The Scope and Method of Economics Chapter 1: The Scope and Method of Economics

Key Concepts (* elaborated on in lecture) Cartesian coordinate system and graphs* Criteria for evaluating economic results Economic growth c. Equity Efficiency d. Stability Criteria for evaluating economic choices (or making decisions or solving problems) Opportunity cost* ‘Marginalism’ and sunk costs* Efficient markets*

Key Concepts (cont’d) Economics* Errors or cautions in logic or reasoning* Post hoc Fallacy of composition Ceteris paribus Correlation vs. causality Macroeconomics vs. microeconomics* Models, theories, and variables Normative vs. positive economics Negative vs. positive slopes*

Economics is a social science that studies how people, either individually or collectively, make choices to use scarce resources. Q. Explain further or define each of the underlined words above.

A. People  consumers, workers, gov’t officials Choices  consumption, production, exchange, policies Scarce  limited Resources  natural (e.g. land, water) capital (man-made bldgs & equip) labor managerial skills financial (i.e. money) time

Opportunity Cost Examples of A student skipping Dr. Deiter’s Econ class? Going to college versus entering the work place? An investor waiting a year to sell some property versus selling now? A business firm buys some new machinery?

‘Efficient’ markets (or situations) implies unequal ‘costs’ or ‘profits’ associated with alternatives are eliminated as people respond to incentives (e.g. profit, risk, time savings, price, money, etc.) Examples: Drive-through lanes at a bank Local gas station making ‘excessive’ profits Business firm producing a product out of two plants

Marginal Analysis Example #1 Joe lives in Houston and is traveling to Kansas City on business. What is the ‘marginal’ cost to Joe of visiting his grandmother who lives in Des Moines by extending his trip one more day?

Marginal Analysis Example #2 Why does an airline sometimes set aside a few seats to be sold at big discounts through pricline.com or other Web sites?

Marginal Analysis Example #3 Sue has been asked by her boss to attend a business meeting 125 miles away by either renting a car for $50 (fuel costs not included) or by driving a company-owned car. Her boss has asked her to choose the cheapest form of transportation for the company. Identify marginal and sunk costs of driving the company car.

Q. What is the favorite bumper sticker of most economists? A. Economists Do It ‘Marginally’

“Good” Economic Decisions Marginal benefits > marginal costs Examples of marginal benefits:  profit  revenue  cost  safety  risk Marginal costs = opposite of above examples

Cautions in analyzing variable relationships Ceteris paribus  hold all relevant explanatory variables EXCEPT one constant e.g. # miles driven depends on price of gasoline, ceteris paribus

Cautions in analyzing variable relationships Post hoc fallacy  falsely assuming a first event caused second event e.g. price of gasoline decrease caused the stock market to decrease

Cautions in analyzing variable relationships Correlation does not imply causality e.g. the number of cars and number of crimes in cities are positively correlated; thus, cars cause crimes

Cautions in analyzing variable relationships Fallacy of composition  what is good for one is not necessarily good for all e.g. one person vs. everybody standing up to get a better view at a sporting event

Equation of a straight line where: y = vertical axis variable x = horizontal axis variable Y = b + mx where b = vertical-axis intercept (value of y when x = 0) m = slope = Δy/Δx =

The slope (m) of a line has two components: Sign > 0  y and x  (or ) together  positive correlation Number (or magnitude) which shows amount y is expected to change for each 1 unit change in x

Given any 2 points, one can calculate the actual equation of a straight line: Step #1) Step #2)

Refer to Table 1A.2 and Fig. 1A.3 What is the slope of the straight line (number and interpretation)? What is the ‘y-axis intercept’ value? What is the significance of the dashed 45° line in Fig. 1A.3? What does this imply about points ‘A’ and ‘B’?

Refer to Table 1A.2 and Fig. 1A.3 What is the equation of the line in Fig. 1A.3? What is predicted or expected avg. consumer expenditures if avg. consumer income before taxes is $100,000? How would the line in Fig. 1A.3 change if we observed a) a steeper slope, same y-axis intercept and b) a greater y-axis intercept, same slope?