WHAT IS ECONOMICS? 1 CHAPTER © 2003 Pearson Education Canada Inc.1-1

Objectives After studying this chapter, you will be able to: –Define economics and distinguish between microeconomics and macroeconomics –Explain how economists go about their work as social scientists –Explain the ideas that define the economic way of thinking –Explain the three big questions of microeconomics 1-2

Definition of Economics Scarcity –All economic questions arise because we are unable to satisfy all our wants. –Our inability to satisfy all our wants is called scarcity. –Economics is the social science that studies the choices that we make as we cope with scarcity and the institutions that have evolved to influence and reconcile our choices. 1-3

A Definition of Economics Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided. Economics is the study of how scarce resources are allocated among conflicting demands.

Economics: A Social Science Social science –The task of economic science is to discover positive statements that are consistent with what we observe in the world and that enable us to understand how the economic world works. –This task is large and breaks into three steps:  Observation and measurement  Model building  Testing models –Economic Theory 1-5

Economics: A Social Science Obstacles and Pitfalls in Economics –Economists cannot easily do experiments. –To isolate the effect of interest, economists use the logical device called ceteris paribus, or “ other things being equal. ” –Economists try to isolate cause-and-effect relationship by changing only one variable at a time, holding all other relevant factors unchanged. 1-6

1. To Learn a Way of Thinking... Three Fundamental Concepts of Economic Thinking –Opportunity Cost –Marginalism –Information, Incentives, and Market Coordinations

Opportunity Costs The opportunity cost of something is that which we give up when we make that choice or decision. The implication is that all decisions involve trade-offs. “There’s no such thing as a free lunch!!”

Question to Consider What is the opportunity cost of your attending university? Include all forgone options in your consideration.

Margins and Incentives –People make choices at the margin, which means that they evaluate the consequences of making incremental changes in the use of their resources. –The benefit from pursuing an incremental increase in an activity is its marginal benefit. –The opportunity cost of pursuing an incremental increase in an activity is its marginal cost. 1-10

2. Understanding Society Present and past economic decisions have an enormous influence on the character of life in a society. The state of our physical environment, the level of material well-being, and the nature and number of jobs are all products of the economic system.

The Scope of Economics Microeconomics –Microeconomics is the study of choices made by individuals and businesses, the way these choices interact, and the influence that governments exert on them. Macroeconomics –Macroeconomics is the study of the effects on the national and global economy of the choices that individuals, businesses, and governments make. 1-12

The Scope of Economics

Three Big Microeconomic Questions –Goods and services are the objects that people value and produce to satisfy wants. –Microeconomics seeks to understand what determines: – What goods and services are produced – How goods and services are produced – For whom goods and services are produced 1-14

Three Big Microeconomic Questions What Goods and Services are Produced? –Figure 1.1 shows the major items produced in the Canadian economy today. –It emphasizes the dominant place of services in our economy. 1-15

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Three Big Microeconomic Questions –Figure 1.2 shows the trends in what the Canadian economy has produced over the past 50 years. –It shows the decline of agriculture, mining, construction, and manufacturing, and the expansion of services. 1-17

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Three Big Microeconomic Questions –The facts about what we produce raise the deeper question: –What determines the quantities of houses and apartments, DVD players, and corn that we produce? –Microeconomics provides some answers to these questions. 1-19

Three Big Microeconomic Questions How are Goods and Services Produced? –Factors of production are the resources that businesses use to produce goods and services. –They are grouped into four categories:  Land  Labour  Capital  Entrepreneurship 1-20

Three Big Microeconomic Questions –The “ gifts of nature ” that we use to produce goods and services are land. –The work time and effort that people devote to producing goods and services is labour. –The quality of labour depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience. 1-21

Three Big Microeconomic Questions –The tools, instruments, machines, buildings, and other constructions that are used to produce goods and services are called capital. –The human resource that organizes land, labour, and capital is entrepreneurship. 1-22

Three Big Microeconomic Questions –Figure 1.3 shows a measure of the growth of human capital in Canada over the last twenty five years — the percentage of the population that has completed different levels of education. 1-23

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Three Big Microeconomic Questions –The facts about how we produce raise the deeper question: –What determines the quantities of capital, labour, and other resources that get used to produce goods and services? –Microeconomics provides some answers to this question. 1-25

Three Big Microeconomic Questions For Whom are Goods and Services Produced? –Who gets the goods and services depends on the incomes that people earn. – Land earns rent. – Labour earns wages. – Capital earns interest. – Entrepreneurship earns profit. 1-26

Three Big Microeconomic Questions –Figure 1.4 shows the distribution of income in Canada. –The poorest 20 percent earn only 4 percent of total income while the richest 20 percent earn 46 percent of total income. – 1-27

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Three Big Microeconomic Questions –The facts about for whom raise the deeper question: –What determines earnings and the distribution of income that in turn determine who gets the goods and services produced? –Microeconomics provides some answers to this question. 1-29