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  1. Learning Objectives • Discuss the difference between microeconomics and macroeconomics • Evaluate the role that rational self-interest plays in economic analysis • Explain why the study of economics is a science • Distinguish between positive and normative economics Chapter 1 - The Nature of Economics

  2. Defining Economics • Economics • The study of how people allocate their limited resources to satisfy their unlimited wants • The study of how people make choices Chapter 1 - The Nature of Economics

  3. Defining Economics • Resources • Things used to produce other things to satisfy people’s wants • Wants • What people would buy if their incomes were unlimited Chapter 1 - The Nature of Economics

  4. Defining Economics • With limited income (resources), people must make choices to satisfy their wants. • We never have enough of everything, including time, to satisfy our every desire. Chapter 1 - The Nature of Economics

  5. Defining Economics • Individuals, businesses, and nations face alternatives, and choices must be made. • Economics studies how these choices are made. Chapter 1 - The Nature of Economics

  6. The Power of Economic Analysis • The economic way of thinking is a framework to analyze solutions to economic problems. • How much time to study • Choosing which courses to take • Whether troops should be sent abroad • Incentives • Rewards for engaging in a particular activity Chapter 1 - The Nature of Economics

  7. The Power of Economic Analysis • The economic way of thinking gives you the power to reach informed conclusions about what is happening in the world. • Economic analysis helps you make better decisions, and increases your understanding when watching, listening to, or reading the news. Chapter 1 - The Nature of Economics

  8. The Power of Economic Analysis • Economic analysis is a way of thinking about all decisions. • Your education, career, financing your home, family • Your involvement in the business world, or in politics as a voter Chapter 1 - The Nature of Economics

  9. Microeconomics versus Macroeconomics • Microeconomics • The study of decision making undertaken by individuals (or households) and by firms • Like looking though a microscope to focus on the smaller parts of the economy • Decision of a worker to work overtime or not • A family’s choice of having a baby • An individual firm advertising Chapter 1 - The Nature of Economics

  10. Microeconomics versus Macroeconomics • Macroeconomics • The study of the behavior of the economy as a whole • Deals with economy wide phenomena • The national unemployment rate • The rate of growth in the money supply • The national government’s budget deficit Chapter 1 - The Nature of Economics

  11. Microeconomics versus Macroeconomics • Macroeconomics deals with aggregates, or totals, such as total output in an economy. • Modern economic theory blends micro and macro concepts. Chapter 1 - The Nature of Economics

  12. The Economic Person:Rational Self-Interest • Economists assume that individuals act as if motivated by self-interest and respond predictably to opportunities for gain. Chapter 1 - The Nature of Economics

  13. The Economic Person:Rational Self-Interest • Rationality Assumption • The assumption that people do not intentionally make decisions that would leave them worse off Chapter 1 - The Nature of Economics

  14. The Economic Person:Rational Self-Interest • Questions • Does the fact that some people make apparently irrational choices invalidate the rationality assumption in economics? • Can economic models be applied to situations in which behavior is at odds with what we expect from rational people? Chapter 1 - The Nature of Economics

  15. The Economic Person:Rational Self-Interest • Responding to incentives • Rationality and the use of incentives • Making choices • Balancing cost and benefits Chapter 1 - The Nature of Economics

  16. The Economic Person:Rational Self-Interest • Some examples of incentives • Responding to positive incentives • Schoolchildren getting gold stars, working to have a “better life” for yourself • Responding to negative incentives • Penalties, punishments, using credit cards to avoid check overdrafts Chapter 1 - The Nature of Economics

  17. The Economic Person:Rational Self-Interest • Defining self-interest • The pursuit of one’s goals, does not always mean increasing one’s wealth • Prestige • Friendship • Love Chapter 1 - The Nature of Economics

  18. Example: The Perceived Value of Gifts • The perceived value of gifts • Often, the recipient of the gift places a value on it far less than the market value. • Should we substitute gift certificates for physical gifts? Chapter 1 - The Nature of Economics

  19. Economics as a Science • Models or Theories • Simplified representations of the real world used as the basis for predictions or explanations • A map is the quintessential model Chapter 1 - The Nature of Economics

  20. Economics as a Science • Assumptions • The set of circumstances in which a model is applicable • Every model, or theory, must be based on a set of assumptions. Chapter 1 - The Nature of Economics

  21. Example: Getting Directions • A map is a simplifying model of reality. • The degree of simplification varies across maps; some contain more detail than others. • Economic models attempt to focus on what is relevant to the problem at hand and omit what is not. Chapter 1 - The Nature of Economics

  22. Economics as a Science • Ceteris Paribus Assumption • Nothing changes except the factor or factors being studied. • “Other things constant” • “Other things equal” Chapter 1 - The Nature of Economics

  23. Economics as a Science • Economics is an empirical science. • Real-world data is used to evaluate the usefulness of a model. • Models are useful if they predict economic phenomena. • Economic models predict how people react, not how they think. Chapter 1 - The Nature of Economics

  24. Economics as a Science • Behavioral Economics • Approach to the study of consumer behavior • Emphasizes psychological limitations and complications which may interfere with rational decision making Chapter 1 - The Nature of Economics

  25. Economics as a Science • Bounded Rationality • Hypothesis that people are nearly, not fully, rational • They cannot examine every choice available to them • Use simple rules of thumb to sort alternatives Chapter 1 - The Nature of Economics

  26. Positive versus Normative Economics • Positive Economics • Purely descriptive statements or scientific predictions; “If A, then B,” a statement of what is • Normative Economics • Analysis involving value judgments; relates to whether things are good or bad, a statement of what ought to be Chapter 1 - The Nature of Economics

  27. Summary Discussionof Learning Objectives • Microeconomics versus macroeconomics • Economics is the study of how individuals make choices to satisfy wants. • Microeconomics is the study of decision making by individual households and individual firms. • Macroeconomics is the study of nationwide phenomena, such as inflation and unemployment levels. Chapter 1 - The Nature of Economics

  28. Summary Discussionof Learning Objectives • Self-interest in economic analysis • Rational self-interest is the assumption that individuals behave in a reasonable (rational) way in making choices to further their interests. Chapter 1 - The Nature of Economics

  29. Summary Discussionof Learning Objectives • Economics as a science • Economists use models, or theories, that are simplified representations of the real world to analyze and make predictions about the real world. Chapter 1 - The Nature of Economics

  30. Summary Discussionof Learning Objectives • The difference between positive and normative economics • Positive economics deals with what is, whereas normative economics deals with what ought to be. • Positive statements are of the “if…then” variety, while normative ask what “should, or could” be. Chapter 1 - The Nature of Economics