Chapter 1

What Economics is About

 Chapter Topics

 Goods and Bads  Unintended Effects

 Resources  Exchange

 Scarcity  Market and Government

 Opportunity Costs  Ceteris Paribus
 Theory
 Costs and Benefits
 Microeconomics &
 Decisions Made at the
Macroeconomics
Margin
 Positive & Normative Economic
 Efficiency
 Incentives

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 Building a Definition of Economics: Goods and
Bads

 A good is anything from which individuals receive

utility or satisfaction.
 Utility: the satisfaction one receives from a good

 A bad is anything from which individuals receive

disutility or dissatisfaction.
 Disutility: the dissatisfaction one receives from a bad

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 Building a Definition of Economics: Resources

 Resources are required to produce goods.

 Resources can be divided into four categories:
1. Natural resources(land): gifts from nature
2. Labor: the physical and mental talents people contribute to
the production process
3. Capital: produced goods that can be used as inputs for further
production
4. Entrepreneurship: the organization of resources for
production

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 Scarcity and the Definition of
Economics
 Scarcity is the condition in which wants are greater than the
limited resources available to satisfy those wants.
 Everyone faces scarcity.
 Effects of scarcity:
1. People have to make choices.
 Because our wants are greater than our resources, we can’t have or do
everything we want—therefore we have to make decisions. Do I take another
class or buy a flat screen TV? Do I take a nap or do my econ assignment?
2. We need rationing devices—a means of deciding who gets what.
 Since there is not enough of everything to go around, we must have a way to
determine who gets what and how much.
 The most common rationing device is price (money)—people willing and
able to pay get the good or resource. Other devices: lines (first come, first
served), lottery (random drawing),…
3. Competition exists because of scarcity.
 People have to compete for the limited resources or for the rationing device.
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 Scarcity and the Definition of
Economics
 The basic economic problem confronting all
individuals and societies is: SCARCITY.

 Economics is the science of how individuals and

societies deal with the fact that wants are greater
than the limited resources available.
 Economics is the science of scarcity.

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 Scarcity’s Effects
1. The need to make choices
2. The need for a rationing device
• Rationing device: a means for deciding who gets what
and how much
3. Competition

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 Self Test (answers on next slide)

1. Scarcity is the condition of finite

resources. True or false? Explain your
answer.
2. How does competition arise out of
scarcity?
3. How does choice arise out of scarcity?

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 Self Test Answers
1. False. It takes two things for scarcity to exist: finite resources
and infinite wants. If people’s wants were equal to or less than
the finite resources available to satisfy their wants, there would
be no scarcity. Scarcity exists only because people’s wants are
greater than the resources available to satisfy their wants.
Scarcity is the condition of infinite wants clashing with finite
resources.
2. Because of scarcity, there is a need for a rationing device. People
will compete for the rationing device. For example, if dollar
price is the rationing device, people will compete for dollars.
3. Because our unlimited wants are greater than our limited
resources—that is, because scarcity exists—some wants must go
unsatisfied. We must choose which wants we will satisfy and
9 which we will not.
 Opportunity Cost
 Opportunity cost is the most highly valued opportunity
or alternative forfeited when a choice is made.
 Examples:
 You decided to read your econ PowerPoint notes today. You had
many other options for your time—sleep, TV, work, Frisbee,…
Whatever you would have done if you hadn’t decided to study econ
(your next best alternative) is your opportunity cost of studying
econ.
 You decided to go to college. The opportunity cost of college is
getting a job (the next best option). So when considering the cost
of going to college, it is important to consider not only the actual
costs (tuition, housing, etc.) but also the opportunity cost—the
wages you could have made from full-time job.
 A change in opportunity cost can change a person’s behavior.
 The higher the opportunity cost of doing something, the less likely
it will be done.
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 Scarcity, Choice, and Opportunity
Costs

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 Benefits and Costs
 Good decision making requires considering both the
benefits and costs of an action.
 Marginal benefits: the benefits connected to consuming an
additional unit of a good or undertaking one more unit of an
activity.
 Example: Marginal benefits of taking an additional course during the
summer include the additional knowledge and earlier graduation date.
 Marginal costs: the costs connected to consuming an additional
unit of a good or undertaking one more unit of an activity.
 Example: Marginal costs of taking an additional course during the
summer include dollar costs of tuition and less time for work or other
activities.

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 Decisions Made at the Margin
 Decisions at the margin: decision making
characterized by weighing the marginal (additional)
benefits of a change against the marginal
(additional) costs of a change with respect to
current conditions.
 An action should be taken if: marginal benefit is
greater than the marginal cost.

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 Efficiency
 Efficiency exists when marginal benefits equal
marginal costs.
 Net benefits are maximized when efficiency is
achieved.
 Example: What is the optimal (efficient) number of
hours to study for your econ exam?
 Continue to study as long as the marginal benefits are
greater than the marginal costs.

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 Efficiency
 Example continued: What is the optimal (efficient)
number of hours to study for your econ exam?

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 Incentives
 Incentive: something that encourages or motivates
a person to take an action
 A key principle of economics asserts that people
respond to incentives.

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 Unintended Effects
 Unintended effect: a positive or negative outcome
that was not anticipated.
 Example: minimum wage laws
 The intended effect of minimum wage is to help people earn
a better wage and have a higher standard of living.
 The unintended effect is unemployment—some employers
may not be willing or able to pay workers a higher wage.
 Example: pollution
 Pollution is often an unintended effect
of production

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 Exchange (Trade)
 Exchange (trade): giving up one thing for another
 Why do people (or economies) enter into
exchanges?
 To make themselves better off
 People are not going to agree to a trade that will make them
worse off.

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 Self Test (answers on next slide)
1. Give an example to illustrate how a change in
opportunity cost can affect behavior.
2. You stay up an added hour to study for a test. The
intended effect is to raise your test grade. What
might be an unintended effect of staying up an added
hour to study for the test?
3. Studying has both costs and benefits. If you continue
to study (say, for a test) as long as the marginal
benefits of studying are greater than the marginal
costs and stop studying when the two are equal, will
your action be consistent with having maximized the
19 net benefits of studying? Explain your answer.
 Self Test Answers
1. Every time a person is late to history class, the instructor
subtracts one-tenth of a point from the person’s final grade.
If the instructor raised the opportunity cost of being late to
class—by subtracting one point from the person’s final
grade—economists predict there would be fewer persons
late to class. In summary, the higher the opportunity cost of
being late to class, the less likely people will be late to class.
2. You might feel sleepy the next day, you might be less alert
while driving, and so on.
3. Yes. To illustrate, suppose the marginal benefits and costs
(in dollars) are as follows for various hours of studying.
(See next slide)
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 Self Test Answers
Hours Marginal Benefits Marginal Costs
First hour $20.00 $10.00
Second hour $14.00 $11.00
Third hour $13.00 $12.00
Fourth hour $12.10 $12.09
Fifth hour $11.00 $13.00
Clearly, you will study the first hour because the marginal benefits are greater
than the marginal costs. In this case, you will study through the fourth hour.
You will not study the fifth hour because it is not worth it; the marginal
benefits of studying the fifth hour are less than the marginal costs. In short,
there is a net cost to studying the fifth hour. (next slide)

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 The Market and Government
 When it comes to economic problems, the national debate
usually proceeds along these lines:
 First, the problem is identified and defined or described.
 Second, individuals attempt to identify the cause of the problem.
 Third, individuals propose solutions to the problem.
 With respect to both the cause and the solution, we often
hear two words mentioned: the “market” and “government.”
 Either: The market (or capitalism) is the cause of the problem.
 Or: The government is the cause of the problem.
 Either: The market (or capitalism) is the solution to the problem.
 Or: The government is the solution to the problem.
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 Ceteris Paribus and Theory
 Ceteris paribus means “all other things held constant” or “nothing else changes.”
 Invoking this assumption allows us to clearly designate what we believe is the correct
relationship between two variables.
 The statement, “People buy fewer Royals tickets when the price of Royals tickets
increases”, assumes ceteris paribus.
 Assumes everything else stays the same; that it is not another factor that caused the decrease
in purchases of Royals tickets. For example: bad weather, poor team performance, health
violations at concession stands, no promotions, etc.
 Economists build theories to answer questions that do not have obvious answers.
 To an economist, a theory is an abstract representation of the world. When they build a
theory they leave out certain things and focus on the major factors or variables that
they believe will explain the phenomenon they are trying to understand.
 A theory emphasizes only the variables that the theorist believes are the main or
critical ones that explain an activity or event.
 Abstraction: the process (used in building a theory) of focusing on a limited number
of variables to explain or predict an event or phenomenon
 Multiple theories might exist to explain the same event or phenomenon.
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 Positive and Normative Economics
 Economists have two main roles:
1. Researcher
2. Policy advisor
 Positive economics: the study of “what is” in economic
matters
 Cause and effect relationships that can be tested with data
 Example: Raising the minimum wage increases unemployment.
 Normative economics: the study of “what should be” in
economic matters
 Value judgments and opinions that cannot be tested
 Example: The Federal government should lower the minimum wage.

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 Microeconomics and
Macroeconomics
 Microeconomics deals with human behavior and choices as
they relate to relatively small units—an individual, a
business firm, an industry, a single market.
 Examples of microeconomic questions:
 How does a market work?
 What level of output does a firm produce?
 What price does a firm charge for the good it produces?
 How does a consumer determine how much of a good he or she
will buy?
 Can government policy affect business behavior?
 Can government policy affect consumer behavior?

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 Microeconomics and
Macroeconomics
 Macroeconomics deals with human behavior and choices as
they relate to highly aggregate markets (e.g., the goods and
services market) or the entire economy.
 Examples of macroeconomic questions:
 How does the economy work?
 Why is the unemployment rate sometimes high and sometimes low?
 What causes inflation?
 Why do some national economies grow faster than other national
economies?
 What might cause interest rates to be low one year and high the next?
 How do changes in the money supply affect the economy?
 How do changes in government spending and taxes affect the
economy?
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 Brief History and Intro
 See the following link to a video with a brief
history and introduction to economics:
 Introduction to Economics

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