? Will higher taxes on cigarettes reduce the amount people Will higher taxes on cigarettes reduce the amount people

smoke? If so, by how much?smoke? If so, by how much? Why do professional athletes make so much money?Why do professional athletes make so much money? Why do US auto producers like tariffs (taxes) on imported Why do US auto producers like tariffs (taxes) on imported

cars?cars?

Another reason to study economics is that it may Another reason to study economics is that it may teach you how to think better.teach you how to think better.

The economic way of thinking is a set of problem–The economic way of thinking is a set of problem–solving tools that may prove to be valuable in solving tools that may prove to be valuable in your professional and personal life.your professional and personal life.

Much of economic life involves making choices Much of economic life involves making choices between conflicting wants in a world of limited between conflicting wants in a world of limited resourcesresources

Economics gives us clues on how to intelligently Economics gives us clues on how to intelligently evaluate out options.evaluate out options.

The economic approach sheds light The economic approach sheds light on many social issues such as on many social issues such as discrimination, education, crime and discrimination, education, crime and divorce.divorce.

Many front page stories are filled with Many front page stories are filled with articles relating to economics.articles relating to economics.

EconomicsEconomics is the study of the allocation of is the study of the allocation of our limited resources to satisfy our unlimited our limited resources to satisfy our unlimited wants. wants.

ResourcesResources are inputs that are used to are inputs that are used to produce goods and services.produce goods and services.

ScarcityScarcity forces us to make choices on how forces us to make choices on how to best use our limited resources. to best use our limited resources.

The economic problemThe economic problem: Scarcity forces us : Scarcity forces us to choose, and choices are costly because we to choose, and choices are costly because we must give up other opportunities that we must give up other opportunities that we value.value.

Living in a world of scarcity means Living in a world of scarcity means facing facing tradeoffstradeoffs—a trip to the —a trip to the grocery store versus the mall; grocery store versus the mall; finishing a research paper or going to finishing a research paper or going to the beach or a movie; sleep or class. the beach or a movie; sleep or class.

1.2 Economics as a Science1.2 Economics as a Science

Economics, like the other social Economics, like the other social sciences, is concerned with reaching sciences, is concerned with reaching generalizations about human generalizations about human behavior.behavior.

Conventionally, we distinguish Conventionally, we distinguish between two main branches of between two main branches of economics:economics: macroeconomicsmacroeconomics, and, and microeconomicsmicroeconomics..

MacroeconomicsMacroeconomics is the study of the is the study of the aggregateaggregate, or total economy. , or total economy.

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

MicroeconomicsMicroeconomics deals with the deals with the smaller units within the economy.smaller units within the economy.

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

Microeconomics looks at the trees; Microeconomics looks at the trees; Macroeconomics looks at the forest.Macroeconomics looks at the forest.

1.3 Economic Behavior1.3 Economic Behavior Economists assume that individuals actEconomists assume that individuals act as as

ifif they are motivated by self-interest and they are motivated by self-interest and respond in predictable ways to changing respond in predictable ways to changing circumstances. circumstances.

To a worker, self-interest means pursuing To a worker, self-interest means pursuing a higher paying job and/or better working a higher paying job and/or better working conditions.conditions.

To a consumer, self-interest means To a consumer, self-interest means gaining a greater level of satisfaction from gaining a greater level of satisfaction from their limited income and time. their limited income and time.

Most economists believe that it is Most economists believe that it is rationalrational for people to try to anticipate the likely for people to try to anticipate the likely future consequences of one's behavior future consequences of one's behavior before choosing it—like driving with a before choosing it—like driving with a suspended driver’s license or choosing to suspended driver’s license or choosing to take up smoking. take up smoking.

Actions have consequences—even Actions have consequences—even inactions, which are choices not to do inactions, which are choices not to do something or not to make changes, have something or not to make changes, have consequences—failing to study for an consequences—failing to study for an exam.exam.

In mainstream economics, to say that In mainstream economics, to say that people are rational is not to assume that people are rational is not to assume that they never make mistakes. It is merely to they never make mistakes. It is merely to say that they do NOT make systematic say that they do NOT make systematic mistakes.mistakes.

And when economists talk of self-interest, And when economists talk of self-interest, they are not just referring to satisfaction they are not just referring to satisfaction of material wants but to a broader idea of of material wants but to a broader idea of “preferences” that can easily encompass “preferences” that can easily encompass the welfare of others.the welfare of others.

1.4 Economic Theory1.4 Economic Theory TheoriesTheories are statements or propositions are statements or propositions

used to explain and predict behavior in the used to explain and predict behavior in the real world. real world.

Because of the complexity of human Because of the complexity of human behavior, economists must abstract to behavior, economists must abstract to focus on the most important components of focus on the most important components of a particular problem.a particular problem.

This is similar to maps that highlight the This is similar to maps that highlight the important information (and assume away important information (and assume away many of the minor details) to help people many of the minor details) to help people get from here to there. get from here to there.

A A hypothesishypothesis in economic theory is a in economic theory is a testable prediction about how people will testable prediction about how people will behave or react to a change in economic behave or react to a change in economic circumstances. circumstances.

For example, if the price of CDs increase, For example, if the price of CDs increase, we can hypothesize that fewer CDs would we can hypothesize that fewer CDs would be sold. be sold.

Empirical analysisEmpirical analysis, the use of data to test , the use of data to test hypotheses, is applied to determine hypotheses, is applied to determine whether or not a hypothesis fits well with whether or not a hypothesis fits well with the facts. If an economic hypothesis is the facts. If an economic hypothesis is supported by the data, we can tentatively supported by the data, we can tentatively accept as an economic theory.accept as an economic theory.

1.5 Problems to Avoid in 1.5 Problems to Avoid in Scientific ThinkingScientific Thinking

Virtually all theories in economics are Virtually all theories in economics are expressed using a expressed using a ceteris paribusceteris paribus (“holding (“holding everything else constant”) assumption. everything else constant”) assumption.

An example of ceteris paribus: The theory An example of ceteris paribus: The theory that if I study harder, I will perform better on that if I study harder, I will perform better on a test must carefully hold other things a test must carefully hold other things constant. constant.

These other things might include—what if These other things might include—what if you studied so hard you overslept or you you studied so hard you overslept or you were too sleepy to think clearly? Or what if were too sleepy to think clearly? Or what if you studied the wrong stuff?you studied the wrong stuff?

One must always be careful not to confuse One must always be careful not to confuse correlationcorrelation with with causationcausation..

The fact that two events usually occur The fact that two events usually occur together (together (correlationcorrelation) does not necessarily ) does not necessarily mean that one caused the other to occur mean that one caused the other to occur ((causationcausation) .) .

Does a roosters crowing cause the sun to Does a roosters crowing cause the sun to rise? Why are ice cream sales and crime rise? Why are ice cream sales and crime positively correlated? People drive slowly positively correlated? People drive slowly when roads are icy—are lower speeds the when roads are icy—are lower speeds the cause of increased accidents? Or do icy roads cause of increased accidents? Or do icy roads lead to lower speeds and more accidents. lead to lower speeds and more accidents.

Fallacy ofFallacy of compositioncomposition——thethe incorrect incorrect view that what is true for the individual is view that what is true for the individual is always true for the group. always true for the group.

For example, standing up at a football For example, standing up at a football game or a concert to see better only works game or a concert to see better only works if others do not do the same thing. How if others do not do the same thing. How about getting to school early to get a about getting to school early to get a better parking place? What if everybody better parking place? What if everybody gets up early to get a better parking spot?gets up early to get a better parking spot?

Positive analysisPositive analysis---an objective testable -an objective testable statement. Positive statements are attempts statement. Positive statements are attempts to to describedescribe what happens and why it what happens and why it happens. happens.

Normative analysisNormative analysis--a subjective non---a subjective non-testable item about what should be or what testable item about what should be or what ought to happen. Normative statements are ought to happen. Normative statements are attempts to attempts to prescribeprescribe what should be done. what should be done.

For example, should the government give For example, should the government give “free” prescription drugs to seniors? Or “free” prescription drugs to seniors? Or should the government increase spending in should the government increase spending in the space program?the space program?

1.6 Positive and 1.6 Positive and Normative AnalysisNormative Analysis

Disagreement is common in most Disagreement is common in most disciplines.disciplines.

The majority of disagreements in The majority of disagreements in economics stem from normative economics stem from normative issues. issues.

However, there is some disagreement However, there is some disagreement over positive analysis—there may be over positive analysis—there may be mixed empirical evidence or mixed empirical evidence or insufficient information.insufficient information.

Most economists agree on a wide Most economists agree on a wide range of issues including the effects range of issues including the effects of rent control, import tariffs, export of rent control, import tariffs, export restrictions, the use of wage and price restrictions, the use of wage and price controls to curb inflation, and the controls to curb inflation, and the minimum wage.minimum wage.

Appendix: Working with GraphsAppendix: Working with Graphs

Graphs are an important economic tool. Graphs are an important economic tool. They:They: allow economists to better understand allow economists to better understand

the workings of the economy, andthe workings of the economy, and enhance the understanding of important enhance the understanding of important

economic relationships.economic relationships.

The most useful graph for our The most useful graph for our purposes is one that merely connects purposes is one that merely connects a vertical line (the a vertical line (the Y-axisY-axis) with a ) with a horizontal line (the horizontal line (the X-axisX-axis).).

Exhibit 1: Plotting a GraphExhibit 1: Plotting a GraphY

X-50 -40 -30 -20 -10 10 20 30 5040

-10

-20

-30-40

-50

5040

30

2010

Three common types of graphs are: Three common types of graphs are: pie chartspie charts,, bar graphsbar graphs, , and and time series graphstime series graphs..

Exhibit 2:Exhibit 2:

Exhibit 2:Exhibit 2:

Exhibit 2:Exhibit 2:

Graphs can be used to show the Graphs can be used to show the relationship between two variables.relationship between two variables.

A A variablevariable is something that is is something that is measured by a number–like your measured by a number–like your height. height.

Relationships between two variables Relationships between two variables can be expressed in a simple can be expressed in a simple two‑dimensional graph.two‑dimensional graph.

A A positive relationshippositive relationship means that means that two variables move in the same two variables move in the same direction. direction.

That is, an increase in one variable That is, an increase in one variable (practice time) is accompanied by an (practice time) is accompanied by an increase in another variable (overall increase in another variable (overall score) or a decrease in one variable is score) or a decrease in one variable is accompanied by a decrease in accompanied by a decrease in another variable.another variable.

Exhibit 3: A Positive RelationshipExhibit 3: A Positive RelationshipS

core

s a

t Z G

am

es

Sco

res

at Z

Ga

me

s

10987654321

100 20 30 40Practice Time per WeekPractice Time per Week

(10, 4)

(20, 6)

(30, 8)

(40, 10)

A

B

C

D The graph shows The graph shows

an example of a an example of a positive positive relationship.relationship.

The skaters who The skaters who practiced the practiced the most scored the most scored the highest.highest.

When two variables move in different When two variables move in different directions, there is adirections, there is a negative negative relationshiprelationship between the two between the two variables. variables.

When one variable rises, the other When one variable rises, the other variable falls.variable falls.

A downward‑sloping line, the demand A downward‑sloping line, the demand curve, shows the different combinations curve, shows the different combinations of price and quantity purchased. of price and quantity purchased.

The higher you go up on the vertical The higher you go up on the vertical (price) axis, the smaller the quantity (price) axis, the smaller the quantity purchased on the horizontal axis, and purchased on the horizontal axis, and the lower you go down along the vertical the lower you go down along the vertical (price) axis, the greater the quantity (price) axis, the greater the quantity purchased.purchased.

(1, $25)

(2, $20)

(3, $15)

(4, $10)

(5, $5)

Exhibit 4: Emily’s Demand CurveExhibit 4: Emily’s Demand CurveA Negative RelationshipA Negative Relationship

Pri

ce o

f C

Ds

$25

20

15

10

5

0 21 3 4 5 6Quantity of CDs Purchased

Demand Curve

A

B

C

D

E

The downward The downward slope of the curve slope of the curve means that price means that price and quantity are and quantity are inversely, or inversely, or negatively related.negatively related.

As price falls, As price falls, quantity purchased quantity purchased increases and vice increases and vice versa.versa.

Even when only two variables are shown on Even when only two variables are shown on the axes, graphs can be used to show the the axes, graphs can be used to show the relationship between three variables. relationship between three variables.

For example, a rise in income may increase For example, a rise in income may increase the quantity of CDs purchased at each the quantity of CDs purchased at each possible price.possible price.

This would shift the whole demand curve This would shift the whole demand curve for CDs outward to a new position.for CDs outward to a new position.

Exhibit 5: Shifting a CurveExhibit 5: Shifting a CurveP

rice

of

CD

sP

rice

of

CD

s

Pri

ce o

f C

Ds

Pri

ce o

f C

Ds

(with higher income)(with higher income)D

Quantity of CDs PurchasedQuantity of CDs Purchased

D

0

(with lower income)(with lower income)

D

Quantity of CDs PurchasedQuantity of CDs Purchased

D

0

It is important to remember the difference It is important to remember the difference between a movement up and down along a between a movement up and down along a curve and a shift in the whole curve. curve and a shift in the whole curve.

A change in one of the variables on the A change in one of the variables on the graph, like price or quantity purchased, will graph, like price or quantity purchased, will cause a movement along the curve.cause a movement along the curve.

A change in one of the variables not shown, A change in one of the variables not shown, like income in our example, will cause the like income in our example, will cause the whole curve to shift.whole curve to shift.

Exhibit 6: Shifts vs. MovementsExhibit 6: Shifts vs. MovementsP

ric

e o

f C

Ds

Pri

ce

of

CD

s

D0

Quantity of CDs PurchasedQuantity of CDs Purchased

D1

0

Going from Going from Point A to B Point A to B indicates indicates movementmovement along a along a demand curve.demand curve.

Going from DGoing from D00

to Dto D11 is a is a shift.shift.

A

B

The The slopeslope, or steepness, of curves can , or steepness, of curves can be either positive (upward sloping) or be either positive (upward sloping) or negative (downward sloping). negative (downward sloping).

A curve that is downward sloping A curve that is downward sloping represents an inverse, or negative, represents an inverse, or negative, relationship between the two variables.relationship between the two variables.

A curve that is upward sloping A curve that is upward sloping represents a direct, or positive represents a direct, or positive relationship between the two variables.relationship between the two variables.

Exhibit 7: Downward-Sloping Exhibit 7: Downward-Sloping Linear Curves Linear Curves

A downward-A downward-sloping curve sloping curve represents a represents a negative negative relationship relationship between two between two variables.variables.

2525

2020

1515

1010

55

55 1010 1515 2020 2525

Downwardsloping

00

Exhibit 7: Upward-Sloping Exhibit 7: Upward-Sloping Linear Curves Linear Curves

An upward-An upward-sloping curve sloping curve represents a represents a positive positive relationship relationship between two between two variables.variables.

2525

2020

1515

1010

55

55 1010 1515 2020 252500

Upwardsloping

The slope of a linear curve between The slope of a linear curve between two points measures the relative two points measures the relative rates of change of two variables. rates of change of two variables.

The slope of a linear curve can be The slope of a linear curve can be defined as the ratio of the change in defined as the ratio of the change in the the YY value to the change in the value to the change in the XX value, or the ratio of the rise to the value, or the ratio of the rise to the run.run.

Exhibit 8: Slopes of Positive Exhibit 8: Slopes of Positive and Negative Linear Curvesand Negative Linear Curves

Y-

axis

X-axis

109

87654

321

1 2 3 4 5 60

AB

2 Run1 Rise

Positiveslope+1/2

Y-

axis

X-axis

109

87654

321

1 2 3 4 5 60

A

B

+2 Run

Negativeslope

-4-8

Rise

Along a nonlinear curve, the slope Along a nonlinear curve, the slope varies from point to point. varies from point to point.

However, we can find the slope of However, we can find the slope of such a curve at any point by finding such a curve at any point by finding the slope of the tangent to that curve the slope of the tangent to that curve at that point.at that point.

Exhibit 9: The Slope of a Exhibit 9: The Slope of a Nonlinear Curve Nonlinear Curve

Y-a

xis

X-axis

5

4

3

2

1

1 2 3 4 5 760

AC

Slope=0

B