1

What Is Economics?
Why does public discussion of economic policy so
often show the abysmal ignorance of the
participants? Whey do I so often want to cry at
what public figures, the press, and television
commentators say about economic affairs?
Robert M. Solow

Contents
Contents
Ideas
Ideas for
for Beyond
Beyond the
the Final
Final Exam
Exam
Inside
Inside the
the Economists
EconomistsToolkit
Toolkit
Appendix:
Appendix: Using
Using Graphs:
Graphs:A
AReview
Review

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 1:
1: How
How Much
Much Does
Does ItIt Really
Really Cost?
Cost?
Opportunity
Opportunity cost
cost == value
value of
of the
the best
best forgone
forgone
alternative
alternative to
to any
any decision
decision
All
All actions
actions
opportunity
opportunity costs
costs
Opportunity
Opportunity costs
costs
true
true economic
economic costs
costs

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 2:
2: The
The Market
Market Strikes
Strikes Back
Back
Markets
Markets set
set prices.
prices.
Government
Government may
may intervene.
intervene.
Markets
Markets may
may strike
strike back.
back.
Example:
Example: rent
rent control
control reduces
reduces the
the supply
supply of
of
housing.
housing.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 3:
3: The
The Surprising
Surprising Principle
Principle of
of
Comparative
Comparative Advantage
Advantage
When
When two
two nations
nations trade,
trade, both
both benefit.
benefit.
Comparative
Comparative advantage
advantage == the
the production
production of
of
goods
goods with
with the
the lowest
lowest opportunity
opportunity cost
cost
Comparative
Comparative advantage
advantage
specialization
specialization

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 4:
4: Trade
Trade isis aa Win-Win
Win-Win Situation
Situation
Trade
Trade
benefits
benefits for
for both
both buyers
buyers &
& sellers
sellers
Restrictions
Restrictions on
on trade
trade
benefits
benefits
Intervention
Intervention into
into markets
markets
costs
costs

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 5:
5: The
The Importance
Importance of
of Thinking
Thinking at
at the
the
Margin
Margin
Marginal
Marginal == small
small change
change
Marginal
Marginal costs
costs == change
change in
in costs
costs
Rational
Rational decisions
decisions == comparison
comparison of
of costs
costs to
to
benefits
benefits at
at the
the margin
margin

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 6:
6: Externalities:
Externalities: Shortcoming
Shortcoming of
of the
the
Market
Market Cured
Cured by
by Market
Market Methods
Methods
Externalities
Externalities == effects
effects of
of transactions
transactions on
on third
third
parties
parties
Externalities
Externalities
social
social costs
costs
Market
Market failure
failure
need
need for
for government
government
intervention
intervention
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 7:
7: The
The Trade-off
Trade-off between
between Efficiency
Efficiency
and
and Equality
Equality
More
More efficiency
efficiency
more
more output
output &
& jobs
jobs
More
More equality
equality
less
less efficiency
efficiency
Labor
Labor markets
markets distribute
distribute income
income efficiently,
efficiently, not
not
equally.
equally.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 8:
8: The
The Short-Run
Short-Run Trade-off
Trade-off between
between
Inflation
Inflation and
and Unemployment
Unemployment
Low
Low unemployment
unemployment
rising
rising prices
prices
High
High unemployment
unemployment
falling
falling prices
prices

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
Idea
Idea 9:
9: Productivity
Productivity Growth
Growth Is
Is (Almost)
(Almost)
Everything
Everything in
in the
the Long
Long Run
Run
Productivity
Productivity growth
growth
more
more output
output
More
More output
output
higher
higher living
living standards
standards
In
In the
the long
long run,
run, productivity
productivity growth
growth isis (almost)
(almost)
everything.
everything.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Inside
Inside the
the Economists
Economists
Toolkit
Toolkit
Economics
Economics as
as aa Discipline
Discipline
Economics
Economics isis the
the most
most scientific
scientific of
of the
the social
social
sciences.
sciences.
Yet,
Yet, itit isis much
much more
more social
social than
than the
the natural
natural
sciences.
sciences.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Inside
Inside the
the Economists
Economists
Toolkit
Toolkit
The
The Need
Need for
for Abstraction
Abstraction
Real
Real world
world complexity
complexity
simplification
simplification in
in
economic
economic theory
theory
The
The art
art of
of economics:
economics: focus
focus on
on the
the essential;
essential;
ignore
ignore the
the trivial.
trivial.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Inside
Inside the
the Economists
Economists
Toolkit
Toolkit
The
The Role
Role of
of Economic
Economic Theory
Theory
Economic
Economic theory
theory == explanation
explanation of
of why
why
economic
economic events
events occur
occur
Correlation
Correlation causality
causality
Economic
Economic theories
theories
predictions
predictions

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Inside
Inside the
the Economists
Economists
Toolkit
Toolkit
What
What Is
Is an
an Economic
Economic Model?
Model?
Economic
Economic model
model == formal
formal statement
statement of
of
economic
economic theory
theory
Usually
Usually expressed
expressed in
in mathematics,
mathematics, with
with
equations
equations and
and graphs
graphs

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Inside
Inside the
the Economists
Economists
Toolkit
Toolkit
Reasons
Reasons for
for Disagreements:
Disagreements: Imperfect
Imperfect
Information
Information and
and Value
Value Judgments
Judgments
Among
Among economists,
economists,
agreement
agreement >> disagreement
disagreement
Imperfect
Imperfect information
information
disagreements
disagreements
Value
Value judgments
judgments
disagreements
disagreements

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Appendix
Using Graphs: A Review

Graphs
Graphs Used
Used in
in Economic
Economic
Analysis
Analysis
Display
Display large
large quantity
quantity of
of data
data quickly
quickly
Facilitate
Facilitate data
data interpretation
interpretation and
and analysis
analysis
Important
Important statistical
statistical relationships
relationships more
more
apparent
apparent than
than from
from written
written descriptions
descriptions or
or
long
long lists
lists of
of numbers
numbers

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Two-Variable
Two-Variable Diagrams
Diagrams
Variable
Variable == something
something measured
measured by
by aa
number
number
Examples:
Examples: price
price and
and quantity
quantity

View
View two
two variables
variables together
together to
to see
see ifif they
they
exhibit
exhibit aa relationship.
relationship.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

TABLE
TABLE 1-1
1-1 Quantities
Quantities of
of Natural
Natural

Gas
Gas Demanded
Demanded at
at Various
Various Prices
Prices

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-1
1-1

Hypothetical
Hypothetical Demand
Demand
Curve
Curve for
for Gas
Gas
6

Price

Price

2
1

a
b

1
0

20

40

60

Q
80 100 120 140

Quantity
(a)

20

40

60

Q
80 100 120 140

Quantity
(b)

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

The
The Definition
Definition and
and
Measurement
Measurement of
of Slope
Slope
Slope
Slope == ratio
ratio of
of vertical
vertical change
change to
to
horizontal
horizontal change
change
Rise/run
Rise/run
Measure
Measure of
of steepness
steepness of
of the
the line
line

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

The
The Definition
Definition and
and
Measurement
Measurement of
of Slope
Slope
The
The slope
slope of
of aa straight
straight line
line
Negative
Negative slope
slope == one
one variable
variable rises
rises while
while the
the
other
other variable
variable falls
falls
The
The two
two variables
variables move
move in
in opposite
opposite directions.
directions.

Positive
Positive slope
slope == two
two variables
variables rise
rise and
and fall
fall
together
together
The
The two
two variables
variables move
move in
in the
the same
same direction.
direction.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-2a
1-2a

Slope
Slope

Negative
Negative

Negative
slope

X
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-2b
1-2b

Slope
Slope

Positive
Positive

Positive
slope

X
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

The
The Definition
Definition and
and
Measurement
Measurement of
of Slope
Slope
Zero
Zero slope
slope == the
the variable
variable on
on the
the horizontal
horizontal
axis
axis can
can be
be any
any value
value while
while the
the variable
variable on
on the
the
vertical
vertical axis
axis isis fixed
fixed
Horizontal
Horizontal line
line

Infinite
Infinite slope
slope == the
the variable
variable on
on the
the vertical
vertical
axis
axis can
can be
be any
any value
value while
while the
the variable
variable on
on the
the
horizontal
horizontal axis
axis isis fixed
fixed
Vertical
Vertical line
line
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-2c
1-2c

Slope
Slope

Zero
Zero

Zero
slope

X
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-2d
1-2d

Slope
Slope

Infinite
Infinite

Infinite
slope

X
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

The
The Definition
Definition and
and
Measurement
Measurement of
of Slope
Slope
The
The slope
slope of
of aa straight
straight line
line
Slope
Slope isis constant
constant along
along aa straight
straight line.
line.
Slope
Slope can
can be
be measured
measured between
between any
any two
two
points
points on
on one
one axis
axis and
and the
the corresponding
corresponding two
two
points
points on
on the
the other
other axis.
axis.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-3
1-3

How
How to
to Measure
Measure Slope
Slope
Y

Y
3
Slope =
10
C

11
C

9
8

1
Slope =
10
B

13
(a)

13

(b)

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

The
The Definition
Definition and
and
Measurement
Measurement of
of Slope
Slope
The
The slope
slope of
of aa curved
curved line
line
Slope
Slope changes
changes from
from point
point to
to point
point on
on aa
curved
curved line.
line.
Curved
Curved line
line bowed
bowed toward
toward the
the origin
origin has
has aa
negative
negative slope.
slope.
Variables
Variableschange
changein
inopposite
oppositedirections.
directions.

Curved
Curved line
line bowed
bowed away
away from
fromthe
the origin
origin has
has aa
positive
positive slope.
slope.
Variables
Variableschange
changein
inthe
thesame
samedirection.
direction.
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-4a
1-4a

Negative
Negative Slope
Slope in
in Curved
Curved Lines
Lines
Y

Negative
slope

X
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-4b
1-4b

Positive
Positive Slope
Slope in
in Curved
Curved Lines
Lines
Y

Positive
slope

X
Copyright 2003 South-Western/Thomson Learning. All rights reserved.

The
The Definition
Definition and
and
Measurement
Measurement of
of Slope
Slope
The
The slope
slope of
of aa curved
curved line
line
A
Acurved
curved can
can have
have both
both aa positive
positive and
and
negative
negative slope
slope depending
depending on
on where
where on
on the
the
curve
curve isis measured.
measured.
The
The slope
slope at
at aa point
point on
on aa curved-line
curved-line isis
measured
measured by
by aa line
line tangent
tangent to
to that
that point.
point.

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-4c,d
1-4c,d

Behavior
Behavior of
of
Slope
Slope in
in Curved
Curved Lines
Lines
Y

Y
Negative
slope

Positive
slope
Negative
slope

Positive
slope
0

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-5
1-5

How
How to
to
Measure
Measure Slope
Slope at
at aa Point
Point
on
on aa Curve
Curve
Y

7
6
5

2
1
0

A
t

B
1

10

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Rays
Rays Through
Through the
the Origin
Origin and
and
45-degree
45-degree Lines
Lines
Y-intercept
Y-intercept == point
point at
at which
which aa line
line
touches
touches the
the yy axis
axis
Ray
Ray through
through the
the origin
origin == straight
straight line
line
graph
graph with
with aa y-intercept
y-intercept of
of zero
zero

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-6
1-6

Rays
Rays through
through the
the Origin
Origin
Y
Slope = + 2

Slope = + 1

3 C

E
0

Slope = + 1

D
3

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

Squeezing
Squeezing 33 Dimensions
Dimensions
into
into 2:
2: Contour
Contour Maps
Maps
Some
Some problems
problems involve
involve more
more than
than two
two
variables
variables
Economic
Economic contour
contour map
map called
called aa
production
production indifference
indifference map
map
Shows
Shows how
how variable
variable ZZ changes
changes as
as we
we change
change
either
either XX or
or YY

Copyright 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE
FIGURE 1-8
1-8

An
An Economic
Economic Contour
Contour Map
Map
Y

Yards of Cloth per Day

80
70
60
50
A

40

Z = 40
B

30

Z = 30

20

Z = 20

10

Z = 10
0

10

20

30

40

50

60

70

80

Labor Hours per Day

Copyright 2003 South-Western/Thomson Learning. All rights reserved.