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Economics, 13th
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WHAT IS
ECONOMICS?
C h a p t e r
1
The Big Picture
Where we are going:
After completing Chapter 1, the student will have a good sense
for the range of questions that economics addresses and will be
on the path towards an economic way of thinking. The students
will begin to think of cost as a forgone alternative—an
opportunity cost—and also about making choices by balancing
marginal costs and marginal benefits.
Chapter 2 reinforces the central themes of Chapter 1 by laying
out a core economic model, the production possibilities frontier
(PPF), and using it to illustrate the concepts of tradeoff and
opportunity cost. Chapter 2 also provides a deeper explanation,
again with a model, of the concepts of marginal cost and marginal
benefit, beginning with the concept of efficiency, and concluding
with a review of the source of the gains from specialization and
exchange.
Lecture Notes
What Is Economics?
I. Definition of Economics
Economic questions arise because we always want more than we can get,
so we face scarcity, the inability to satisfy all our wants. Everyone
faces scarcity because no one can satisfy all of his or her wants.
Scarcity forces us to make choices over the available alternative. The
choices we make depend on incentives, a reward that encourages a choice
or a penalty that discourages a choice.
Forbes lists Bill Gates and Warren Buffet among some of the wealthiest
Americans. Do these two men face scarcity? According to The Wall Street
Journal, both men are ardent bridge players, yet they have never won one of
the many national bridge tournaments they have entered as a team. These two
men can easily afford the best bridge coaches in the world and but other
duties keep them from practicing as much as they would need to in order to
win. So even the wealthiest two Americans face scarcity (of time) and must
choose how to spend their time.
Economics
Economics is the social science that studies the choices that
individuals, businesses, governments and entire societies make when
they cope with scarcity and the incentives that influence and
reconcile those choices.
Economists work to understand when the pursuit of self-interest
advances the social interest
Economics is divided into microeconomics and macroeconomics:
Microeconomics is the study of the choices that individuals and
businesses make, the way these choices interact in markets, and the
influence of governments.
Macroeconomics is the study of the performance of the national
economy and the global economy.
On the first day do a “pop quiz.” Have your students write on paper the
answer to “What is Economics?” Reassure them that this is their opinion
since it is the first day. You will find most of the answers focused around
money and/or business. Stress that Economics is a social science, a study
of human behavior given the scarcity problem. All too often first-time
students (especially business students) think that Economics is just about
making money. Certainly, the discipline can and does outline reasons why
workers work longer hours to increase their wage earnings, or why firms
seek profit as their incentive. But Economics also explains why a
terminally ill cancer patient might opt for pain medication as opposed to
continued chemotherapy/radiation, or why someone no longer in the workforce
wants to go to college and attain a Bachelor’s degree, in their sheer
pleasure of learning and understanding. Stressing the social part of our
science now will help later when relating details to the overall bigger
picture (especially when time later in the semester seems scarce, no pun
intended!).
The definition in the text: “Economics is the social science that studies
the choices that individuals, businesses, governments, and societies make
as they cope with scarcity and the incentives that influence and reconcile
these choices,” is a modern language version of Lionel Robbins famous
definition, “Economics is the science which studies human behavior as a
relationship between ends and scarce means that have alternative uses.”
Other definitions include those of Keynes and Marshall:
John Maynard Keynes: “The theory of economics does not furnish a body of
settled conclusions immediately applicable to policy. It is a method rather
than a doctrine, an apparatus of the mind, a technique of thinking, which
helps it possessors to draw correct conclusions.”
Alfred Marshall: “Economics is a study of mankind in the ordinary
business of life; it examines that part of individual and social action
which is most closely connected with the attainment and with the use of the
material requisites of wellbeing.”
A “shorthand” definition that resonates with students is: “Economics is
the study of trying to satisfy unlimited wants with limited resources.”
Students can—and do—easily abbreviate this definition to “unlimited wants
and limited resources,” which captures an essential economic insight.
Do Choices Made in the Pursuit of Self-Interest also promote the social interest?
You make a choice in your self-interest if you think that choice is
the best one available for you.
An outcome is in the social interest if it is best for society as a
whole.
A major question economists explore is “Could it be possible that when
each of us makes choices in our self-interest, these choices are in
the social interest?’
Students (and others!) often take the answers to the what, how, and for
whom questions for granted. For instance, most of the time we do not bother
to wonder “How does our economy determine how many light bulbs,
automobiles, and pizzas to produce?” (what), or “Why does harvesting wheat
from a plot of land in India occur with hundreds of laborers toiling with
oxen pulling threshing machines, while in the United States, a single
farmer listening to a Garth Brooks CD and sitting in an air-conditioned cab
of a $500,000 machine harvests the same quantity of wheat from the same
sized plot of land?” (how), or “Why is the annual income of an inspiring
and effective grade school teacher much less than that of an average major-
league baseball player?” (for whom). Explaining the answers to these types
of questions and determining whether the answers are in the social interest
is a major part of microeconomics.
Figure 1.1 in the textbook “What Three Countries Produce” ties in nicely
with Chapter 2’s later discussion on the PPF. Figure 1.1 also links the
three questions of what, how and for whom nicely to the component parts of
those questions: goods and services, factors of production (land, labor,
capital, entrepreneurship), and incomes economic agents earn (rent, wages,
interest and profit).
only 24 hours in a day. They have stumbled on the fact that scarcity, which
even Bill Gates faces, is not poverty.
A Choice is a Tradeoff
A tradeoff is an exchange—giving up one thing to get another.
Whatever choice you make, you could have chosen something else.
Virtually every choice that can be thought of involves a tradeoff.
Presenting a few of the following as examples can help your class better
appreciate this key point:
Consumption and savings: If someone decides to save more of his or her
income, savings can be funneled through the financial system to finance
businesses new capital purchases. As a society, we trade off current
consumption for economic growth and higher future consumption.
Education and training: A student remaining in school for another two
years to complete a degree will need to forgo a significant amount of
leisure time. But by doing so, he or she will be better educated and
will be more productive. As a society, we trade off current production
for greater future production.
Research and development: Factory automation brings greater productivity
in the future, but means smaller current production. As a society, we
trade off current production for greater future production.
To ensure that people do not die of any serious side effects, the Food and
Drug Administration (FDA) requires all drug companies to thoroughly test
newly developed medicines before allowing them to be sold in the United
States. However, it takes many years to perform these tests and many people
suffering from the terminal diseases these new medicines are designed to
cure will die before good new medicines are eventually approved for use.
Yet, if the FDA were to abandon this testing process, many others would die
from the serious side effects of those bad medicines that made it to
market. People’s lives will be at risk under either policy alternative.
This stark example of a tradeoff reveals the idea that choices have
opportunity costs.
Self interest can be said to be in the eye of the beholder. Thus, covering
the next portion on positive versus normative analysis can be crucial to
the student’s understanding how economic agents act in their own self-
interests, but perhaps not (and often not) in other’s self-interest.
It wouldn’t even reflect the thought processes of the pool shark that
relies on years of experience and the right “touch.” Yet, constructed
correctly, this mathematical model would predict exactly where the cue ball
would strike the eight ball, hit opposite the bank, and fall into the
corner pocket. (You can easily invent analogous examples from any sport.)
Additional Problems
1. You plan a major adventure trip for the summer. You won’t be able
to take your usual summer job that pays $6,000, and you won’t be
able to live at home for free. The cost of your travel
accomodations on the trip will be $3,000, gasoline will cost you
$200, and your food will cost $1,400. What is the opportunity
cost of taking this trip?
2. The university has built a new parking garage. There is always an
available parking spot, but it costs $1 per day. Before the new
garage was built, it usually took 15 minutes of cruising to find
a parking space. Compare the opportunity cost of parking in the
new garage with that in the old parking lot. Which is less costly
and by how much?
Economic Literature, Vol. 36, No.1, March 1998). Get the students
to see how properly applying the science of economics to social
issues helps us strip away inflammatory rhetoric and examine the
problem carefully and objectively.
Lecture Notes
Goggle Theory
Explain to students that you are going to ask them to use three sets of
goggles to view math in the course. I have found this to be a great tool
for students to understand why we present data in different ways.
1. Equation Goggles: Write an equation in slope-intercept form and explain
that this is one way to show relationships between two variables. I like
to use X and Y for this one and then quickly explain that economics is
much more fun than math because we may be talking about X-rays and Yo-
Yo’s. This helps some students break the barrier early on what
“variable” means.
2. Graphing Goggles: Work through a graph of the equation you wrote
highlighting slope and intercept. Indicate that this may be a Demand or
Supply curve for instance.
3. Now you can explain that they will see all three of these forms of math
at different times during the course and it is important for them to
understand that you can move between all three anytime. We usually have
it shown just one way for convenience. It is also fun during lecture to
say, “I need you to pull out your graphing goggles.”
I. Graphing Data
Graphs are valuable tools that clarify what otherwise might be obscure
relationships.
Graphs represent “quantity” as a distance. Two-variable graphs use two
perpendicular scale lines. The vertical line is the y-axis. The
horizontal line is the x-axis. The zero point in common to both axes
is the origin.
Scatter diagram—a graph that plots the value of one variable on the x-
axis and the value of the associated variable on the y-axis. A scatter
diagram can make clear the relationship between two variables.
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