Why is economics useful? and Method Can economists predict ...

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chapter 1

The Role and Method of Economics

1.1 ECONOMICS: A BRIEF INTRODUCTION

What is economics?

1.2 ECONOMICS AS A SCIENCE

Why is economics useful?

1.3 ECONOMIC BEHAVIOR

Can economists predict human behavior?

1.4 ECONOMIC THEORY

Why do we need a theory?

1.5 PROBLEMS TO AVOID IN SCIENTIFIC THINKING

What are the key problems to avoid in scientific thinking?

1.6 POSITIVE AND NORMATIVE ANALYSIS

Why is it important that we distinguish between positive and normative analysis?

APPENDIX: WORKING WITH GRAPHS

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CHAPTER ONE | The Role and Methods of Economics

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1.1

Economics: A Brief Introduction

Why study economics? What is economics? What is scarcity?

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WHY STUDY ECONOMICS?

As you begin your first course in economics, you may be asking yourself why you're here. What does economics have to do with your life? While there are many good reasons to study economics, perhaps the best reason is that many issues in our lives are at least partly economic in character. For example, a good understanding of economics would allow you to answer such questions as: Why do 10 A.M. classes fill up quicker than 8 A.M. classes during registration? Why is it difficult to find a taxicab after a play on a cold and rainy night in New York City? Why is it so hard to find an apartment in cities such as San Francisco, Berkeley, and New York? Why is teenage unemployment always higher than adult unemployment? Why are the prices of prescription drugs so high? What are the costs of unanticipated inflation? Will higher taxes on cigarettes reduce the number of people smoking? Why do professional athletes make so much money? Why are unemployment rates higher in some parts of the country than in others? Why don't we just get rid of the penny? Why do U.S. auto producers like tariffs (taxes) on imported cars? The study of economics improves your understanding of these and many other concerns.

Another reason to study economics is that it may teach you how to "think better"-- economics helps develop a disciplined method of thinking about problems. While economics may not always give you clear-cut answers, it will give you something even more powerful: the economic way of thinking. The problem-solving tools you will develop by studying economics will prove valuable to you both in your personal and professional life, regardless of your career choice. A student of economics becomes aware that, at a basic level, much of economic life involves choosing among alternative courses of action-- making choices between our conflicting wants and desires in a world of limited resources. Economics provides some clues as to how to intelligently evaluate these options and determine the most appropriate choices in given situations.

When you come across this Web icon in your book, go to the Sexton Web site at and click on the links that will take you to fun, useful, and interesting economics or economics-related sites.

ECONOMICS--A WORD WITH MANY DIFFERENT MEANINGS

Some individuals think economics involves the study of the stock market and corporate finance, and it does--in part. Others think that economics is concerned with the wise use of money and other matters of personal finance, and it is--in part. Still others think that economics involves forecasting or predicting what business conditions will be in the future, and again, it does--in part.

A Unique Way of Looking at Human Behavior Economics is a unique way of analyzing many areas of human behavior. Indeed, the range of topics to which economic analysis is applied is quite broad! Many researchers have dis-

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CHAPTER ONE | The Role and Method of Economics

Economics: A Brief Introduction

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covered that the economic approach to human behavior sheds light on social problems that have been with us for a long time: discrimination, education, crime, divorce, political favoritism, and many more. In fact, economics is frontpage news almost every day, whether it involves politicians talking about tax cuts, inflation, interest rates, or unemployment; business executives talking about restructuring their companies to cut costs; or the average citizen trying to figure out how to make ends meet each month. Economics is all of this and more.

Growing Wants and Scarce Resources

Precisely defined, economics is the study of the allocation of our limited resources to satisfy our unlimited wants. Resources are inputs, such as land, human effort and skills, and machines and factories, used to produce goods and services. The problem is that our wants exceed our limited resources, a fact that we call scarcity. Scarcity forces us to make choices on how to best use our limited resources. This is the economic problem: Scarcity forces us to choose, and choices are costly because we must give up other opportunities that we value. This economizing problem is evident in every aspect of our lives. Choosing between a trip to the grocery store or the mall, or between finishing a research paper or going to a movie, can be understood more easily when one has a good handle on the "economic way of thinking."

ECONOMICS IS ALL AROUND US

Although many things that we desire in life are considered to be "non-economic," economics concerns anything that is considered worthwhile to some human being. For instance, love, sexual activity, and religion have value for most people. Even these have an economic dimension. Consider religion, for example. Concern for spiritual matters has led to the development of institutions such as churches and temples that provide religious and spiritual services. These services are goods that many people desire. Love and sex likewise have received economists' scrutiny. One product of love, the institution of the family, is an important economic decision-making unit. Also, sexual activity results in the birth of children, one of the most important "goods" that humans desire.

Even time has an economic dimension. In fact, perhaps the most precious single resource is time. We all have the same limited amount of time per day, and how we divide our time between work and leisure (including perhaps study, sleep, exercise, etc.) is a distinctly economic matter. If we choose more work, we must sacrifice leisure. If we choose to study, we must sacrifice time with friends, or time spent sleeping or watching TV. Virtually everything we decide to do, then, has an economic dimension.

Living in a world of scarcity means trade-offs. And it is important that we know what these trade-offs are so we can make better choices about the options available to us.

The front pages of our daily newspapers are filled with articles related to economics-- either directly or indirectly. News headlines might read: Fuel Prices Soar; Should Social Security Be Revamped?; Stocks Rise; Stocks Fall; President Vows to Increase National Defense Spending; Health Costs Continue to Rise.

economics the study of the allocation of our limited resources to satisfy our unlimited wants

resources inputs used to produce goods and services

scarcity this occurs when our wants exceed our limited resources

the economic problem scarcity forces us to choose, and choices are costly because we must give up other opportunities that we value

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CHAPTER ONE | The Role and Methods of Economics

INIn TThHe NEEWNSEWS

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A B C D F

AMERICANS SCORE POORLY ON ECONOMIC LITERACY

--LYNN BRENNER

AVERAGE AMERICAN GRADE: F The National Council of Economic Education tested 1,010 adults and 1,085 high school students on their knowledge of basic economic principles.

Among Adults (percent)

6 10 15 20 49

Among High School Students (percent)

3 7 11 13 66

On average, adults got a grade of 57 percent on a test on the basics of economics. Among high school students, the average grade was 48 percent.

Almost two-thirds of those tested did not know that in times of inflation money does not hold its value.

Only 58 percent of the students understood that when the demand for a product goes up but the supply doesn't, its price is likely to increase.

Half of the adults and about two-thirds of the students didn't know that the stock market brings people who want to buy stocks together with those who want to sell them.

Just over one in three Americans realize that society must make choices about how to use resources.

SOURCE: Lynn Brenner, "What We Need to Know About Money," Parade Magazine, April 18, 1999, pp. 4 ?7. Reprinted with permission from Parade, copyright ? 1999.

Section Check

SECTION CHECK

1. Economics is a problem-solving science. 2. Economics is the study of the allocation of our limited resources to satisfy our

unlimited wants. 3. Resources are inputs used to produce goods and services. 4. Our unlimited wants exceed our resources, so we must make choices.

1. Why is economics worth studying? 2. What is the definition of economics? 3. Why does scarcity force us to make choices? 4. Why are choices costly? 5. Why do even "non-economic" issues have an economic dimension?

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Economics as a Science

How is economics similar to other social sciences? What are macroeconomics and microeconomics? Are microeconomic tools important to macroeconomists?

ECONOMICS IS A SOCIAL SCIENCE

Like psychology, sociology, anthropology, and political science, economics is considered a social science. Economics, like the other social sciences, is concerned with reaching gen-

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Economic Behavior

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eralizations about human behavior. Economics is the study of people. It is the social science that studies the choices people make in a world of limited resources.

Economics and the other social sciences often complement one another. For example, a political scientist might examine the process that led to the adoption of a certain tax policy, while an economist might analyze the impact of that tax policy. Or while a psychologist may try to figure out what makes the criminal mind work, an economist might study the factors causing a change in the crime rate. Social scientists, then, may be studying the same issue but from different perspectives.

MACROECONOMICS AND MICROECONOMICS

Conventionally, we distinguish two main branches of economics, macroeconomics and microeconomics. Macroeconomics deals with the aggregate, or total economy; it looks at economic problems as they influence the whole of society. Topics covered in macroeconomics include discussions of inflation, unemployment, business cycles, and economic growth. Microeconomics, by contrast, deals with the smaller units within the economy, attempting to understand the decision-making behavior of firms and households and their interaction in markets for particular goods or services. Microeconomic topics include discussions of health care, agricultural subsidies, the price of everyday items such as running shoes, the distribution of income, and the impact of labor unions on wages. To put it simply, microeconomics looks at the trees while macroeconomics looks at the forest.

Section Check

SECTION CHECK

macroeconomics the study of the whole economy including the topics of inflation, unemployment, and economic growth

aggregate the total amount--such as the aggregate level of output

microeconomics the study of household and firm behavior and how they interact in the marketplace

1. Economics is concerned with reaching generalizations about human behavior. 2. Economics provides tools to intelligently evaluate and decide on choices. 3. Macroeconomics deals with the aggregate, or total, economy. 4. Microeconomics focuses on smaller units within the economy--firms and

households, and how they interact in the marketplace.

1. What makes economics a social science? 2. What distinguishes macroeconomics from microeconomics? 3. Why is the market for running shoes considered a microeconomic topic? 4. Why is inflation considered a macroeconomic topic?

Economic Behavior

What is self-interest? Why is self-interest not the same as selfishness?

SELF-INTEREST Economists assume that individuals act as if they are motivated by self-interest and respond in predictable ways to changing circumstances. In other words, self-interest is a good predictor of human behavior. For example, to a worker, self-interest means pursuing a higher paying job and better working conditions. To a consumer, it means gaining a greater level of satisfaction from their limited income and time.

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