Getting  Started		Chapter   1
CHAPTER OUTLINE

I.  Define economics and explain the kinds ofquestions that economists try to answer.

A. Scarcity

B.  EconomicsDefined

1.  Microeconomics

2.  Macroeconomics

C. What,How, and For Whom?

1.  What?

2.  How?

3.  ForWhom?

D. WhenIs the Pursuit of Self-Interest in the Social Interest?

1.  Self-Interestand the Social Interest

2.  Globalization

3.  TheInformation-Age

4.  ClimateChange

5.  ASocial Security Time Bomb

2. Explain the ideas that define the economic wayof thinking.

A. EconomicIdeas

B.  AChoice Is a Tradeoff

C. Rational Choice

C. Benefit:What You Gain

D. Cost:What You Must Give Up

E.  HowMuch? Choosing at the Margin

1.  MarginalCost

2.  MarginalBenefit

3.  Makinga Rational Choice

F.  ChoicesRespond to Incentives

G. Economicsas Social Science

1.  EconomicModels

2.  CheckModels Against Facts

3.  Disagreement:Normative versus Positive

I.   Economicsas Policy Tool

1.  PersonalEconomic Policy

2.  BusinessEconomic Policy

3.  GovernmentEconomic Policy

 

n What’s New in this Edition?

The chapter has been revised tostreamline it. Macroeconomics and microeconomics are now defined in the firstcheckpoint. The number of topics used to motive discussion about differences insocial interest and self-interest has been reduced to four: Globalization, theinformation-age, climate change, and a Social Security time bomb. The coreideas of economics now include the point that “a choice is a tradeoff.” Ceteris paribus is no longer defined inthe chapter, though it is, as before, defined in the appendix.

n Where We Are

In Chapter 1, we review definitions andaddress questions that economics helps answer. We also discuss how people makerational choices and preview the fact that these are the choices thatindividuals and firms make everyday.

n Where We’re Going

After layingout the basic ideas of economics in this chapter, and some basic facts aboutthe economy in the next, in Chapter 3 we’ll start building tools and modelsthat help us understand how the economy works. These tools and models, such asthe production possibilities frontier and the demand and supply framework,provide valuable insight into how the economy that we operate in each dayworks.

 

IN THECLASSROOM

nClass Time Needed

You can complete this chapter in one session.As simple as the ideas might seem to you, covering the definitions andquestions are important to your students, especially in the context of currentevents and topics. Thus do not shortchange this chapter.

           Anestimate of the time per checkpoint is:

·            1.1 Definitions andQuestions—15 to 20 minutes

·            1.2 The Economic Way ofThinking—25 to 30 minutes

 

Classroom Activity: For the first week,have the students bring to class newspaper headlines that deal with storiesabout what goods and services are produced, how goods and services areproduced, and for whom the goods and services are produced. When they bringtheir headlines to class, use the headlines to grab the students’ attention andraise a sense of excitement about learning this subject. Point out to them theywill gain real insights into topics such as those in the headlines when they’vecompleted their course.

Classroom Activity: Help the students toappreciate the power of models as tools for understanding reality. The analogyof a model as a map is easy and convincing. Jim Peach, a fine economics teacherat the University of New Mexico, gets hisstudents to make paper airplanes on the first day of class. After flying theirpaper planes around the classroom (and picking up the debris!) he gets them totalk about what they can learn about real airplanes from experimenting withpaper (and other model) planes.

Classroom Activity: You also can helpyour students appreciate that no matter how appealing or “realistic looking” amodel appears to be, it is useless if it fails to predict. And the converse, nomatter how abstract or far removed from reality a model appears to be, if itpredicts well, it is valuable. Milton Friedman’s pool hall example illustratesthe point nicely: Imagine a physicist’s model that predicts where a carefullyplaced shot of a pool shark would go as he tries to sink the eight ball intothe corner pocket. The model would be a complex, trigonometric equationinvolving tangents, cosines and a plethora of Greek symbols that no ordinaryperson would even recognize as representing a pool shot. It wouldn’t depictwhat we see—a pool stick striking a pool cue on a rectangular patch of greenfelt. It wouldn’t even reflect the thought processes of the pool shark, whorelies on years of experience and the right “touch.” But constructed correctly,this mathematical model would predict exactly where the cue ball would strikethe eight ball, hit opposite the bank, and fall into the corner pocket. (Youcan invent analogous examples from any sport.)

CHAPTER LECTURE

n 1.1       Definition and Questions

Scarcity

• Economic     questions arise because we always want more than we can get, so we face scarcity, the inability     to satisfy all our wants. Everyone faces scarcity because no one can satisfy     all of his or her wants.

Forbes listsBill Gates and Warren Buffet as the two wealthiest Americans. Do these two menface scarcity? According to The Wall Street Journal, both men areardent bridge players, yet they have never won one of the many national bridge tournaments they have entered asa team. These two men can easily afford the best bridge coaches in the worldbut other duties keep them from practicing as much as they would need to inorder to win. So even the wealthiest two Americans face scarcity (of time) andmust choose how to spend their time.

Economics Defined

• Economics is the social     science that studies the choices     that individuals, businesses, governments and entire societies make when     they cope with scarcity,     the incentives that influence     those choices, and the arrangements that coordinate them.

·        Microeconomicsis the study of thechoices that individuals and businesses make and the way these choices interactand are influenced by governments.

·        Macroeconomicsis the study of theaggregate (total) effects on the national economy and the global economy of thechoices that individuals, businesses, and governments make.

Lecture Launcher: Students might notfully appreciate that economics is truly a science. They believe thateconomists are often incorrect in their predictions and assessments of the economy.Here is an opportunity for you to demonstrate humility and also show them(albeit charitably) the error in their conclusion. First, it is important tostate honestly that many economists who have made forecasts have not only beenwrong but sometimes spectacularly wrong. However, point out that being wrongdoesn’t make their work unscientific. Remind the students that all science isconstantly evolving. For instance, it was only five centuries ago thatscientists believed the earth to be flat! No one claimed that these scientistswere engaged in unscientific methods. Instead, when theories no longer fit thefacts, they must either be reformulated or discarded in favor of new ones.

Lecture Launcher: Maggy Shannon, whoteaches at Gordon College inGeorgia, tells her class a storyfrom when she was an undergraduate: She telephoned her mother and in the courseof her conversation, mentioned that “Dr. Thomas” had said she might have mono.Her mother was horrified, and didn’t calm down until she had managed to explainthat Dr. Thomas was an anthropologist. The point is that some opinions carrymore weight than others. And, what the students are preparing to learn is the“opinions” of economists—positive models—about how the economy works.

Lecture Launcher:  To help students identify that economists often don’t make one definitiveprediction about the future, but instead offer likely possible scenarios basedupon the best available data, I always find it useful to quote President Harry S. Truman. Truman wasactually quite fond of using economic advisors to help formulate policy, thoughhe quickly recognized how economists liked to hedge their bets by offering aprediction and then the disclaimer, “but, on the other hand…” to account forother possible outcomes. An exasperated Truman famously proclaimed “Give me aone-armed economist!” It is important to point out that economic forecasting isremarkably similar to weather forecasting – it is a scientific process basedupon the best available data and models, but will always be subject to a marginof error.

What, How, and For Whom?

• Goods and     services     are the objects (goods) and actions (services) that people value and     produce to satisfy human wants.

• Societies must     answer three very basic questions:

·        What?: What determinesthe quantities of the goods and services produced?

·        How?: How are goods andservices produced?

·        For Whom?: For whom are goodsand services produced?

When Is the Pursuit of Self-Interestin the Social Interest?

• People make choices they are think are best for them, that is,     choices in their self-interest.

• Choices that     are the best for society as a whole are said to be in the social interest.

• A     major question economists explore is “Could it be possible that when each     of us makes choices in our self-interest, these choices are in the social     interest?”

Students (and others!) often take theanswers to the what, how, and for whom questions for granted. For instance,most of the time we do not bother to wonder “How does our economy determine howmany light bulbs, automobiles, and pizzas to produce?” (what), or “Whydoes harvesting wheat from a plot of land in India occur with hundreds oflaborers toiling with oxen pulling threshing machines, while in the UnitedStates, a single farmer listening to a Garth Brooks CD and sitting in anair-conditioned cab of a $500,000 machine harvests the same quantity of wheatfrom the same sized plot of land?” (how), or “Why is the annual incomeof an inspiring and effective grade school teacher much less than that of a below-average major-league baseball player?”(for whom). Explaining the answers to these types of questions anddetermining whether the answers are in the social interest is a major part ofmicroeconomics.

• We     can examine whether the self-interested choices serve the social interest     for a variety topics:

·        Globalization: The accelerationof economic growth in the last two decades has made economic decision-makingmore complex as multinational concerns must be taken into account. Rationalbusiness decisions which bring a wider variety of lower-price choice toconsumers may have negative side-effects on some producers.

·        The information-age: The InformationRevolution, an economic restructuring comparable to the Agricultural Revolutionand the Industrial Revolution, has brought about new questions of socialinterest. Was the development of computers and of the Windows operating systemby Microsoft in the social interest?

·        Climate change: Climatologistsagree that global warming is at least in part the result of economic activity.The warming may lead to large economic costs. How can individuals and nationssatisfy their self-interested desire for goods and services while alsoprotecting the social-interest of the environment?

·        A Social Securitytime bomb:TheU.S.government has been running a budget deficit every year since 2001. In approximately2019 the deficit will come under increasing pressure because in that yearpayments from Social Security for retirement and health benefits will exceedpayments into Social Security. Do our self-interested choices as votersconflict with the social interest?

n 1.2       The Economic Way of Thinking

Economic Ideas

• Six     core ideas describe the economic way of thinking:

·        Achoice is a tradeoff.

·        Peoplemake rational choices by comparingcosts and benefits.

·        Benefit is what you gainfrom something.

·        Costis what must be given up to getsomething.

·        Mostchoices are “how much” choices madeat the margin.

·        Choicesrespond to incentives.

A Choice Is a Tradeoff

·        Becausewe face scarcity, we must make choices and select from the available alternatives.A tradeoff is an exchange –giving up one thing to get something else.

Rational Choice

• A     rational is one that     uses the available resources to most effectively satisfy the wants of the     person making the choice. Rational choices compare costs and benefits and     are made on the margin. They respond to incentives.

Benefit: What You Gain

• The benefit of something is the gain     or pleasure it brings and is determined by personal preferences – by what a person likes and dislikes and the     intensity of those feelings. Economists measure the benefit of something     by what a person is willing to give up to get it.

Cost: What You Must Give Up

• The opportunity cost of something is the best     thing you must give up to get it.

• Choices have an     opportunity costs; for example, the opportunity cost of attending college     include goods and services forgone from paying for tuition and textbooks,     and the goods and services forgone because the student does not have the     income from a full-time job.

To ensure that people do not die of any serious side effects, theFood and Drug Administration (FDA) requires all drug companies to thoroughlytest newly developed medicines before allowing them to be sold in theUnited States.However, it takes many years to perform these tests, and many people sufferingfrom the terminal diseases these new medicines are designed to cure will diebefore good new medicines are eventually approved for use. Yet, if the FDA wereto abandon this testing process, many others would die from the serious sideeffects of those bad medicines that made it to market. People’s lives will beat risk under either policy alternative. This stark example of a tradeoff reveals the idea thatchoices have opportunity costs.

How Much? Choosing at theMargin

• Making choices     at the margin means     comparing all the relevant alternatives systematically and incrementally.

• People make     choices at the margin by comparing the benefit from a one-unit change in an activity (which is the marginal benefit) to the cost of     making a one-unit change in an activity (which is the marginal cost).

• If     the marginal benefit of an action exceeds the marginal cost of the action,     then the rational choice is to     take the action.

Should Jim give up watching the Super Bowlgame to take out his girlfriend Amy on her birthday? Jim will make his choiceat the margin. Jim’s marginal benefitis that his relationship with Amy strengthens as they share a romanticbirthday celebration together. His marginal cost is that he will miss watchingthe NFL championship game. If the marginal benefit of the dinner exceeds the marginalcost, then Jim will choose to take his girlfriend out on her birthday.

Choices Respond toIncentives

• An incentiveis a reward     that encourages an action or a penalty that discourages an action.

• Changes in     marginal benefits and marginal costs alter the incentives that we face     when making choices. When incentives change, people’s decisions change.     For example, if homework assignments are weighed more heavily in a class’s     final grade, the marginal benefit of completing homework assignments has     increased and more students will do the homework.

Economics asSocial Science

• Economists try     to understand and predict the effects of economic forces by using the scientific method – a commonsense     way of systematically checking what works and what doesn’t work.

·        Aneconomist begins with a question or a puzzle about cause and effect arisingfrom some observed facts.

·        Aneconomist’s second step is to build an economic model, a description of some feature of the economic world that includes onlythose features assumed necessary to explain the observed facts.

•  

• The third step is to check the economic model against the facts by      using:

·        A natural experiment: a situation that arises in theordinary course of economic life in which the one factor of interest isdifferent and other things are equal (or similar).

·        A statistical investigation: looking for a correlation – a tendency for the values of two variables to move together in apredictable and related way.

·        An economic experiment: puts people in adecision-making situation and varies the influence of one factor at a time todiscover how they respond.

•  

• Economists sometimes      disagree about assumptions, models, and policies. Disagreements that      can’t be settled by facts are normative      statements, statements about “what ought to be,” which are opinions      and so are inherently not testable. Disagreements that can be settled by      facts are positive statements, statements about “what is” and are      testable. A positive statement is “Raising the tax on a gallon of      gasoline will raise the price of gasoline and lead more people to buy      smaller cars” while a normative statement is “The tax on gasoline should      be raised.”

qLand Mine: Students sometimes have difficulty sorting out economic facts fromeconomic opinions. One way to cure this problem is to have them cut outarticles from a newspaper (possiblyU.S.A.Today, The Wall Street Journal, or the New York Times) or copysections of articles from reliable sources from the Internet. Ask the studentsto label the headlines as either positive or normative economic statements.Make sure to tell them that one way of distinguishing the headlines is byasking themselves whether the statements represent testable propositions. Ifthe headlines do not, then they are normative statements (that is, valuejudgments). Explain that some of the common buzzwords that are tip-offs to anormative statement are: should, must, or ought.

        Anotherproblem that students have is with positive statements that are incorrect.Explain that the veracity of an economic statement is not the litmus test ofwhether an assertion is a positive statement or not. The litmus test is thetestability! Of course, if the statement is incorrect, likely the person makingthe statement ought to change it! Indeed, one of the biggest problems recentlyis untangling opinions from prejudices. Opinions are founded in information,and can change as new information is acquired. Thus, after learning the informationin Chapter One, a student’s answers to the Critical Thinking exercises shoulddemonstrate that the student has learned Chapter One and incorporates this newinformation into his or her analysis of the questions posed. All too frequently,however, students seem to think that all opinions are created equal, that is,that no opinion can be counted wrong. Point out that while it is not possibleto prove that a normative statement is wrong, nonetheless they should be basedon positive results.

qLandMine:  Correlationis a tendency for the values of two variables to move together (either in thesame direction or in opposite directions) in a predictable and related way. Correlationversus causation is an issue of logic that can represent a real challenge tostudents’ intuition. There is a natural human tendency to conclude that whentwo variables move together, or against one another, that there is causation.Point out that there is a difference between correlation and causation. Supposeeconomists found that there is a positive correlation between the level ofeducation and worker health. We might conclude that the increase in educationis the cause of the better health. But perhaps the higher income that workersenjoy as the result of their higher education allows them to purchase morehealth care. Or it could be that there are other intervening variables at work.Perhaps education and health move together because of characteristics that thetwo have in common. That is, it might be possible that talent, motivation, andwork ethic, which help many people enjoy good health, are the same characteristicsthat help the same people earn a higher income.

Economics As Policy Tool

• Economics is a     tool which helps us make an endless array of decisions.

• Personal     Economic Policy involves decisions about an individual’s need for shelter,     transportation, and time management.

• Business     Economic Policy involves decisions made at the margin to accomplish a business’s     goals such as increasing sales, opening a new branch, or gaining market     share.

• Government     Economic Policy is perhaps the most controversial of the three types of economic     policy. How should goals such as better education, military preparedness,     and safe food be balanced against limited tax revenue and the desire of     individual members of government to be reelected?

 

 

 

 

 

 

 

 

 

 

USING EYE ONTHE past

n  AdamSmith and the Birth of Economics as a Social Science

Adam Smith usedthe example of pin making in his opus, TheWealth of Nations, to explain an elementary but profound point. It was anexample to which people of his time could easily relate. Before introducingSmith’s work, you might want to consider asking students how productive oneworker could be if he or she were the only one on duty at a local McDonald’srestaurant at noon time. The likely response is not very productive. The personwould have to cook the burgers, fry the french fries, prepare the drinks, ringup the orders, and clean the dining area. Students will not find it difficultto accept that few customers will be served at this restaurant under theseconditions! Next, ask how productivity would change if a second worker wereasked to help out at this same restaurant and at the same time. Students willanswer that the restaurant will be able to serve more customers. You can pointout the gains from division of labor and specialization that are likely to beenjoyed by hiring the second worker. Explain that we owe this simple logic tothe founding father of modern day economics, Adam Smith.

USING EYE ONthe Benefit and Cost of School

n  DidYou Make the Right Decision?

In order to helpstudents get settled into the classroom, learn a few names, get engaged in thematerial, and reevaluate the purpose of taking the course, it can be useful toget into a small group activity that goes through this “Eye On” on the firstday. While the explicit opportunity costs (tuition, fees, books, materials,etc) might be easier for students to quantify, you can help students quantifythe implicit opportunity costs as well (foregone earnings or the value of theirleisure time). If the students wouldn’t be working, then assigning a dollarvalue for the implicit cost is a bit more challenging, but not impossible…afterall, leisure time is not “priceless” as many people will initially assume. Askthem what hourly wage would they require to get them to give up an hour oftheir leisure time – that is the value of an hour’s worth of leisure to them.Depending on the institution at which you teach, the implicit cost associatedwith your students’ higher education may far exceed the explicit cost. As forthe benefits outlined in the “Eye On,” you may also want to suggest they estimatethe value to them of a possible job with more desirable non-wage characteristics,having more knowledge, and being a more informed decision maker and voter. Hopefullyyour students end up with a cost-benefit comparison that tells them they aremaking a rational choice, or you may not see them again!

ADDITIONALEXERCISEs FOR ASSIGNMENT

nQuestions

n   Checkpoint 1.1  Definitionsand Questions

1.     Imaginea situation in which there is a device that can help improve productivity inany enterprise by as much as one thousand times. Assume that this device couldbe operated by anyone. Would this device eliminate scarcity?

n   Checkpoint 1.2  The EconomicWay of Thinking

2.     Assumeyour neighbor is a doctor. He complains bitterly about the overtime that he isputting in at the hospital each weekend. While the overtime is not required, heargues that by not taking it he would be sacrificing $1,000 each weekend. If hewere to ask for your opinion about what to do, what would you advise him?

3.     Surveyyour classmates (or, a selected group of your classmates) regarding theopportunity cost of attending class. If you get different answers (which youwill!), explain how these differences affect choices.

nAnswers

n   Checkpoint 1.1  Definitionsand Questions

1.     Scarcityis not eliminated by this device. Scarcity is the inability of the availableresources to satisfy all of everyone’s wants. The ability of each of us tosatisfy our wants is limited by time and by the incomes we earn and the priceswe pay for the things we buy. The device would expand the amount of goods andservices available but it would not constrain our wants.

n   Checkpoint 1.2  The EconomicWay of Thinking

2.     You can advise your neighbor that the$1,000 each weekend that he would give up by not working is not his onlyopportunity cost. When he works he also incurs opportunity costs. For instance,by working he is giving up time he could be spending with his family.

3.     You will get a variety of answers. Thisfact shows that everyone faces different opportunity costs and, people makedifferent choices. Students for whom the opportunity cost is too high simplywere not present to participate in your survey! And, even though people havedifferent opportunity costs, their choices remain rational.

 

 

 

 

 

 

 

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