1. 1
What Is Economics?
Why does public discussion of economic policy so often show the abysmal ignorance of the participants? Whey do I so often want to cry at what public figures, the press, and television commentators say about economic affairs?
Robert M. Solow

2. Contents Ideas for Beyond the Final Exam
Inside the Economist’s Toolkit
Appendix: Using Graphs: A Review
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

3. Ideas for Beyond the Final Exam
Idea 1: How Much Does It Really Cost?
Opportunity cost = value of the best forgone alternative to any decision
All actions  opportunity costs
Opportunity costs  true economic costs

4. Ideas for Beyond the Final Exam
Idea 2: The Market Strikes Back
Markets set prices.
Government may intervene.
Markets may “strike back.”
Example: rent control reduces the supply of housing.

5. Ideas for Beyond the Final Exam
Idea 3: The Surprising Principle of Comparative Advantage
When two nations trade, both benefit.
Comparative advantage = the production of goods with the lowest opportunity cost
Comparative advantage  specialization

6. Ideas for Beyond the Final Exam
Idea 4: Trade is a Win-Win Situation
Trade  benefits for both buyers & sellers
Restrictions on trade   benefits
Intervention into markets   costs

7. Ideas for Beyond the Final Exam
Idea 5: The Importance of Thinking at the Margin
Marginal = small change
Marginal costs = change in costs
Rational decisions = comparison of costs to benefits at the margin

8. Ideas for Beyond the Final Exam
Idea 6: Externalities: Shortcoming of the Market Cured by Market Methods
Externalities = effects of transactions on third parties
Externalities  social costs
Market failure  need for government intervention

9. Ideas for Beyond the Final Exam
Idea 7: The Trade-off between Efficiency and Equality
More efficiency  more output & jobs
More equality  less efficiency
Labor markets distribute income efficiently, not equally.

10. Ideas for Beyond the Final Exam
Idea 8: The Short-Run Trade-off between Inflation and Unemployment
Low unemployment  rising prices
High unemployment  falling prices

11. Ideas for Beyond the Final Exam
Idea 9: Productivity Growth Is (Almost) Everything in the Long Run
Productivity growth  more output
More output  higher living standards
In the long run, productivity growth is (almost) everything.

12. Inside the Economist’s Toolkit
Economics as a Discipline
Economics is the most scientific of the social sciences.
Yet, it is much more social than the natural sciences.

13. Inside the Economist’s Toolkit
The Need for Abstraction
Real world complexity  simplification in economic theory
The “art” of economics: focus on the essential; ignore the trivial.

14. Inside the Economist’s Toolkit
The Role of Economic Theory
Economic theory = explanation of why economic events occur
Correlation  causality
Economic theories  predictions

15. Inside the Economist’s Toolkit
What Is an Economic Model?
Economic model = formal statement of economic theory
Usually expressed in mathematics, with equations and graphs

16. Inside the Economist’s Toolkit
Reasons for Disagreements: Imperfect Information and Value Judgments
Among economists,
agreement > disagreement
Imperfect information  disagreements
Value judgments  disagreements

17. Appendix Using Graphs: A Review

18. Graphs Used in Economic Analysis
Display large quantity of data quickly
Facilitate data interpretation and analysis
Important statistical relationships more apparent than from written descriptions or long lists of numbers

19. Two-Variable Diagrams
Variable = something measured by a number
Examples: price and quantity
View two variables together to see if they exhibit a relationship.

20. TABLE 1-1 Quantities of Natural Gas Demanded at Various Prices
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21. FIGURE 1-1 Hypothetical Demand Curve for Gas6 6 5 5 4 4
Price
Price P a Q P a 3 3 b b 2 2 1 1 Q 20 40 60 80
100
120
140 20 40 60 80
100
120
140
Quantity
(a)
Quantity
(b)
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22. The Definition and Measurement of Slope
Slope = ratio of vertical change to horizontal change
Rise/run
Measure of steepness of the line

23. The Definition and Measurement of Slope
The slope of a straight line
Negative slope = one variable rises while the other variable falls
The two variables move in opposite directions.
Positive slope = two variables rise and fall together
The two variables move in the same direction.

24. FIGURE 1-2a Negative SlopeY
Negative
slope X
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25. FIGURE 1-2b Positive SlopeY
Positive
slope X
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26. The Definition and Measurement of Slope
Zero slope = the variable on the horizontal axis can be any value while the variable on the vertical axis is fixed
Horizontal line
Infinite slope = the variable on the vertical axis can be any value while the variable on the horizontal axis is fixed
Vertical line

27. FIGURE 1-2c Zero Slope Y Zero slope X
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28. FIGURE 1-2d Infinite SlopeY
Infinite
slope X
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29. The Definition and Measurement of Slope
The slope of a straight line
Slope is constant along a straight line.
Slope can be measured between any two points on one axis and the corresponding two points on the other axis.

30. FIGURE 1-3 How to Measure SlopeY Y 3 — 10
Slope = C 11 B C 9 1 — 10
Slope = B 8 8 A A X X 3 13 3 13
(a)
(b)
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31. The Definition and Measurement of Slope
The slope of a curved line
Slope changes from point to point on a curved line.
Curved line bowed toward the origin has a negative slope.
Variables change in opposite directions.
Curved line bowed away from the origin has a positive slope.
Variables change in the same direction.

32. FIGURE 1-4a Negative Slope in Curved LinesY
Negative
slope X
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33. FIGURE 1-4b Positive Slope in Curved LinesY
Positive
slope X
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34. The Definition and Measurement of Slope
The slope of a curved line
A curved can have both a positive and negative slope depending on where on the curve is measured.
The slope at a point on a curved-line is measured by a line tangent to that point.

35. FIGURE 1-4c,d Behavior of Slope in Curved LinesY Y
Negative
slope
Positive
slope
Negative
slope
Positive
slope X X
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36. FIGURE 1-5 How to Measure Slope at a Point on a CurveY r 8 D 7 E 6 R t F 5 C 4 G T 3 M 2 1 A B X 1 2 3 4 5 6 7 8 9 10
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37. Rays Through the Origin and 45-degree Lines
Y-intercept = point at which a line touches the y axis
Ray through the origin = straight line graph with a y-intercept of zero

38. FIGURE 1-6 Rays through the Origin
Slope = + 2 5
Slope = + 1 4 B C D 3 A 2 1 – 2
Slope = + K 1 E X 1 2 3 4 5
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39. Squeezing 3 Dimensions into 2: Contour Maps
Some problems involve more than two variables
Economic “contour map” called a production indifference map
Shows how variable Z changes as we change either X or Y

40. FIGURE 1-8 An Economic Contour MapY Z
= 40 80 Z
= 30 70 Z
= 20 Z
= 10 60 50
Yards of Cloth per Day A 40 30 B 20 10 X 10 20 30 40 50 60 70 80
Labor Hours per Day
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