The nature and method of economics

1. The nature and method of economics Chapter 1

2. The nature and method of economics • What is economics? • the social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants. • II. The Economic Perspective • A. Scarcity and Choice • 1. Resources are scarce (limited). • 2. Scarcity causes us to make choices. • 3. “There is no free lunch.” • 4. Opportunity cost – to get one more of one thing, you forgo the opportunity of getting something else.

3. The nature and method of economics • B. Rational behavior • 1. Assume human behavior reflects “rational self-interest.” • 2. Same person may make different choices under different circumstances. • C. Marginalism: Benefits and Costs • 1. Marginal means “extra,” “additional,” or “a change in.” • 2. Any option involves marginal benefits and marginal costs. • 3. The marginal cost of an action should not exceed its marginal benefits • 4. Marginal analysis is a comparison between marginal benefits and marginal costs.

4. The nature and method of economics • III. Economic Methodology • A. Theorteical economics • 1. The process of deriving theories and principles. • 2. Economic theories and principles are statements about economic behavior or the economy that enable prediction of the probable effects of certain actions. • B. Other-Things-Equal Assumption • Economists assume that all other variables except those under • immediate consideration are held constant for a particular analysis. • C. Abstractions • Economic principles/theories are abstractions – simplifications that omit irrelevant facts and circumstances.

5. The nature and method of economics • D. Policy Economics – recognition that theories and data can be used to formulate policies – causes of action based on economic principles intended to resolve a specific economic problem or further an economic goal. Basic steps of policy making are: • 1. state the goal – must be specific. • 2. determine the policy options – come up with several ways to reach your goal. • 3. implement and evaluate the policy that was selected – how well did the policy work?

6. The nature and method of economics • E. Economic Goals of US, many other countries • 1. economic growth • 2. full employment • 3. economic efficiency – maximum wants fulfilled in relation to available resources • 4. price-level stability – avoid inflation and deflation • 5. economic freedom – freedom in economic choices • 6. equitable distribution of income – no group faces poverty while most others enjoy abundance • 7. economic security – provide for those who can not provide for themselves. • 8. balance of trade – imports equal to exports

7. The nature and method of economics • IV. Macroeconomics and Microeconomics • A. Macroeconomics • 1. looks at the economy as a whole, or its basic subdivisions or aggregates. • 2. ex: total income, total employment, general price level. • B. Microeconomics • 1. looks at specific economic units, very small segment of the economy. • 2. ex: firms, households, individual industry

8. The nature and method of economics • C. Positive and Normative Economics • 1. Positive economics – focuses on facts and cause-and-effect relationships, avoids value judgments, deals with what the economy is actually like. “What is” • 2. Normative economics – incorporates value judgments about what the economy should be like or what policy actions should be recommended to achieve a desirable goal. “What might be.”

9. The nature and method of economics • V. Pitfalls to Sound Reasoning • A. Biases – most all people have economic biases; ex: corporate profits are excessive. • B. Loaded Terminology – media and others may slant their comments; ex: using the following phrase: “obscene” profits. • C. Definitions – some words have different meanings when used in the economic context. Ex: Typically “investment” means purchasing stock in a corporation; in economics, it means purchasing assets like machinery and equipment. • D. Fallacy of Composition • A statement that is valid for an individual is not necessarily valid for the larger group or whole.

10. The nature and method of economics • E. Causation Fallacies • 1. Post Hoc Fallacy – Just because event A proceeds event B, does not mean event A caused event B. • 2. Correlation versus Causation • a. Correlation between two events or two sets of data indicates only that they are associated in some systematic and dependable way. • b. Causation means that one event caused a different event to happen.