1. 1 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Art and Science of Economic Analysis

2. 2 The Economic Problem Wants, desires: unlimited Resources: scarce –Not freely available Economic choice Economics –How people use scarce resources to satisfy unlimited wants © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3. 3 Resources Inputs; factors of production –Used to produce goods and services Goods and services are scarce because resources are scarce 1.Labor 2.Capital 3.Natural resources 4.Entrepreneurial ability © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

4. 4 Resources Labor –Physical and mental effort used to produce goods and services –We allocate our time to different uses –Payment: Wage © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5. 5 Resources Capital –Buildings, equipment, and human skills used to produce goods and services –Physical capital Human creations used to produce goods and services –Human capital Knowledge and skill people acquire to increase their productivity –Payment: Interest © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6. 6 Resources Natural resources –All gifts of nature –Renewable resource Can be drawn on indefinitely if used conservatively –Exhaustible resource Does not renew itself Available in a limited amount –Payment: Rent © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. 7 Resources Entrepreneurial ability –Imagination required to develop a new product or process –Skill needed to organize production –Willingness to take the risk of profit or loss –Payment: Profit © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

8. 8 Resources Entrepreneur –Profit-seeking decision maker who starts with an idea –Organizes an enterprise to bring that idea to life –Assumes the risk of the operation © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

9. 9 Goods and Services Good –Tangible product used to satisfy human wants Service –Activity, or intangible product, used to satisfy human wants Scarcity –When the amount people desire exceeds the amount available at a zero price © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10. 10 Goods and Services Scarce good/service –The amount people desire exceeds the amount available at a zero price Choice –Give up some goods and services © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

11. 11 Goods and Services Bads –We want none of them; not even at a zero price Free goods and services “There is no such thing as a free lunch” –Involve a cost to someone © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

12. 12 Economic Decision Makers Households –Consumers Demand goods and services –Resource owners Supply resources Firms, Governments, Rest of the World –Demand resources –Produce goods and services © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

13. 13 Markets Market –Set of arrangements by which buyers and sellers carry out exchange at mutually agreeable terms Product markets –Goods and services are bought and sold Resource markets –Resources are bought and sold © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

14. 14 A Simple Circular-Flow Model Flow of –Resources –Products –Income –Revenue Among economic decision makers Interaction –Households –Firms © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15. 15 Exhibit 1 The simple circular-flow model for households and firms Households earn income by supplying resources to the resource market, as shown in the lower portion of the model. Firms demand these resources to produce goods and services, which they supply to the product market, as shown in the upper portion of the model. Households spend their income to demand these goods and services. This spending flows through the product market as revenue to firms. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

16. 16 Rational Self-Interest Individuals are rational –Make the best choice –Given the available information –Maximize expected benefit With a given cost –Minimize expected cost For a given benefit The lower the personal cost of helping others, the more help we offer © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

17. 17 Choice Requires Time & Information Time and information –Scarce –Valuable Rational decision makers –Willing to pay for information Improve choices –Acquire information: Additional benefit expected exceeds the additional cost © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

18. 18 Economic Analysis Is Marginal Analysis Comparison –Expected marginal benefit –Expected marginal cost Marginal –Incremental, additional, extra Rational decision maker: –Change the status quo if expected marginal benefit exceeds expected marginal cost © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

19. 19 Microeconomics & Macroeconomics Microeconomics –Study of the economic behavior in particular markets Individual economic choices Markets coordinate the choices of economic decision makers Individual pieces of the puzzle © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

20. 20 Microeconomics & Macroeconomics Macroeconomics –Study of the economic behavior of entire economies Performance of the economy as a whole Economic fluctuations –Rise and fall of economic activity Relative to the long-term growth trend of the economy –Business cycles © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

21. 21 The Science of Economic Analysis Economic theory / model –Simplification of economic reality –Make predictions about cause and effect in the real world Good theory –Guide –Sort, save, understand information © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

22. 22 The Scientific Method 1.Identify the question and define relevant variables 2.Specify assumptions –Other-things-constant –Behavioral assumptions 3.Formulate the hypothesis –Key variables relate to each other 4.Test the hypothesis - evidence © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

23. 23 The Scientific Method Variable –A measure that can take on different values at different times Other-things-constant assumption –Other variables remain unchanged –Ceteris paribus © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

24. 24 The Scientific Method Behavioral assumption –Describes the expected behavior of economic decision makers, what motivates them Hypothesis –Theory about how key variables relate © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

25. 25 Exhibit 2 The Scientific Method: Step by Step The steps of the scientific method are designed to develop and test hypotheses about how the world works. The objective is a theory that predicts outcomes more accurately than the best alternative theory. A hypothesis is rejected if it does not predict as accurately as the best alternative. A rejected hypothesis can be modified or reworked in light of the test results. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

26. 26 Normative Versus Positive Positive economic statement –Can be proved or disproved by reference to facts –‘What is’ Normative economic statement –Reflects an opinion, which cannot be proved or disproved by reference to the facts – ‘What should be’ © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

27. 27 Predicting Average Behavior Individual behavior –Difficult to predict –Random actions of individuals Offset one another Average behavior of groups –Predicted more accurately © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

28. 28 Pitfalls of Faulty Economic Analysis Fallacy = incorrect idea / belief The fallacy that association is causation –If two variables are associated in time, one must necessarily cause the other The fallacy of composition –What is true for the individual, or part, must necessarily be true for the group, or the whole © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

29. 29 Pitfalls of Faulty Economic Analysis The mistake of ignoring the secondary effects –Unintended consequences Secondary effects –Unintended consequences of economic actions that may develop slowly over time as people react to events © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

30. 30 Exhibit 3 Median Annual Pay by College Major © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

31. Appendix 31 Understanding Graphs Origin Horizontal axis Vertical axis Graph Functional relation –The value of the dependent variable depends on the value of the independent variable © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

32. Exhibit 4 32 Basics of a graph 15 10 5 20 y Vertical axis a b Any point on a graph represents a combination of particular values of two variables. Here point a represents the combination of 5 units of variable x (measured on the horizontal axis) and 15 units of variable y (measured on the vertical axis). Point b represents 10 units of x and 5 units of y. 0 Origin 2015105x Horizontal axis © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

33. 33 Exhibit 5 U.S. Unemployment rate since 1900 A time-series graph depicts the behavior of some economic variable over time. Shown here are U.S. unemployment rates since 1900. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

34. Appendix 34 Drawing Graphs Types of relations between variables –Positive; direct As one variable increases, the other increases –Negative; inverse As one variable increases, the other decreases –Independent; unrelated As one variable increases, the other remains unchanged © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

35. Exhibit 6 35 Schedule Relating Distance Traveled to Hours Driven The distance traveled per day depends on the number of hours driven per day, assuming an average speed of 50 miles per hour. This table shows combinations of hours driven and distance traveled. These combinations are shown as points in Exhibit 7. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36. Exhibit 7 36 a b c d e Graph Relating Distance Traveled to Hours Driven 0 4 3 2 1 Hours driven per day 5 150 100 50 200 Distance traveled per day (miles) 250 Points a through e depict different combinations of hours driven per day and the corresponding distances traveled. Connecting these points creates a graph. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

37. Appendix 37 Slopes of Straight Lines Slope –Change in vertical variable –For a given increase in horizontal variable Slope = Change in the vertical distance/ Increase in the horizontal distance Slope of a straight line –The same value along the line © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

38. 38 Exhibit 8 (a), (b) Alternative slopes for straight lines (a) Positive relation 0 x 20 10 15 20 y 5 10 Slope = 5/10 = 0.5 (b) Negative relation 0 x 20 10 3 20 y 10 Slope = - 7 /10 = - 0.7 -7 The slope of a line indicates how much the vertically measured variable changes for a given increase in the variable measured along the horizontal axis. Panel (a) shows a positive relation between two variables; the slope is 0.5, a positive number. Panel (b) depicts a negative, or inverse, relation. When the x variable increases, the y variable decreases; the slope is 0.7, a negative number. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

39. 39 Exhibit 8 (c), (d) Alternative slopes for straight lines (c) No relation: zero slope 0 x 20 10 15 20 y Slope = 0/10 = 0 (d) No relation: assumed infinite slope 0 x 10 20 y 10 Slope = 10 /0 = ∞ 10 Panels (c) and (d) represent situations in which two variables are unrelated. In panel (c), the y variable always takes on the same value; the slope is 0. In panel (d), the x variable always takes on the same value; the slope is mathematically undefined but we simplify by assuming the slope is infinite. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

40. Appendix 40 Slopes Value of slope –Depends on units of measurement –Measures marginal effects Slope of a curved line –Differs along the curve Slope of a curved line at one point –Slope of the tangent © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

41. 41 Exhibit 9 Slope depends on the unit of measure (a) Measured in feet 0 Feet of copper tubing 6 5 5 $6 Total cost 1 1 Slope = 1/1 = 1 (b) Measured in yards 0 Yards of copper tubing 2 1 3 $6 Total cost 3 1 Slope = 3/1 = 3 The value of the slope depends on the units of measure. In panel (a), output is measured in feet of copper tubing; in panel (b), output is measured in yards. Although the cost is $1 per foot in each panel, the slope is different in the two panels because copper tubing is measured using different units. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

42. 42 Exhibit 10 Slope at different points on a curved line 0 40 30 20 10 x 30 20 10 40 y a b B A The slope of a curved line varies from point to point. At a given point, such as a or b, the slope of the curve is equal to the slope of the straight line that is tangent to the curve at the point. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

43. Exhibit 11 43 Curves with both positive and negative slopes 0 x y a b Some curves have both positive and negative slopes. The hill-shaped curve (in red) has a positive slope to the left of point a, a slope of 0 at point a, and a negative slope to the right of that point. The U-shaped curve (in blue) starts off with a negative slope, has a slope of 0 at point b, and has a positive slope to the right of that point. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

44. Appendix 44 Line Shifts Change in the assumption –Changes the relationship between variables –Expressed by a line shift © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

45. 45 Exhibit 12 0 4 3 2 1 Hours driven per day 5 150 100 50 200 Distance traveled per day (miles) 250 Shift of line relating distance traveled to hours driven f T’ d T Line T appeared originally in Exhibit 7 to show the relation between hours driven and distance traveled per day, assuming an average speed of 50 miles per hour. If the average speed is only 40 miles per hour, the entire relation shifts to the right to T, indicating that any given distance traveled requires more driving time. For example, 200 miles traveled takes 4 hours of driving at 50 miles per hour but 5 hours at 40 miles per hour. This figure shows how a change in assumptions, in this case, the average speed assumed, can shift the entire relationship between two variables. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.