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Chapter 1. Thinking like an economist. Key concepts. The problem of scarcity Scarce resources and production Economics: the study of scarcity and choice The methodology of economics Hazards of the economic way of thinking Why do economists disagree?. The problem of scarcity.
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Chapter1 Thinking like an economist
Key concepts • The problem of scarcity • Scarce resources and production • Economics: the study of scarcity and choice • The methodology of economics • Hazards of the economic way of thinking • Why do economists disagree?
The problem of scarcity • Scarcity forces us all to make choices as we never have the amount of goods and services we want: • individuals: a bigger flat screen TV etc. • governments: improved schools, highways and high speed internet network (NBN) etc.
The problem of scarcity • Economicsaims to explain what occurs as a result of scarcity because wants are forever greater than the available resources. • Economistsaim to explain how individuals, groups and society can: • satisfy their wants given the resources at their disposal.
Scarce resources and production • Scarcity is also called the economic problem. • Individuals and countries never have as much of all the goods and services they would like because there are insufficientresources to produce such goods and services.
Scarce resources and production • Resources are the basic inputs used to produce goods and services. • Resources are also called the factors of production and are split into three main categories:
Resources: land • Any natural resource provided by nature used in the process of production: • forests, minerals, wildlife, oil, rivers, lakes and oceans. • May be renewable or non-renewable.
Resources: labour • Measured by the number of people available for work and the number of workers. • The mental and physical capacity of workers to produce goods and services. • These include:
Entrepreneurship • Entrepreneurshipis a special type of labour. • This is the creative ability of individuals to organise and manage the combination of resources to produce goods and services. • An example of this: Edward Joseph Nathan
Resources: capital • Capital relates to human-made goods that produce goods and services. • Capital is used to produce the goods and services desired, such as a factory that produces televisions. • Unlike in accounting, money is notincluded in the economic definition of capital as money is a measure of value placed on goods.
Economics: the study of scarcity and choice • Economics is the study of how society chooses to allocate its scarce resources to the production of goods and services in order to satisfy unlimited wants. • Society makes two types of choices: • economy-wide (Macro) • individual (Micro).
The methodology of economics • Economists (like other scientists) use scientific method. • Scientific method is a step-by-step procedure for solving problems.
More about models • A model is a simplified view of reality. • It sets out the relationship between variables; causes and effects. • A model is only valid when it enables economists to forecast or predict the results of various changes in variables. ‘Models should be as simple as possible, but not any simpler’ - Albert Einstein
Hazards of the economic way of thinking • There are two potential problems to be aware of: • the ceteris paribus assumption • possible confusion of association and causation.
Ceteris paribus • Ceteris(pronounced ‘keteris’)paribus • Latin: ‘other things remaining unchanged’. • It enables economists to see how a change in one variable affects the overall outcome. • Reason: if all the variables change at the same time, there is no way to know which one caused the change.
Association vs. causation • We cannot always assume that when one event follows another, the first caused the second. • For example, assume exports from Indonesia rose last month. Two events might be associated: • the hole in the ozone layer grew last month. • currency movements reduced the cost to Australians of buying Indonesian goods. • But are they both possible causes?
Why do economists disagree? • As in other professions, disagreements occur. • A major reason for disagreements in economics is due to the assumptions made about human nature. • Modelling more elaborate assumptions about human nature has resulted in the growth of behavioural economics.
Positive economics • Positive economics is an analysis limited to statements that are verifiable. • Positive statements are testable they can be proven true or false. • Examples • ‘Airbags save lives.’ • ‘Smoking is harmful to your health.’
Normative economics • Normative economics is an analysis based on value judgements. • Normative statements cannot be proven by facts to be true or false. • Examples: • ‘Every teenager who wants a job should have one.’ • ‘The government shouldallocate more money to education.’
Appendix to Chapter1 Applying graphs to economics
Key concepts • Why use graphs in economics? • What is a direct relationship? • What is an inverse relationship? • What is an independent relationship between two variables? • How do we measure the slope of a line? • How do graphs show three-variable relationships?
A direct relationship • A direct relationship is a positive association between two variables. • When one variable increases, the other also increases. • When one variable decreases, the other also decreases. • Note the line on the next slide has a positive slope.
An inverse relationship • An inverse relationship is a negative association between two variables. • When one variable increases, the other decreases. • When one variable decreases, the other increases. • Note the line on the next slide has a negativeslope.
An independent relationship • An independent relationship is where there is no (zero)association between two variables. • When one variable changes, the other remains unchanged.
The slope of a straight line • The ratio of change in the variable on the vertical axis (the rise or fall) to change in the variable on the horizontal axis (the run). • Slope=rise/run = vertical axis/horizontal axis = Y/X
The slope of a curve • A ‘straight-line’ relationship is a linear relationship. • The slope of a curve changes from one point on the curve to another. • To determine the slope of a curve at any point, draw a tangent to the line at that point, and measure the slope of the tangent.
Introducing a third variable • How can a model drawn in two dimensions show the impact of changes in a third variable? • Remember Ceteris Paribus: • We must distinguish between movements and shifts. • Movements along a graph show changes in one variable on the graph’s axes • Shifts show changes in other variables.
