1. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1 ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2010-2011 1 CHAPTER The Art and Science of Economic Analysis Micro

2. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 2 LO 1 The Economic Problem  Wants, desires: unlimited  Resources: scarce  Economic choice  Economics  How people use scarce resources to satisfy unlimited wants

3. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 3 LO 1 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

4. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 4 LO 1 Resources  Labor – human effort  Physical effort  Mental effort  Time  Payment: Wage  Capital – human creations  Physical capital  Human capital  Payment: Interest

5. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 5 LO 1 Resources  Natural resources – Gifts of nature  Renewable  Exhaustible  Payment: Rent  Entrepreneurial ability  Talent, idea  Risk of operation  Payment: Profit

6. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 6 LO 1 Goods and Services  Good: see, feel, touch  Service: intangible  Scarce good/service  The amount people desire exceeds the amount available at zero price  Choice  Give up some goods and services

7. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 7 LO 1 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

8. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 8 LO 1 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

9. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 9 LO 1 Markets  Bring together buyers and sellers  Determine price and quantity  Product markets  Goods and services  Resource markets  Resources

10. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 10 LO 1 A Simple Circular-Flow Model  Flow of  Resources  Products  Income  Revenue  Among economic decision makers  Interaction  Households  Firms

11. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 11 LO 1 The Simple Circular-Flow Model for Households and Firms Exhibit 1 Households - Supply resources to resource market; earn income - Demand goods and services from product market; spend income Firms - Demand resources to produce goods and services; payment for resources - Supply goods and services to product market; earn revenue

12. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 12 Rational Self-Interest LO 2  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

13. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 13 Choice Requires Time and Information LO 2  Time and information – scarce; valuable  Rational decision makers  Willing to pay for information  Improve choices  Acquire information  Additional benefit expected exceeds the additional cost

14. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 14 Economic Analysis Is Marginal Analysis LO 2  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  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

15. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 15 Microeconomics and Macroeconomics LO 2  Microeconomics  Individual economic choices  Markets coordinate the choices of economic decision makers  Individual pieces of the puzzle  Macroeconomics  Performance of the economy as a whole  Big picture

16. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 16 The Science of Economic Analysis LO 3  Economic theory / model  Simplification of economic reality  Important elements of the problem  Make predictions about the real word  Good theory  Guide  Sort, save, understand information

17. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 17 The Scientific Method LO 3 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

18. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 18 LO 3 The Scientific Method: Step by Step 1. Identify the Question and Define Relevant Variables 2. Specify Assumptions or 3. Formulate a hypothesis 4. Test the hypothesis Reject the hypothesis Use the hypothesis until a better one comes along Modify Approach Exhibit 2

19. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 19 Normative Versus Positive LO 3  Positive economic statement  Assertion about economic reality  Supported or rejected by evidence  True or false  ‘What is’  Normative economic statement  Opinion  ‘What should be’

20. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 20 LO 3 Case Study A Yen for Vending Machines  Japan – lower unemployment  Low birthrate  No immigration  Aging population  Vending machines  Wider variety of products  Preferred

21. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 21 Predicting Average Behavior LO 3  Individual behavior  Difficult to predict  Random actions of individuals  Offset one another  Average behavior of groups  Predicted more accurately

22. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 22 Pitfalls of Faulty Economic Analysis LO 4  The fallacy that association is causation  Event A caused event B – associated in time  The fallacy of composition  What is true for the individual is true for the group  The mistake of ignoring the secondary effects  Unintended consequences

23. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 23 LO 5 Case Study College Major and Annual Earnings  College degree  Better jobs  Higher pay  Median annual earnings  Men: $43,199  Women: $32,155  Major in economics  Rank: #7  No gap between men and women

24. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 24 LO 5 Exhibit 3 Median Annual Earnings of 35- to 44-Year-Olds with Bachelor’s as Highest Degree, by Major

25. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 25 Understanding Graphs Appendix  Origin  Horizontal axis  Vertical axis  Graph  Functional relation –Dependent variable –Independent variable

26. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 26 Exhibit 4 15 10 5 20 y Vertical axis a b 0 Origin 2015105x Horizontal axis Point a: - 5 units X - 15 units Y Point b: - 10 units X - 5 units Y Basics of a Graph

27. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 27 U.S. Unemployment Rate Since 1900 Exhibit 5

28. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 28 Drawing Graphs  Dependent variable –Depends on the independent variable  Types of relations between variables –Positive; direct –Negative; inverse –Independent; unrelated Appendix

29. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 29 Exhibit 6; Exhibit 7 a b c d e Hours driven per day Distance traveled per day (miles) abcdeabcde 1234512345 50 100 150 200 250 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 graphs a line. Schedule and Graph Relating Distance Traveled to Hours Driven

30. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 30 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 Appendix

31. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 31 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 Exhibit 8(a), (b)

32. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 32 Alternative Slopes for Straight Lines (c) No relation: zero slope 0 x 20 10 20 y Slope = 0/10 = 0 (d) No relation: infinite slope 0 x 10 20 y 10 Slope = 10/0 = ∞ 10 Exhibit 8(c ), (d)

33. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 33 Slope, Units of Measurement, Marginal Analysis  Value of slope –Depends on units of measurement –Measures marginal effects Appendix

34. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 34 (a) Measured in feet(b) Measured in yards 0 Feet of copper tubing 65 5 $6 Total cost 1 1 Slope = 1/1 = 1 0 Yards of copper tubing 2 1 3 $6 Total cost 3 1 Slope = 3/1 = 3 Slope Depends on the Unit of Measure (a)Output is measured in feet of copper tubing. (b)Output is measured in yards. The cost: $1 per foot. Slope is different: copper tubing is measured using different units Exhibit 9

35. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 35 The Slopes of Curved Lines  Differs along the curve  Slope of a curved line at one point –Slope of the tangent Appendix

36. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 36 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 point a, the slope of the curve is equal to the slope of the tangent A. At point b, the slope of the curve is equal to the slope of the tangent B. Exhibit 10

37. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 37 a Curves with Both Positive and Negative Slopes 0 x y b Some curves have both positive and negative slopes. The hill-shaped curve has: positive slope to the left of a slope of 0 at point a negative slope to the right of a. The U-shaped curve has: negative slope to the left of b slope of 0 at point b positive slope to the right of b. Exhibit 11

38. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 38 Line Shifts  Change assumptions –Changed relationship between variables –Line shift Appendix

39. Chapter 1Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 39 Shift of Line Relating Distance Traveled to Hours Driven Exhibit 12 0 4 3 2 1 Hours driven per day 5 150 100 50 200 Distance traveled per day (miles) 250 f T’ d T Line T hours driven/day and distance traveled/day average speed = 50 mph Line T’ hours driven/day and distance traveled/day average speed = 40 mph