The Scope and Method of Economics

2009 Pearson Education, Inc.
Publishing as Prentice Hall Principles of Macroeconomics 9e by Case, Fair and Oster

1
PART I INTRODUCTION TO ECONOMICS
The Scope and
Method of Economics
Fernando & Yvonn Quijano
Prepared by:
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2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9e by Case, Fair and Oster 2 of 34
1
PART I INTRODUCTION TO ECONOMICS
The Scope and
Method of Economics
Why Study Economics?
To Learn a Way of Thinking
To Understand Society
To Understand Global Affairs
To Be an Informed Voter
The Scope of Economics
Microeconomics and
Macroeconomics
The Diverse Fields of Economics
The Method of Economics
Theories and Models
Economic Policy
An Invitation
Appendix: How to Read
and Understand Graphs
CHAPTER OUTLINE
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The Scope And Method Of Economics
economics The study of how individuals
and societies choose to use the scarce
resources that nature and previous
generations have provided.
The key word in this definition is choose.
Economics is a behavioral, or social, science. In large measure it
is the study of how people make choices.
The choices that people make, when added up, translate into
societal choices.
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Three fundamental concepts:
Opportunity cost
Marginalism, and
Efficient markets
To Learn A Way Of Thinking
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opportunity cost The best alternative
that we forgo, or give up, when we
make a choice or a decision.
scarce Limited.
Opportunity Cost
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marginalism The process of
analyzing the additional or incremental
costs or benefits arising from a choice
or decision.
sunk costs Costs that cannot
be avoided, regardless of what is
done in the future, because they
have already been incurred.
Marginalism and Sunk Costs
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efficient market A market
in which profit opportunities are
eliminated almost instantaneously.
The study of economics teaches us a way of thinking and
helps us make decisions.
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Industrial Revolution The period in England during the
late eighteenth and early nineteenth centuries in which
new manufacturing technologies and improved
transportation gave rise to the modern factory system
and a massive movement of the population from the
countryside to the cities.
To Understand Society
The study of economics is an essential part of the study of
society.
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To Understand Global Affairs
An understanding of economics is essential to an understanding
of global affairs.
E C O N O M I C S I N P R A C T I C E
iPod and the World
An iPod Has Global Value. Ask the
(Many) Countries That Make It.
The New York Times
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To Be An Informed Citizen
When we participate in the political process, we are voting on
issues that require a basic understanding of economics.
A knowledge of economics is essential to
be an informed citizen.
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microeconomics The branch of economics that
examines the functioning of individual industries and the
behavior of individual decision-making unitsthat is,
business firms
and households.
Microeconomics and Macroeconomics
macroeconomics The branch of economics that
examines the economic behavior of aggregates
income, employment, output, and so onon a national
scale.
Microeconomics looks at the individual unitthe household, the
firm, the industry. It sees and examines the trees.
Macroeconomics looks at the whole, the aggregate. It sees and
analyzes the forest.
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TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns
Divisions
of Economics

Production

Prices

Income

Employment
Microeconomics Production/output in
individual industries and
businesses

How much steel
How much office
space
How many cars
Price of individual
goods and services

Price of medical care
Price of gasoline
Food prices
Apartment rents
Distribution of
income and
wealth

Wages in the auto
industry
Minimum wage
Executive salaries
Poverty
Employment by
individual businesses
and industries

Jobs in the steel
industry
Number of employees
in a firm
Number of
accountants
Macroeconomics National
production/output

Total industrial output
Gross domestic
product
Growth of output
Aggregate price level

Consumer prices
Producer prices
Rate of inflation
National income

Total wages and
salaries
Total corporate
profits
Employment and
unemployment in
the economy

Total number of jobs
Unemployment rate
Microeconomics and Macroeconomics
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TABLE 1.2 The Fields of Economics
Comparative economic
systems
examines the ways alternative economic systems function. What are the
advantages and disadvantages of different systems?
Econometrics applies statistical techniques and data to economic problems in an effort to test
hypotheses and theories. Most schools require economics majors to take at least
one course in statistics or econometrics.
Economic development focuses on the problems of low-income countries. What can be done to promote
development in these nations? Important concerns of development economists
include population growth and control, provision for basic needs, and strategies for
international trade.
Economic history traces the development of the modern economy. What economic and political events
and scientific advances caused the Industrial Revolution? What explains the
tremendous growth and progress of postWorld War II Japan? What caused the
Great Depression of the 1930s?
Economics of race and
gender
examines the role of race and gender in economic theory, in economic life, and in
policymaking. How has discrimination by race or gender affected the well-being of
households and the distribution of income and wealth?
Environmental economics studies the potential failure of the market system to account fully for the impacts of
production and consumption on the environment and on natural resource depletion.
Have alternative public policies and new economic institutions been effective in
correcting these potential failures?
Finance examines the ways in which households and firms actually pay for, or finance, their
purchases. It involves the study of capital markets (including the stock and bond
markets), futures and options, capital budgeting, and asset valuation.
Continued...
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TABLE 1.2 The Fields of Economics (continued)
The history of economic
thought,
which is grounded in philosophy, studies the development of economic ideas and
theories over time, from Adam Smith in the eighteenth century to the works of
economists such as Thomas Malthus, Karl Marx, and John Maynard Keynes.
Because economic theory is constantly developing and changing, studying the
history of ideas helps give meaning to modern theory and puts it in perspective.
Industrial organization looks carefully at the structure and performance of industries and firms within an
economy. How do businesses compete? Who gains and who loses?
International economics studies trade flows among countries and international financial institutions. What are
the advantages and disadvantages for a country that allows its citizens to buy and
sell freely in world markets? Why is the dollar strong or weak?
Labor economics deals with the factors that determine wage rates, employment, and unemployment.
How do people decide whether to work, how much to work, and at what kind of job?
How have the roles of unions and management changed in recent years?
Law and economics analyzes the economic function of legal rules and institutions. How does the law
change the behavior of individuals and businesses? Do different liability rules make
accidents and injuries more or less likely? What are the economic costs of crime?
Public economics examines the role of government in the economy. What are the economic functions
of government, and what should they be? How should the government finance the
services that it provides? What kinds of government programs should confront the
problems of poverty, unemployment, and pollution? What problems does
government involvement create?
Urban and regional
economics
studies the spatial arrangement of economic activity. Why do we have cities? Why
are manufacturing firms locating farther and farther from the center of urban areas?
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positive economics An approach to economics that
seeks to understand behavior and the operation of
systems without making judgments. It describes
what exists and how it works.
normative economics An approach to economics that
analyzes outcomes of economic behavior, evaluates
them as good or bad, and may prescribe courses of
action. Also called policy economics.
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descriptive economics The compilation of data that
describe phenomena and facts.
Descriptive Economics and Economic Theory
economic theory A statement or set of related
statements about cause and effect, action and
reaction.
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model A formal statement of a theory, usually a
mathematical statement of a presumed relationship
between two or more variables.
variable A measure that can change from time to time
or from observation to observation.
Theories and Models
Ockhams razor The principle that irrelevant detail
should be cut away.
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ceteris paribus, or all else equal A device used to
analyze the relationship between two variables while the
values of other variables are held unchanged.
All Else Equal: Ceteris Paribus
Using the device of ceteris paribus is one part of the
process of abstraction. In formulating economic theory,
the concept helps us simplify reality to focus on the
relationships that interest us.
Theories and Models
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The most common method of expressing the quantitative
relationship between two variables is graphing that
relationship on a two-dimensional plane.
Expressing Models in Words, Graphs, and Equations
Theories and Models
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Cautions and Pitfalls
The Post Hoc Fallacy
post hoc, ergo propter hoc Literally, after this (in time),
therefore because of this. A common error made in thinking
about causation: If Event A happens before Event B, it is not
necessarily true that A caused B.
Theories and Models
The Fallacy of Composition
fallacy of composition The erroneous belief that what is true
for a part is necessarily true for the whole.
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empirical economics The collection and use of
data to test economic theories.
Testing Theories and Models: Empirical Economics
Theories and Models
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Economic Policy
Criteria for judging economic outcomes:
1. Efficiency
2. Equity
3. Growth
4. Stability
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efficiency In economics, allocative efficiency. An
efficient economy is one that produces what people
want at the least possible cost.
Efficiency
equity Fairness.
Equity
Economic Policy
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economic growth An increase in the total output of
an economy.
Growth
stability A condition in which
national output is growing steadily, with low inflation
and full employment of resources.
Stability
Economic Policy
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An Invitation
As you proceed, it is important that you keep track
of what you have learned in earlier chapters. This
book has a plan; it proceeds step by step, each
section building on the last. It would be a good idea
to read each chapters table of contents and scan
each chapter before you read it to be sure you
understand where it fits in the big picture.
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REVIEW TERMS AND CONCEPTS
ceteris paribus
descriptive economics
economic growth
economic theory
economics
efficiency
efficient market
empirical economics
equity
fallacy of composition
Industrial Revolution
macroeconomics
marginalism
microeconomics
model
normative economics
Ockhams razor
opportunity cost
positive economics
post hoc, ergo propter hoc
scarce
stability
sunk costs
variable
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A graph is a two-dimensional representation of a
set of numbers, or data.
HOW TO READ AND UNDERSTAND GRAPHS
A P P E N D I X
A time series graph shows how
a single variable changes over
time.
TIME SERIES GRAPHS
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HOW TO READ
AND UNDERSTAND GRAPHS
A P P E N D I X
TIME SERIES GRAPHS
TABLE 1A.1 Total Disposable
Personal Income in the United States,
19752006 (in billions of dollars)
Year
Total
Disposable
Personal
Income Year
Total
Disposable
Personal
Income
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1,181.4
1,299.9
1,436.0
1,614.8
1,808.2
2,019.8
2,247.9
2,406.8
2,586.0
2,887.6
3,086.5
3,262.5
3,459.5
3,752.4
4,016.3
4,293.6
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
4,474.8
4,754.6
4,935.3
5,165.4
5,422.6
5,677.7
5,968.2
6,355.6
6,627.4
7,120.2
7,393.2
7,827.7
8,159.9
8,646.9
8,945.6
9,501.5
FIGURE 1A.1 Total Disposable Personal
Income in the United States: 19752006 (in
billions of dollars)
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GRAPHING TWO VARIABLES ON A CARTESIAN
COORDINATE SYSTEM
Appendix
FIGURE 1A.2 A Cartesian Coordinate
System
A P P E N D I X
A Cartesian coordinate system is
constructed by drawing two
perpendicular lines: a vertical
axis (the Y-axis) and a horizontal
axis (the X-axis). Each axis is a
measuring scale.
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A graph is a simple two-dimensional geometric
representation of data. This graph displays the
data from Table 1A.2. Along the horizontal scale
(X-axis), we measure household income. Along
the vertical scale (Y-axis), we measure
household consumption.
Note: At point A, consumption equals $19,120
and income equals $9,676.
At point B, consumption equals $28,921 and
income equals $25,546.
TABLE 1A.2 Consumption Expenditures
and Income, 2005
Average Income
Before Taxes
Average
Consumption
Expenditures
Bottom fifth
2nd fifth
3rd fifth
4th fifth
Top fifth
$ 9,676
25,546
42,622
67,813
147,737
$ 19,120
28,921
39,098
54,354
90,469
FIGURE 1A.3 Household Consumption and
Income
PLOTTING INCOME AND CONSUMPTION DATA
FOR HOUSEHOLDS
A P P E N D I X
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SLOPE
A P P E N D I X
A positive slope indicates that increases in X are
associated with increases in Y and that decreases
in X are associated with decreases in Y.
FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope
2 1
2 1
Y Y Y
X X X

A negative slope indicates the opposite
when X increases, Y decreases and when
X decreases, Y increases.
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FIGURE 1A.5 Changing Slopes Along Curves
A P P E N D I X
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It is important to think carefully about what is
represented by points in the space defined by the axes
of a graph. In this graph, we have graphed income
with consumption, as in Figure 1A.3, but here each
observation point is national income and aggregate
consumption in different years, measured in billions of
dollars.
TABLE 1A.3 Aggregate National Income and
Consumption for the United States,
19302006 (in billions of dollars)
Aggregate National Income Aggregate Consumption
1930
1940
1950
1960
1970
1980
1990
2000
2004
2005
2006
$ 75.6
81.1
241.0
427.5
837.5
2,243.0
4,642.1
7,984.4
10,306.8
10,887.6
11,655.6
$ 70.2
71.2
192.7
332.3
648.9
1,762.9
3,831.5
6,683.7
8,195.9
8,707.8
9,224.5
FIGURE 1A.6 National Income and
Consumption
SOME PRECAUTIONS
A P P E N D I X
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Cartesian coordinate system
graph
negative relationship
origin
positive relationship
slope
time series graph
X-axis
X-intercept
Y-intercept
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5
Macroeconomic Concerns
Output Growth
Unemployment
Inflation and Deflation

The Components of the Macroeconomy
The Circular Flow Diagram
The Three Market Arenas
The Role of the Government in the
Macroeconomy

A Brief History of Macroeconomics

The U.S. Economy Since 1970
CHAPTER OUTLINE
Introduction to
Macroeconomics
PART II CONCEPTS AND PROBLEMS
IN MACROECONOMICS
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Introduction to Macroeconomics
microeconomics Examines the functioning of
individual industries and the behavior of
individual decision-making unitsfirms and
households.
macroeconomics Deals with the economy as a
whole. Macroeconomics focuses on the
determinants of total national income, deals
with aggregates such as aggregate
consumption and investment, and looks at the
overall level of prices instead of individual
prices.
aggregate behavior The behavior of all
households and firms together.
sticky prices Prices that do not always adjust
rapidly to maintain equality between quantity
supplied and quantity demanded.
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Three of the major concerns of
macroeconomics are

Output growth

Unemployment

Inflation and deflation
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Output Growth
business cycle The cycle of short-term ups
and downs in the economy.
aggregate output The total quantity of goods
and services produced in an economy in a
given period.
recession A period during which aggregate
output declines. Conventionally, a period in
which aggregate output declines for two
consecutive quarters.
depression A prolonged and deep recession.
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Output Growth
expansion or boom The period in the business
cycle from a trough up to a peak during which
output and employment grow.
contraction, recession, or slump The period in
the business cycle from a peak down to a
trough during which output and employment
fall.
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Output Growth
FIGURE 5.1 A Typical
Business Cycle
In this business cycle, the
economy is expanding as it
moves through point A from
the trough to the peak.

When the economy moves
from a peak down to a trough,
through point B, the economy
is in recession.
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Output Growth
FIGURE 5.2 U.S. Aggregate Output (Real GDP), 19002007
The periods of the Great Depression and World Wars I and II show the largest fluctuations in
aggregate output.
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Unemployment
unemployment rate The percentage of the
labor force that is unemployed.
Inflation and Deflation
inflation An increase in the overall price level.
hyperinflation A period of very rapid increases
in the overall price level.
deflation A decrease in the overall price level.
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Macroeconomics focuses on four groups. To
see the big picture, it is helpful to divide the
participants in the economy into four broad
groups:

(1) households,

(2) firms,

(3) the government, and

(4) the rest of the world.
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circular flow A diagram showing the income
received and payments made by each sector of
the economy.
transfer payments Cash payments made by
the government to people who do not supply
goods, services, or labor in exchange for these
payments. They include Social Security
benefits, veterans benefits, and welfare
payments.
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FIGURE 5.3 The Circular Flow
of Payments
Households receive income from
firms and the government,
purchase goods and services
from firms, and pay taxes to the
government. They also purchase
foreign-made goods and services
(imports). Firms receive
payments from households and
the government for goods and
services; they pay wages,
dividends, interest, and rents to
households and taxes to the
government. The government
receives taxes from firms and
households, pays firms and
households for goods and
servicesincluding wages to
government workersand pays
interest and transfers to
households. Finally, people in
other countries purchase goods
and services produced
domestically (exports).
Note: Although not shown in
this diagram, firms and
governments also purchase
imports.
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Another way of looking at the ways
households, firms, the government, and the
rest of the world relate to each other is to
consider the markets in which they interact.

We divide the markets into three broad arenas:

(1) the goods-and-services market,

(2) the labor market, and

(3) the money (financial) market.
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Goods-and-Services Market
Firms supply to the goods-and-services
market. Households, the government, and
firms demand from this market.
Labor Market
In this market, households supply labor and
firms and the government demand labor.
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Money Market
Households supply funds to this market in the
expectation of earning income in the form of
dividends on stocks and interest on bonds.
Firms, the government, and the rest of the
world also engage in borrowing and lending
which is coordinated by financial institutions.
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Money Market
Treasury bonds, notes, and bills Promissory
notes issued by the federal government when
it borrows money.
corporate bonds Promissory notes issued by
firms when they borrow money.
shares of stock Financial instruments that
give to the holder a share in the firms
ownership and therefore the right to share in
the firms profits.
dividends The portion of a firms profits that
the firm pays out each period to its
shareholders.
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The Role of the Government in the Macroeconomy
fiscal policy Government policies concerning
taxes and spending.
monetary policy The tools used by the Federal
Reserve to control the quantity of money,
which in turn affects interest rates.
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Great Depression The period of severe
economic contraction and high unemployment
that began in 1929 and continued throughout
the 1930s.
fine-tuning The phrase used by Walter Heller
to refer to the governments role in regulating
inflation and unemployment.
stagflation A situation of both high inflation
and high unemployment.
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Macroeconomics in
Literature
The Great
Gatsby
The Grapes of Wrath
The underlying phenomena
that economists study are the
stuff of novels as well as
graphs and equations.
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The U.S Economy Since 1970
FIGURE 5.4 Aggregate Output (Real GDP), 1970 I2007 IV
Aggregate output in the United States since 1970 has risen overall, but there have been four
recessionary periods: 1974 I1975 IV, 1980 II1983 I, 1990 III1991 I, and 2001 I2001 III.
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FIGURE 5.5 Unemployment Rate, 1970 I2007 IV
The U.S. unemployment rate since 1970 shows wide variations. The four recessionary
reference periods show increases in the unemployment rate.
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FIGURE 5.6 Inflation Rate (Percentage Change in the GDP Deflator, Four-Quarter Average),
1970 I2007 IV
Since 1970, inflation has been high in two periods: 1973 IV1975 IV and 1979 I1981 IV.
Inflation between 1983 and 1992 was moderate. Since 1992, it has been fairly low.
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John Maynard
Keynes
Much of the framework of
modern macroeconomics
comes from the works of John
Maynard Keynes, whose
General Theory of
Employment, Interest and
Money was published in 1936.
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aggregate behavior
aggregate output
business cycle
circular flow
contraction, recession, or
slump
corporate bonds
deflation
depression
dividends
expansion or boom
fine-tuning
fiscal policy
Great Depression
hyperinflation
inflation
macroeconomics
microeconomics
monetary policy
recession
shares of stock
stagflation
sticky prices
transfer payments
Treasury bonds, notes, and
bills
unemployment rate

The Scope and Method of Economics

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Publishing as Prentice Hall Principles of Macroeconomics 9e by Case, Fair and Oster

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