CHAPTER 1: What is Economics?

1. CHAPTER 1:What is Economics?

2. CHAPTER CHECKLIST • Define economics, distinguish between microeconomics and macroeconomics, and explain the questions of macroeconomics. • Describe the work of economists as social scientists. • Explain four core ideas that define way economists think about macroeconomic questions. • Explain why economics is worth studying.

3. I. IntroductionA Definition of Economics • Economicsis the science of choice — the science that explains the choices that we make and how those choices change as we cope with scarcity. • Society’s wants exceed the resources available to satisfy them. • Rich and poor alike are faced with scarcity.

4. This course will use this text: • Bade & Parkin, Foundations of Macroeconomics, 1st edition • This comes in a package, with a Study Guide, access to web resources and phone help. • Practice with Study Guide or web multiple choice questions/sample quizzes is the best way to prepare for tests • Explore what is in the package; it’s costing you about $80, get your money’s worth out of it.

5. Using Bade-Parkin • Don’tbring the text to class • Do read it -- preferably before and after the class that the chapter is assigned for • Do use the web and the Study Guide -- it is best to do it with some friends, rather than alone.

6. Email and the Web • If you don’t have an FSU email address, get one as soon as possible. You will get lots of important information about this class by email. It is easy to get email forwarded from your FSU garnet account to your preferred email account. • By the end of the semester, there will be lots of material for the class on the web. See http://mailer.fsu.edu/~jcobbe/eco2013.htm

7. JARGON • Economics uses jargon a lot • Jargon means a special vocabulary • Economics jargon can be confusing because it often gives special meaning to ordinary, every day words, that have a different meaning in normal usage

8. Why jargon? • Jargon allows precision • Jargon allows shorter statements • Jargon permits more efficient communication • It’s standard in economics, so we have to know it to understand economics

9. Quote: Joan Robinson[Professor of Economics at U. of Cambridge] • “You study economics in order to avoid being fooled by economists”

10. Bad aspects of Jargon • Jargon can be used to obfuscate or exclude • Jargon can be confusing to those who are unsure of it • Unnecessary jargon hinders efficient communication rather than helping it

11. Economics as a Foreign Language • ALL economics and economists use jargon to some extent • MOST of economics is common sense • Except for a very few non-intuitive ideas, learning economics amounts to learning how to express what you know in the right jargon, i.e. it is like learning a new language

12. LECTURE TOPICS • Definitions and Questions • Economics: A Social Science • Macroeconomic Ideas • Why Economics Is Worth Studying

13. 1.1 DEFINITIONS AND QUESTIONS All economic questions and problems arise because human wants exceed the resources available to satisfy them. Scarcity • The condition that arises because the available resources are insufficient to satisfy all wants. Economics • Studies the choices that individuals, businesses, government, and entire societies make as they cope with scarcity.

14. 1.1 DEFINITIONS AND QUESTIONS • Microeconomics • Microeconomics: The study of the choices that individuals and businesses make, the way these choices interact, and the influence that governments exert on these choices. Micro = ‘small’ • Macroeconomics • Macroeconomics: The study of the aggregate (or total) effects on the national economy and the global economy of the choices that individuals, businesses, and governments make. Macro = ‘big’

15. 1.1 DEFINITIONS AND QUESTIONS • Macroeconomic Questions • Three big issues that macroeconomics tries to understand are: • The standard of living • The cost of living • Economic fluctuations—recessions and expansions

16. 1.1 DEFINITIONS AND QUESTIONS The Standard of Living • Standard of living • The level of consumption of goods and services that people enjoy, on the average; it is measured [not perfectly] by average income per person. • Goods and services • What people value and produce to satisfy human wants. Goods are physical objects, and services are things done for people.

17. 1.1 DEFINITIONS AND QUESTIONS • For most people achieving a high standard of living means finding a good job. • Unemployment • The state of being available and willing to work but unable to find acceptable work.

18. 1.1 DEFINITIONS AND QUESTIONS • The Cost of Living • Cost of living • The number of dollars it takes to buy the goods and services that provide a given standard of living. • Inflation • A situation in which the cost of living is rising and the value of money is shrinking.

19. 1.1 DEFINITIONS AND QUESTIONS • Economic Fluctuations: Recessions and Expansions • Business cycle • The periodic but irregular up-and-down movement in production and jobs is called the business cycle. • The worst recession ever was the Great Depression. • Great Depression • A period during the 1930s in which the economy experienced its worst-ever recession.

20. 1.1 DEFINITIONS AND QUESTIONS • Figure 1.1 shows a stylized business cycle. • An expansion ends at a peak and a recession ends at a trough.

21. 1.2 ECONOMICS: A SOCIAL SCIENCE • The goal of economists is to discover how the economic world works. Economists distinguish between: • Positive statements: What is • Normative statements: What [someone thinks] ought to be • The task of economic science: • To discover and catalog positive statements that are consistent with what we observe in the world and that help us to understand how the economic world works.

22. 1.2 ECONOMICS: A SOCIAL SCIENCE • This task can be broken into three steps: • Observing and measuring • Model building • Testing • Observing and Measuring Items such as: • Quantities of resources • Wages and work hours • Prices and quantities of goods and services • Taxes and government spending • Volume of international trade

23. 1.2 ECONOMICS: A SOCIAL SCIENCE • Model Building • Economic model • A description of some aspect of the economic world that includes only those features of the world that are needed for the purpose at hand, and is tractable – i.e. we can learn from it, because we can play with the model and get results.

24. ‘Models’ • Economics uses models a lot • A model is an abstraction, a simplification, that concentrates on a few things, excluding detail that is not essential to the task at hand. • “Horses for courses” -- if the model serves its purpose, then lack of detail and realism doesn’t matter. Example:

26. 1.2 ECONOMICS: A SOCIAL SCIENCE • Testing • A model’s predictions might be consistent with, or in conflict with, the data – our measurements or estimates of reality. If consistent, then we tentatively accept the model as useful. • Economic theory • A generalization that summarizes what we understand about the economic choices that people make and the economic performance of industries and nations.

27. 1.2 ECONOMICS: A SOCIAL SCIENCE • Unscrambling Cause and Effect • A central idea that economists use to unscramble cause and effect is ceteris paribus. • Ceteris Paribus • Ceteris paribus means “other things being equal.” • But ceteris paribus can be a problem in economics when trying to test a model: in the real world, usually ‘ceteris’ is not ‘paribus’.

28. 1.2 ECONOMICS: A SOCIAL SCIENCE • Economists take three complimentary approaches to dealing with ceteris not being paribus: • Natural experiments • Econometric investigations • Economic experiments • Natural Experiments • A situation that arises in the ordinary course of economic life in which the one factor of interest changes and other things don’t.

29. 1.2 ECONOMICS: A SOCIAL SCIENCE • Econometric Investigations • Econometric investigations use statistical tools. Correlation The tendency for the values of two variables to move in a predictable and related way. Post hoc fallacy The error of reasoning that a first event causes a second event because the first occurred before the second. Correlation is not causation.

30. Two Fallacies • Post hoc ergo propter hoc* -- correlation is not causation. • [*’After this, therefore because of this’ -- obviously a fallacy: does the sun rise because the cock crows?] • The Fallacy of Composition -- what is true for one may not be true for all.

31. 1.2 ECONOMICS: A SOCIAL SCIENCE • Economic Experiments Economic experiments put real subjects in a decision making situation and vary the influence of interest to discover how the subjects respond to one factor at a time. A relatively new approach.

32. 1.3 MACROECONOMIC IDEAS • Four core ideas: • Rational choice • Standard of living • Cost of living • Economic fluctuations

33. 1.3 MACROECONOMIC IDEAS • Rational Choice • Using the available resources to most effectively satisfy the wants of the person or agent making the choice. Also called ‘optimization.’ Cost: What You Must Give Up Opportunity cost The highest-valued alternative forgone.

34. 1.3 MACROECONOMIC IDEAS Benefit: Gain Measured by What You Are Willing to Give Up to get it. • Benefit • The gain or pleasure that something brings. On the Margin • Margin • A choice that is made by comparing all the relevant alternatives systematically and incrementally.

35. 1.3 MACROECONOMIC IDEAS Marginal cost • The cost of a one-unit increase in an activity Marginal benefit • What you gain when you get one moreunit of • something. • We make a rational choice when we take those actions for which marginal benefit exceeds or equals marginal cost.

36. The Margin: • We usually make choices in small steps, or at the margin, and choices are influenced by incentives. • Marginal Benefit vs. Marginal Cost • Incentives are inducements to take particular actions • By looking for changes in marginal cost and marginal benefits, we can predict the way choices will change in response to changes in incentives.

37. Implication ……. • Economics is good at assessing small changes from existing situations • Economics is NOT good at dealing with the consequences of big changes -- it is hard to do a cost-benefit study of a revolution • “Natura non facit saltum*” -- Marshall, Economics as ‘natural history’ of people’s behavior. • *Latin again: “Nature does not make a jump”

38. 1.3 MACROECONOMIC IDEAS • The Standard of Living and Productivity • The dollar value of production [‘output’] can increase for three reasons: Because • Prices rise and/or • People employed increases and/or • Productivity increases • Productivity, measured nationally, is: • total production per person employed.

39. 1.3 MACROECONOMIC IDEAS • The Cost of Living and the Quantity of Money • A rising cost of living [“inflation”] means that more dollars are needed to buy the same fixed quantity of goods and services. • Inflation is caused by an increase in the quantity of money that is not matched by an increase in the quantity of goods and services, ceteris paribus. [Would this still be correct if we had a shift from paying workers monthly to paying them weekly?]

40. 1.3 MACROECONOMIC IDEAS • Expenditure and Productivity Fluctuations • Sources of economic fluctuations can be grouped as: • Expenditure fluctuations • Productivity fluctuations • Smoothing the Business Cycle • Economic fluctuations are undesirable: recession brings involuntary unemployment and overly strong expansion brings inflation. • Macroeconomic policy tries to smooth the business cycle, make the fluctuations around the trend smaller.

41. Two ways of analyzing economic issues • Efficiency -- how do we maximize the total value of all production, ignoring who gets it and who bears the costs? • Equity -- what are the distributional implications, i.e. who benefits and who loses?

42. Need both to be complete • The U.S. tradition is to emphasize the efficiency aspect of economic questions • However, all economic decisions normally have equity implications as well as efficiency ones, and an economic analysis is incomplete without discussion of the equity aspects.

43. How Economists Study Issues • Economists attempt to discover an explanation for how economic systems work -- to predict. • Economists distinguish between Positive Statements and Normative Statements • Positive statements are about how things actually are -- facts could show a positive statement was false if it was false.. • Normative statements are about what ought to be, involve opinion or value judgments -- they cannot be shown to be false.

44. Economics and Politics • Efficiency statements will usually be positive, so although we may disagree about the facts we can use them, try to find ‘truth.’ • Equity statements can be positive, but often quickly become normative, reflecting opinions about who should benefit or bear the cost -- and often these views feed into political disagreements.

45. 1.4 WHY ECONOMICS IS WORTH STUDYING • Two main benefits from studying economics are: • Understanding • Expanded career opportunities • Understanding • Economic ideas are all around you. You cannot ignore them. • As you progress with you study of economics, you’ll gain a deeper understanding of what is going on around you.

46. 1.4 WHY ECONOMICS IS WORTH STUDYING • Expanded Career Opportunities • Most students of economics don’t become economists. • But knowledge of economics is useful in many fields such as banking, finance, business, management, insurance, real estate, law, government, journalism, health care and the arts. • Economics graduates are not the highest-paid professional, but they are close to the top.

47. 1.4 WHY ECONOMICS IS WORTH STUDYING 1.4 WHY ECONOMICS IS WORTH STUDYING • Figure 1.2 • Graduates in disciplines that teach problem identifying and solving and strategic brokering are top of the earnings distribution: • engineering • computer science • economics

48. 4.1 WHY ECONOMICS IS WORTH STUDYING 1.4 WHY ECONOMICS IS WORTH STUDYING • The Costs of Studying Economics • The main cost of studying economics is forgone leisure time. • Most students find that economics is difficult and that it takes time and effort to master. • The trick is practice, or learning by doing. • Benefits Versus Costs • Weigh up your benefits and costs!

49. APPENDIX CHECKLIST • Interpret a scatter diagram, a time-series graph, and a cross-section graph. • Interpret the graphs used in economic models. • Define and calculate slope. • Graph relationships among more than two variables.

50. APPENDIX: MAKING AND USING GRAPHS • Basic Idea • A graph is a diagram or ‘cartoon’ that enables us to visualize the relationship between two [or more] variables. • To make a graph set two lines perpendicular to each other: • The horizontal line is called the x-axis. • The vertical line is called the y-axis. • The common zero point is called the origin.