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Chapter

|1 |What is economics? |

Outline

Economics Helps Us Understand our Ever-Changing World

A. Economics is the science of choice. It gives us valuable insight into how we can best deal with the challenges and opportunities that we all face.

1. Our global economy allows technological changes to bring affordable, innovative products and services to consumers around the world.

2. Our global economy also allows the repercussions from a single terrorist act or the poor economic policies of a single nation to spread economic hardship worldwide.

B. This makes for a life that is rich with problems to be tackled and choices to be understood. A course in economics can help students to understand the powerful forces that shape and change our world.

Outline

I. Definition of Economics

A. Economic questions arise because we face scarcity—we all want more than we can get.

1. Because we are unable to satisfy all of our wants, we must make choices.

2. Incentives are the rewards that encourage us, or the penalties that discourage us, from taking an action. The incentives that we face will influence the choices that we make when dealing with scarcity.

B. Economics is the social science that studies the choices that individuals, businesses, governments, and societies make as they cope with scarcity. It can be divided into two areas of study:

1. Microeconomics is the study of the choices individuals and businesses make, the way those choices interact in the markets, and the influence of governments.

2. Macroeconomics is the study of the performance of the national economy and the global economy.

II. Two Big Economics Questions

A. The first big question is “How do choices end up determining what, how and for whom are goods and services produced?

1. What goods and services are produced in our economy?

a) Goods and services are the objects that people value and produce to satisfy human wants.

b) Figure 1.1 shows the trends in what the U.S. economy has produced over the past 60 years. It shows the decline of agriculture, mining, construction, and manufacturing goods, and the expansion of services.

2. How are goods and services produced?

a) Factors of production are the productive resources used to produce goods and services. These include land (natural resources), labor (the work time and work effort of people), capital (tools, instruments, and machines that are used to produce goods and services), and entrepreneurship (the human resource that organizes land, labor, and capital).

b) The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, work experience, and on-the-job training. Figure 1.2 shows how the level of human capital (measured by educational attainment) in the United States has increased over the past century.

3. For whom are goods and services produced?

a) Who gets to consume the goods and services that are produced depends on the incomes that people earn.

b) Owners of the factors of production earn income, which is a monetary return for using the resources for production: Land earns rent, labor earns wages, capital earns interest, and entrepreneurship earns profit.

c) In the United States, labor earns the largest share of all income (70 percent), but this income is not distributed equally across the population.

B. The second big question is “When is the pursuit of self-interest also in the social interest?”

1. People make choices in their own self-interest—they make choices they think are best for their own well-being.

a) The incentives surrounding an individual’s choice amongst available alternatives influence the tradeoffs involved in making that choice.

b) The choice made by one individual changes the incentives surrounding the tradeoffs facing other individuals, which influences their choices.

c) In this way, many self-interested individuals making choices in society will bring about change to the incentive surrounding all decisions to be made by individuals in the economy.

2. When people make self-interested choices that are the best for society, they make choices that are considered in the social interest.

a) In 1776 Adam Smith published The Wealth of Nations describing how a market based system can theoretically motivate self-interested individuals to make choices that promote the social interest.

b) Economists try to identify those characteristics of a market system that successfully promote self-interested individuals to make choices that coincide with the social interest.

3. We can examine a number of current events to determine whether self-interested individuals made choices in the social interest:

a) Privatization: The fall of socialism and the rise of capitalism in Europe

b) Globalization: The local impact of growing international trade

c) The “New” Economy: Workers adjusting to changing technologies

d) The post 9-11 economy: Terror changes vacation habits

e) Corporate scandals: Preventing stealing by corporate officials through lying

f) HIV/AIDs: Poorest countries hit hardest but lack medicines

g) Disappearing tropical rainforests: Lack of property rights creates waste

h) Water shortages: Consumers fail to pay the opportunity cost of consumption

i) Unemployment: Persistence in minority teenage unemployment

j) Deficits and Debt: Having future generations pay for today’s services

IV. The Economic Way of Thinking: Choices and Tradeoffs

A. Because we all face scarcity, we all must make choices between available alternatives—which creates a tradeoff.

1. A tradeoff is an exchange—giving up one thing to get something else.

2. “Guns versus Butter” is a classic tradeoff that every country faces when deciding how much of its factors of production should go towards producing national security versus goods and services like food and shelter.

B. What, How, and For Whom Tradeoffs

1. “What?” Tradeoffs arise when people choose how to spend their incomes, when governments choose how to spend their tax revenues, and when businesses choose what to produce with their factors of production.

2. “How?” Tradeoffs arise when businesses and governments choose among alternative production technologies. For example: businesses might switch to using robotics rather than labor in assembly lines, thereby effectively trading off labor for capital.

3. “For Whom?” Tradeoffs arise when choices change the distribution of goods and services produced across individuals. Government redistribution of income from the rich to the poor changes the incentives facing owners of productive resources, creating the Big Tradeoff: the tradeoff between efficiency and equity.

C. The results arising from all the choices made in society will influence the incentives surrounding the future choices by other people, businesses, and governments. For example:

1. Consumers’ decisions to consume less and save more increases the funds that are available for businesses to borrow and invest, increasing future output.

2. Workers’ decision to decrease leisure time to acquire human capital increases their income as well as government income tax revenues, increasing how much public services the government chooses to offer.

3. Businesses’ decisions to increase research and development for innovative products rather than to increase current production improves investor’s expectations, increasing the level of income people invest (save).

D. Thinking about a choice as a tradeoff emphasizes how cost is an opportunity forgone.

1. Opportunity cost is the highest-valued alternative that we give up to get something.

2. The opportunity cost of attending college includes not only the money cost of books, tuition and (perhaps) room and board, but also the money income forgone from not being able to work full time, as well as the leisure time lost from studying nights and weekends.

E. People make choices at the margin. Making choices at the margin means people look at tradeoffs that arise from making small changes in an activity.

1. The benefit that arises from an increase in an activity is its marginal benefit.

2. The opportunity cost of an increase in an activity is its marginal cost.

3. Marginal benefit and marginal cost act as an incentive influencing people’s choices.

a) If the marginal benefit of an alternative exceeds the marginal cost, people have an incentive to do more of that activity.

b) If the marginal cost of an alternative exceeds the marginal benefit, people have an incentive to do less of that activity.

F. A change in the incentives people face changes the choices they make.

1. Economists can predict how people will choose based on understanding the incentives they face.

1. When the incentives facing the individual are in the social interest, their choices will promote the social interest.

2. When people make choices that are not in the social interest, they do so because they face the wrong incentives.

V. Economics is a Social Science

A. Economists distinguish between two types of statements about the world:

1. Positive statements make a claim about “what is” and can be tested to determine whether they are valid.

2. Normative statements make a claim of “what ought to be.” Such a statement is an opinion and cannot be tested for validity.

B. Economists build models

1. Economists observe and measure economic activity, build economic models, and test their models.

2. An economic model is a description of some aspect of the economic world that includes only those features of the world that are needed for the purpose at hand.

C. Economists test their models

1. An economic theory is a generalization that summarizes what we think we understand about the economic choices that people make and the performance of industries and entire economies.

D. Obstacles and Pitfalls in Economics

1. Ceteris Paribus means “other things being equal.” Economists try to isolate cause-and-effect relationship by changing only one variable at a time, and hold all other relevant factors unchanged.

2. The Fallacy of Composition is the (false) statement that what is true for the parts is true of the whole or that what is true for the whole is true of the parts.

3. The Post Hoc Fallacy gets its name from the Latin term “Post hoc, ergo propter hoc,” which means “after this, therefore, because of this.” This fallacy is (false) claim that a first event causes a second event because the first occurred before the second.

E. Agreement and Disagreement

1. Economists are often accused of contradicting each other. In contrast to the popular image, economists find much common ground on a wide range of issues. (Page X lists twelve different economic propositions that at least 70 percent of all economists polled will agree upon.)

New in the Seventh Edition

The chapter has been reorganized to place a greater emphasis on the role of incentives that influence people’s choices made in a world of scarcity. The macroeconomics and analysis of living standards portion of this chapter has been replaced with an emphasis on understanding how incentives can alter choices. It also adds an emphasis to how these incentives can alter whether self-interested choices to promote the social interest.

The three big microeconomic questions—What?, How?, and For Whom?— have been condensed into the First Big Economic Question: How do people’s choices end up addressing the How, What, and For Whom questions?

The three big macroeconomic questions have been removed and replaced with the second big economic question: When do choices made by self-interested people promote the social interest?

Teaching Suggestions

1. Definition of Economics

No definition of economics can adequately capture the subject. For that reason, some teachers don’t like definitions and skip right over them. If you are one of these teachers, go ahead. Not much is lost.

Other teachers regard a basic definition as essential, and the textbook takes this view. 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,” 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.”

Some teachers like to play with definitions a bit more elaborately. If you are one of these, here are four more, all of which add some useful insight and the last one a bit of fun:

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.”

Jacob Viner: “Economics is what economists do.”

Jim Duesenberry: “Economics is all about how people make choices. Sociology is about why there isn’t any choice to be made.”

2. The Two Big Microeconomic Questions

Don’t skip the questions in a rush to get to the economic way of thinking. Open your students’ eyes to economic in the world around them. Ask them to bring a newspaper to class and to identify headlines that deal with stories about What, How, and For Whom. Use Economics in the News Today on your Parkin Web site for a current news item and for an archive of past items (with questions). Pose questions and be sure that the students appreciate that they will have a much better handle on questions like these when they’ve completed their economics course.

3. The Economic Way of Thinking

Begin by encouraging the students to use the economic way of thinking to reflect on choices that they or others will make in their own lives. Here are some starter questions:

What is the Difference between Scarcity and poverty? Ask the students why they haven’t yet attained all of their personal goals. One reason will be that they lack sufficient money. Ask them if they could attain all of their goals if they were as rich as Bill Gates. They quickly realize that time is a big constraint—and the great leveler: we all have only 24 hours in a day. They have stumbled on the fact that scarcity, which even Bill Gates faces, is not poverty.

Why are you here in college? Most students will answer this question by saying that they want a good paying job. Tell them about jobs such as postal workers, long haul truck drivers, or grocery clerks that require relatively little training and offer $30,000 a year or more plus benefits.

What is the Opportunity Cost of Getting a College Degree? When the students calculate their opportunity cost of being in school, be sure they place a value on their leisure time lost to studying on weekends and evenings. Most students are shaken when they realize that when lost leisure time and income is included in their calculations, the opportunity cost of a college degree approaches $200,000 or more. Don’t leave them hanging here though. Mention that a college education does yield a high rate of financial return over.

Will your tradeoffs ever improve? You can do your student’s a further favor by helping them to realize that the tradeoffs they face today are as favorable as they will ever be. It’s an old cliché, but effective, to remind them that they are not going to be any more attractive than they are now, nor are they going to gain any additional physical prowess or have any greater capacity to learn than they have at this very moment in their lives. Right now they could do almost anything they set their minds to do. Encourage the students to figure out and be utterly convinced that the benefits they receive from being in college exceed the large opportunity cost that scarcity forces them to bear. Most importantly, remind them of the relevance of this cost-benefit calculation to their decisions to skip classes, not study for exams, or retake core courses and delay graduation.

4. Economics: A Social Science

The value of models. Help the students to appreciate the power of models as tools for understanding reality. The analogy of a model as a map is easy and convincing. Jim Peach, a fine economics teacher at the University of New Mexico, gets his students to make paper airplanes on the first day of class. After flying their paper planes around the classroom (and picking up the debris!) he gets them to talk about what they can learn about real airplanes from experimenting with paper (and other model) planes.

The success of a model is judged by its ability to predict. Help your student’s appreciate that no matter how appealing or “realistic looking” a model appears to be, it is useless if it fails to predict. And the converse, no matter how abstract or far removed from reality a model appears to be, if it predicts well, it is valuable.

Milton Friedman’s Pool Hall example illustrates the point nicely. Imagine a physicist’s model that predicts where a carefully placed shot of a pool shark would go as he tries to sink the eight ball into the corner pocket. The model would be a complex, trigonometric equation involving a plethora of Greek symbols that no ordinary person would even recognize as representing a pool shot. It certainly wouldn’t depict what we actually see—a pool stick striking a pool cue on a rectangular patch of green felt. 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.)

The Big Picture

Where we are going:

After completing Chapter 1, the student has good sense of the range of questions that economics addresses and has begun to glimpse the economic way of thinking:

1. The student is becoming more aware of scarcity and its implication, choice, and of thinking about a choice as a tradeoff.

2. The student is beginning to think of cost as a forgone alternative—an opportunity cost, and to think about the choices that people, businesses, and governments make as the outcome of balancing marginal costs and marginal benefits.

3. The student is more aware of how individual choices are made at the margin, and that choices by one person influence the incentives surrounding the choices made by others, such that choices bring about change—sometimes in the public interest and sometimes not.

Chapter 2 reinforces the central themes of Chapter 1 by laying out the core economic model, the PPF, and using it to illustrate the concepts of tradeoff and opportunity cost. Chapter 2 goes on to a deeper explanation, again with a model, of the concepts of marginal cost and marginal benefit, presents a first look at the concept of efficiency, and concludes with an explanation of the source of the gains from specialization and exchange.

Electronic Supplements

MyEconLab

MyEconLab provides pre- and post-tests for each chapter so that students can assess their own progress. Results on these tests feed an individualized study plan that helps students focus their attention in the areas where they most need help.

Instructors can create and assign tests, quizzes, or graded homework assignments that incorporate graphing questions. Questions are automatically graded and results are tracked using an online grade book.

PowerPoint Lecture Notes

PowerPoint Electronic Lecture Notes with speaking notes are available and offer a full summary of the chapter.

PowerPoint Electronic Lecture Notes for students are available in MyEconLab.

Instructor CD-ROM with Computerized Test Banks

This CD-ROM contains Computerized Test Bank Files, Test Bank, and Instructor’s Manual files in Microsoft Word, and PowerPoint files. All test banks are available in Test Generator Software.

Additional Discussion Questions

1. “Does Bill Gates face scarcity?” The Wall Street Journal recently reported that Bill Gates and Warren Buffet teamed up to play bridge in national competitions. You might imagine that two of the wealthiest and brightest people in the country could certainly hire the best bridge coaches and take sufficient vacation days to achieve perfection in the game. Yet they have failed (miserably) to get into even the quarterfinal rounds of any national bridge tournament. The reason: Bill and Warren face the reality of scarcity just like everyone else. They must allocate their time and substantial resources across their many different interests, including running one of the most powerful companies and one of the most profitable investment funds in the country, respectively. These men don’t face poverty, but they bear an important (to them) opportunity cost imposed upon them by scarcity and this cost is so large that it prevents them from winning a national bridge title.

2. “Why are economists so concerned about the material aspects of life?” Economists are often criticized for focusing on material well-being. Remind students that promoting the emotional (or spiritual) aspect of life depends heavily on attaining material well-being. Ask them to consider the need for life-enhancing goods and services such as health care or education to support spiritual or emotional well-being. Ask how protestors at the WTO meetings in Seattle in 2000 or at the IMF and World Bank meetings in Washington, D.C. in 2002 would be able to voice their opinions without low-cost air travel and the power of the Internet to coordinate the activities of hundreds of protesters. (Be careful not to seem to be either condoning or condemning these activities.) Most students will begin to see that the more efficient we are at producing material prosperity, the more time and opportunity everyone has to promote emotional (or spiritual) goals.

3. Mini Case Study Illustrating How Economists Use Modeling:

“Women are unfairly underpaid when compared to men.” Ask your students whether this statement is positive or normative. Mention that the media frequently reports that the average woman gets paid only 2/3 the wages of the average man. Is this “fact” a sufficient test of the positive statement?

“How would you test this statement to determine whether it has merit in fact?” Ask your students to think about applying the science of economics to this issue by getting them to: 1) recall the necessary aspects of constructing a good economic model; 2) identify and evaluate the cause and effect relationship that is being claimed: Being a woman causes a person’s wages to fall, ceteris paribus; 3) explain how an economist might appropriately measure observed wage differences between men and women so that this model may be tested against real world observation.

“If women were paid more than men in one or two professions (like professional modeling or elementary teaching) is that sufficient evidence to conclude that women in general are not underpaid when compared to men?” Ask the students to think about how to properly test the model and avoid the fallacy of composition.

“What would you take into account when you collected data to compare women’s salaries versus men’s salaries?” Remind the students to use the ceteris paribus condition when modeling this contentious issue, such that any model directly comparing men’s and women’s wages should control for any differences in wage-relevant characteristics between working men and women. You can discuss many different reasons why a gender wage gap can occur, including:

• Women are underrepresented in higher paid occupations and are overrepresented in lower paid occupations (the problem may not be unequal pay but instead it may be unequal access to high paying jobs (glass ceiling?);

• Women are underrepresented among those earning advanced degrees, though mostly among older age cohorts (U.S. Bureau of Labor Statistics, Employment and Earnings, Vol. 45, January, 1998). Here the problem here might not be unequal pay but unequal access to higher education);

• Women have relatively less occupational-specific work experience and have relatively less unbroken work experience, as many women struggle between pursuing a career and raising a family. For example, one study found that women who were not mothers earned 90 percent of men’s salaries, ceteris paribus, whereas those who were mothers earned only 77 percent (Waldfogel, “Understanding the ‘Family Gap’ in Pay for Women with Children,” Journal of Economic Perspectives, Vol. 12, No. 1, 1998).

“Does it further the public interest (and the interests of women workers specifically) to propagate normative statements about wage inequality based on statistics created without ceteris paribus conditions?” Summarize the discussion by noting that economic studies have indeed found evidence that a gender gap in wages exists in the United States, even after controlling for all known relevant factors. However, the gender wage gap is much less than the 1/3 number often quoted by the media, and has been improving significantly over the last few decades (Blau, “Trends in the Well Being of American Women, 1970-1995,” Journal of 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.

Answers to the Review Quiz

Page 2

1. Some examples of scarcity include: not having enough time after a late-night party to sleep-in before attending class; not enough income to afford both tuition and a nice car; not enough learning capacity to study both an economics exam and a chemistry exam in one night.

2. Some people are complaining that millions of dollars are being spent on rebuilding Iraq while many indigent and homeless people are living in the U.S. Others are upset that too much time is spent commuting to and from work and not enough highways are being built in an effort to save “green space” in cities.

3. Macroeconomics: How will U.S. spending to rebuild Iraq after the war influence the national debt? What would happen to total output in the economy if the income tax rates were increased? Microeconomics: What will happen to the wages of the average grocery clerk if the grocery workers chose to unionize? What will happen to the number of students attending college if tuition were to increase 55 percent?

Page 8

1. The question “What gets produced?” is determined by the relative value that people place on consuming various goods and services. The question “How goods and services are produced” is answered by businesses that determine how land, labor, capital and entrepreneurship are to be combined to make the goods and services we all consume. The question “For whom are goods and services to be produced?” is answered by the way income is distributed to workers. In a market-based society, income is allocated according to the value that society places on the contribution a worker makes toward producing goods and services that society values.

2. When domestic steel producers Congress to vote to extend the recently imposed 30% tariffs on imported steel, it helps the workers and businesses in the domestic steel industry earn higher wages and profits, respectively. This would serve their self-interest. However, it hurts all building contractors, auto manufacturers, as well as all consumers of those goods and services that require steel to be produced. This decision would not serve the public interest.

Page 11

1. a) When a student sleeps-in instead of going to his early morning economics class, it may make him feel better in the short term, but when he get a bad grade on his exam, it makes him feel bad in the long term. b) When a student running late for class parks her car illegally, she benefits from saving time getting to the classroom, but she takes the risk of getting an expensive parking ticket. c) A student’s income increases when he takes on a part-time job, but he loses some of the leisure time and study time he might need to be emotionally balanced and ready for his exams.

2. a) When a student faces two final exams in one day, he must determine whether the benefits to spending the last hours studying a little more chemistry or a little more economics will yield a better contribution to her overall GPA. b) A college graduate may contemplate the marginal benefit of choosing a higher paying job offer that never involves foreign travel, or the marginal benefit of a much lower paying job offer that involves potentially exciting travel abroad at company expense. c) A student football fan with a “cheap seat” in the student bleachers located at the far end of the playing field may contemplate whether the marginal benefit of watching the game while sitting up front at the 50 yard line is worth the marginal cost of the higher ticket price.

3. People’s choices change when their incentives, that is the marginal benefit and/or marginal cost, of the choice changes. So economists predict changes in choices by determining when the marginal benefit and/or marginal cost change and then predicting that people make choices that bring them more marginal benefits and/or less marginal costs.

4. Economists emphasize that institutions, such as private property protected by a system of laws, affect people’s incentives. The goal is to have institutions that channel people’s choices so that the choices promote the social interest.

Page 13

1. A positive statement is an objective description of how the world is. It is testable. A normative statement is a subjective description of how the world ought to be. It is, by its very nature, not testable because there is no universally approved criterion by which the statement can be judged. “I will receive an A for this course,” is a positive statement made by an economics student—it might not be true, but it is testable. “I will receive a good grade for this course,” is a normative statement. Whether someone agrees with it depends on his or her interpretation of what makes for a “good” grade.

2. A model is a description of how the real world works. It is designed to reflect those aspects of the world that are relevant to the user of the model and ignore the aspects that are irrelevant. A typical model is a road map. It reflects only those aspects of the real world that are relevant in assisting the user in reaching his or her destination and avoids using information irrelevant to travel.

3. A theory is an implication arising from a model and is used to describe some observable action occurring in the real world. “It might work in theory, but it doesn’t in practice,” is a silly statement because theories are only as good as the models they are based upon. If a theory fails to predict the expected outcome, either the model it was based on was poorly constructed with false assumptions about how the various elements in the model interact with each other and/or the environment, or the model design lacked a relevant aspect of the world. If a model is well constructed, it will generate good theories.

4. Ceteris paribus is a Latin phrase meaning “other things equal,” and this assumption is used in economic modeling of individuals, businesses, or governments making choices. This assumption holds all relevant aspects of an economic model unchanged except the one aspect that economists are interested in when trying to uncover a “cause and effect” relationships within the model.

5. Everyday examples of the fallacy of composition includes: “When I take a side street instead of the highway on my way to work, I avoid much of the traffic and get to work much faster. Therefore, if everybody were to take that side street, everybody would get to work faster.” Examples of a post hoc fallacy includes: “I have noticed that whenever the volume of cards, letters, and packages in the mail increases dramatically, about a week or two later people are singing carols and expressing good will toward each other all over town (people celebrating the Christmas holiday). Therefore, it is the dramatic increase in mail delivery of cards and letters that causes such social behavior to occur.”

Answers to the Problems

1. The opportunity cost of the extra 10 points is the movie forgone when you stayed home to study.

2. The opportunity cost of going to the movies is the fall in your grade. That is the 20 points forgone from choosing to see the movie rather than study.

3. The opportunity cost of going to school is $9,600 of goods and services.

The opportunity cost of going to school this summer is the highest-valued activity that you will give up so that you can go to summer school. In going to summer school, you will forgo all the goods and services that you could have bought with the income from your summer job ($6,000) plus the expenditure on tuition ($2,000), textbooks ($200), and living expenses ($1,400).

4. The opportunity cost of taking this trip is $550 plus 8 hours of study time.

The opportunity cost is the highest-valued activity that you will give up by going skiing for the weekend. In taking the trip, you’ll forgo all the goods and services that you could have bought with the income from your weekend job ($100) plus your expenditure on travel and accommodation ($350), food ($40), and ski rental ($60). You’ll also forgo 8 hours of study time.

5. No, parking at this mall is not free. Yes, you did impose a cost on Harry.

Finding a parking space takes about 30 minutes, so you incur an opportunity cost when you park your car. The opportunity cost is the highest-valued activity that you forgo by spending 30 minutes parking your car. If you would have spent those 30 minutes studying, then the opportunity cost of parking at this mall is 30 minutes of studying.

The cost that you imposed on Harry is the additional 30 minutes that Harry will have to spend searching for a parking space.

6. The opportunity cost of seeing a free movie is the highest-valued activity that you forgo by spending the time (say 3 hours) at the movie house. If you usually buy popcorn and a soft drink, then the cost of these are also part of the opportunity cost of seeing a free movie. The opportunity cost of seeing Lord of the Rings is the same as for a free movie plus the $4 that you could have spent on other goods and services minus the cost of the soft drink. So seeing which movie has the higher opportunity cost depends on whether the value of the soft drink is bigger than or less than $4.

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 on the trip will be $3,000, film and videotape 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?

Solutions to Additional Problems

1. The opportunity cost of taking this trip is $10,600.

The opportunity cost of taking the trip is the highest-valued activity that you will give up so that you can go on the trip. In taking the trip, you will forgo all the goods and services that you could have bought with the income from your summer job ($6,000) plus the expenditure on travel ($3,000), film and videotape ($200), and food ($1,400).

2. The opportunity cost of parking before the building of the new parking garage is the highest-valued activity that you forgo by spending 15 minutes parking your car. The opportunity cost of parking in the new parking garage is $1 that you could have spent elsewhere. If the opportunity cost of 15 minutes spent parking your car is greater than the opportunity cost of $1, then the new parking garage is less costly.

Chapter 1 Appendix, Graphs in Economics

Outline

I. Graphing Data

A. Graphs are valuable tools that clarify what otherwise might be obscure relationships.

B. 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.

C. Three types of graphs are

1. Time-series graph—a graph that plots time along the x-axis and the variable being studied along the y-axis. A time-series graph shows the level of the variable, how it changes over time, whether changes are rapid or slow, and whether there is any trend.

2. Cross-section graph—a graph that plots the values of a variable for different groups at the same point in time.

3. 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.

II. Graphs Used in Economic Models

A. Graphs are used to show the relationship between variables.

B. Graphs can immediately convey the relationship between the variables:

1. A positive relationship (or direct relationship)—when the variable on the x-axis increases the variable on the y-axis increases. A straight line is a linear relationship.

2. A negative relationship (or inverse relationship)—when the variable on the x-axis increases, the variable on the y-axis decreases.

3. A maximum or a minimum—when the variable has a highest or lowest value.

III. The Slope of a Relationship

A. The slope of a curve equals the change in the value of the variable on the vertical axis at the point where the slope is being calculated divided by the change in the value of the variable on the horizontal axis at the relevant point.

1. In terms of symbols, the slope equals Δy/Δx, with ( standing for “change in.”

B. The slope of a straight line is constant. The slope is positive if the variables are positively related and negative if the variables are negatively related.

C. The slope of a curved line at a point equals the slope of the straight line that is tangent to the curved line at the point.

D. The slope of a curved line across an arc equals the slope of the straight line between the two points on the curved line.

IV. Graphing Relationships Among More Than Two Variables

A. When a relationship involves more than two variables, we can plot the relationship between two of the variables by holding other variables constant.

The Big Picture

Where we are going:

Chapter 1 Appendix sets out the types of graphs in economics. Many topics in the economics course require an understanding of the mathematical and graphing concepts explained in this appendix.

Overhead Transparencies

|Transparency |Text figure |Transparency title |

|1 |Figure A1.1 |Making a Graph |

|2 |Figure A1.5 |Positive (Direct) Relationships |

|3 |Figure A1.6 |Negative (Inverse) Relationships |

|4 |Figure A1.7 |Maximum and Minimum Points |

5

| |Figure A1.9 |The Slope of a Straight Line |

6

| |Figure A1.10 |Slope at a Point |

7

| |Figure A1.11 |Slope Across an Arc |

Electronic Supplements

MyEconLab

MyEconLab provides pre- and post-tests for each chapter so that students can assess their own progress. Results on these tests feed an individualized study plan that helps students focus their attention in the areas where they most need help.

Instructors can create and assign tests, quizzes, or graded homework assignments that incorporate graphing questions. Questions are automatically graded and results are tracked using an online grade book.

PowerPoint Lecture Notes

PowerPoint Electronic Lecture Notes with speaking notes are available and offer a full summary of the chapter.

PowerPoint Electronic Lecture Notes for students are available in MyEconLab.

Instructor CD-ROM with Computerized Test Banks

This CD-ROM contains Computerized Test Bank Files, Test Bank, and Instructor’s Manual files in Microsoft Word, and PowerPoint files. All test banks are available in Test Generator Software.

Answers to the Review Quizzes

Page 28

1. The three types of graphs used to show economic data are:

a. Scatter diagram. It plots the value of one economic variable against the value of another variable.

b. Time-series graph. It measures time (for example months or years) on the x-axis and the variable or variables in which we are interested on the y-axis.

c. Cross-section graph. It shows the values of an economic variable for different groups in a population at a point in time.

2. There are numerous examples of time-series graphs including the price of coffee over time, the price of oil over time, the unemployment rate over time, the interest rate over time, and the government deficit over time.

3. Time series graphs quickly and easily show:

a. The level of the variable—when it is high and low.

b. How the variable changes—whether it rises or falls.

c. The speed with which the variable changes—whether it rises or falls quickly or slowly.

4. Student’s examples of scatter diagrams will range widely. Three examples are

a. Positive relationship: A scatter diagram showing the number of kilometres travelled and the quantity of gasoline used.

b. Negative relationship: A scatter diagram showing the price of personal computers and the number sold.

c. No relationship: A scatter diagram showing the average price of a ticket to attend a major league baseball game and the number of students enrolled in Canadian universities.

5. A graph that shows the relationship between two variables that

a. move in the same direction is shown by a line that slopes upward.

b. move in opposite directions is shown by a line that slopes downward.

c. have a maximum is shown by a line that starts out sloping upward, reaches a maximum, and then slopes downward.

d. have a minimum is shown by a line that starts out sloping downward, reaches a minimum, and then slopes upward.

6. The graph in part (a) has a positive relationship. In part (c) the graph starts with a positive relationship until the maximum is reached and in part (d) the graph has a positive relationship to the right of the minimum value. The graph in part (b) has a negative relationship. In part (c) the graph has a negative relationship to the right of the maximum value and in part (d) the graph starts with a negative relationship before the minimum is reached.

7. The slope of a curved line at a point on the line is defined as the slope of the straight line tangent to the curved line at the point. The slope of a curved line across an arc—between two points on the curved line—equals the slope of the straight line between the two points.

8. To graph a relationship among more than two variables, hold constant the values of all the variables except two. Then plot the value of one of the variables against the other variable

Answers to the Problems

1. a. To make a time-series graph, plot the year on the x-axis and the inflation rate on the y-axis. The graph will be a line joining all the points.

b. (i) 1991; (ii) 1998; (iii) 1995, 1996, 1999, 2000; (iv) 1992, 1994, 1997, 1998, 2001; (v) 2000; (vi) 1992

c. Inflation has had a fairly flat trend through these years. The line is close to horizontal.

2. a. To make a time-series graph, plot the year on the x-axis and the interest rate on the y-axis. The graph will be a line joining all the points.

b. (i) 2000; (ii) 1993; (iii) 1994, 1995, 1997, 2000; (iv) 1992, 1993, 1996, 1998, 1999, 2001; (v) 2000; (vi) 2001

c. The interest rate has an upward trend. A straight line through the dots on the graph tends to slope up to the right.

3. To make a scatter diagram, plot the inflation rate on the x-axis and the interest rate on the y-axis. The graph will be a set of dots. The pattern made by the dots tells us that as the inflation rate increases, the interest rate usually increases.

4. To make a scatter diagram, plot the growth rate on the x-axis and the unemployment rate on the y-axis. The graph will be a set of dots. The pattern made by the dots tells us that the growth rate and the unemployment rate are not closely related.

5. a. To make a graph that shows the relationship between x and y, plot x on the x-axis and y on the y-axis. The relationship is positive because x and y move together: As x increases, y increases.

b. The slope increases as x increases. Slope is equal to the change in y divided by the change in x as we move along the curve. When x increases from1 to 2 (a change of 1), y increases from 1 to 4 (a change of 3), so the slope is 3. But when x increases from 4 to 5 (a change of 1), y increases from 16 to 25 (a change of 9), so the slope is 9.

c. The taller the building, the bigger is the cost of building it. The higher the unemployment rate, the higher is the crime rate. The longer the flight, the larger is the amount of fuel used.

6. a. To make a graph that shows the relationship between x and y, plot x on the x-axis and y on the y-axis. The relationship is negative because x and y move in opposite directions: As x increases, y decreases.

b. The slope increases as x increases. Slope is equal to the change in y divided by the change in x as we move along the curve. When x increases from 1 to 2 (a change of 1), y increases from 1 to 2 (a change of 1), so the slope is 1. But when x increases from 4 to 5 (a change of 1), y increases from 8 to 0 (a change of (8), so the slope is (8.

c. The less expensive a good, the greater is the number of people who buy it. The higher the interest rate, the smaller is the number of people who take out home mortgages. The less expensive the gasoline, the greater the distance car owners drive.

7. The slope equals 8.

The slope of the curve at the point where x is 4 is equal to the slope of the tangent to the curve at that point. Plot the points of the relationship and then draw a nice smooth curve through those points. Now draw the tangent line at the point where x is 4 and y is 16. Now calculate the slope of this tangent line. To do this, you must find another point on the tangent. The tangent line will cut the x-axis at 2, so another point is x equals 2 and y equals 0. Slope equals rise/run. The rise is 16 and the run is 2, so the slope is 8.

8. The slope equals (8

The slope of the curve at the point where x is 3 is equal to the slope of the tangent to the curve at that point. Plot the relationship and then draw the tangent line at the point where x is 3 and y is 16. Now calculate the slope of this tangent line. To do this, you must find another point on the tangent. The tangent line will cut the x-axis at 5, so another point is x equals 5 and y equals 0. Slope equals rise/run. The rise is (16 and the run is 2, so the slope is (8.

9. The slope is 7.

The slope of the relationship across the arc when x increases from 3 to 4 is equal to the slope of the straight line joining the points on the curve at x equals 3 and x equals 4. In the graph, draw this straight line. When x increases from 3 to 4, y increases from 9 to 16. Slope equals rise/run. The rise is 7 (16 minus 9) and the run is 1 (4 minus 3), so the slope across the arc is 7.

10. The slope is –8.

The slope of the relationship across the arc when x increases from 4 to 5 is equal to the slope of the straight line joining the points on the curve at x equals 4 and x equals 5. In the graph, the curve is a straight line between the points where x equals 4 and x equals 5. When x increases from 4 to 5, y decreases from 8 to 0. Slope equals rise/run. The rise is -8 (0 minus 8) and the run is 1 (5 minus 4), so the slope across the arc is -8.

11. The slope is (5/4.

The curve is a straight line, so its slope is the same at all points on the curve. Slope equals the change in the variable on the y-axis divided by the change in the variable on the x-axis. To calculate the slope, you must select two points on the line. One point is at 10 on the y-axis and 0 on the x-axis, and another is at 8 on the x-axis and 0 on the y-axis. The change in y from 10 to 0 is associated with the change in x from 0 to 8. Therefore the slope of the curve equals −10/8, which equals (5/4.

12. The slope is (2.

The curve is a straight line, so its slope is the same at all points on the curve. Slope equals the change in the variable on the y-axis divided by the change in the variable on the x-axis. To calculate the slope, you must select two points on the line. One point is at 18 on the y-axis and 0 on the x-axis, and another is at 9 on the x-axis and 0 on the y-axis. The change in y from 18 to 0 is associated with the change in x from 0 to 9. Therefore the slope of the curve equals (18/9, which equals (2.

13. a. The slope at point A is (2, and the slope at point B is (0.75.

To calculate the slope at a point on a curved line, draw the tangent to the line at the point. Then find a second point on the tangent and calculate the slope of the tangent.

The tangent at point A cuts the y-axis at 10. The slope of the tangent equals the change in y divided by the change in x. The change in y equals 4 (10 minus 6) and the change in x equals 2 (0 minus 2). The slope at point a is 4/2, which equals 2.

Similarly, the slope at point B is (0.75. The tangent at point B cuts the x-axis at 8. The change in y equals 1.5, and the change in x equals (2. The slope at point B is (0.75.

b. The slope across the arc AB is (1.125.

The slope across an arc AB equals the change in y, which is 4.5 (6.0 minus 1.5) divided by the change in x, which equals (4 (2 minus 6). The slope across the arc AB equals 4.5/(4, which is (1.125.

14. a. The slope at point A is (4, and the slope at point B is (1.

To calculate the slope at a point on a curved line, draw the tangent to the line at the point. Then find a second point on the tangent and calculate the slope of the tangent.

The tangent at point A cuts the x-axis at 2.5. The slope of the tangent equals the change in y divided by the change in x. The change in y equals 6 (6 minus 0) and the change in x equals (1.5 (1 minus 2.5). The slope at point a is 6/(1.5, which equals (4. Similarly, the slope at point B is (1. The tangent at point b cuts the y-axis at 5. The change in y equals 3, and the change in x equals (3. The slope at point b is (1.

b. The slope across the arc AB is (2.

The slope across an arc AB equals the change in y, which is 4 (6 minus 2) divided by the change in x, which equals (2 (1 minus 3). The slope across the arc AB equals 4/(2, which is (2.

15. a. The relationship is a set of curves, one for each different temperature.

To draw a graph of the relationship between the price and the number of rides, keep the temperature at 50(F and plot the data in that column against the price. The curve that you draw is the relationship between price and number of rides when the temperature is 50(F. Now repeat the exercise but keep the temperature at 70(F. Then repeat the exercise but keep the temperature at 90(F.

b. The relationship is a set of curves, one for each different price.

To draw a graph of the relationship between the temperature and the number of rides, keep the price at $5.00 a ride and plot the data in that row against the temperature. The curve shows the relationship between temperature and the number of rides when the price is $5.00 a ride. Now repeat the exercise but keep the price at $10.00 a ride. Repeat the exercise again and keep the price at $15.00 a ride and then at $20.00 a ride.

c. The relationship is a set of curves, one for each different number of rides.

To draw a graph of the relationship between the temperature and price, keep the number of rides at 32 and plot the data along the diagonal in the table. The curve is the relationship between temperature and price at which 32 rides are taken. Now repeat the exercise and keep the number of rides at 27. Repeat the exercise again and keep the number of rides at 18 and then at 40.

16. a. The relationship is a set of curves, one for each different level of rainfall.

To draw a graph of the relationship between the price and the number of umbrellas, keep the rainfall at 0 inches and plot the data in that column against the price. The curve that you draw is the relationship between price and number of umbrellas when the rainfall is 0 inches. Now repeat the exercise but keep the rainfall at 1 inch. Then repeat the exercise but keep the rainfall at 2 inches.

b. The relationship is a set of curves, one for each different price.

To draw a graph of the relationship between the rainfall and the number of umbrellas, keep the price at $10.00 an umbrella and plot the data in that row against the rainfall. The curve shows the relationship between rainfall and the number of umbrellas when the price is $10.00 an umbrella. Now repeat the exercise but keep the price at $20.00 an umbrella. Repeat the exercise again and keep the price at $30.00 an umbrella and then at $40.00 an umbrella.

c. The relationship is a set of curves, one for each different number of umbrellas.

To draw a graph of the relationship between the rainfall and price, keep the number of umbrellas at 7 and plot the data along the diagonal in the table. The curve is the relationship between rainfall and price at which 7 umbrellas are purchased. Now repeat the exercise and keep the number of umbrellas at 4. Repeat the exercise again and keep the number of umbrellas at 2 and then at 8.

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