Methods of Economics

CHAPTER
1
The Scope and
Method of Economics
Appendix: How to Read and Understand Graphs
Prepared by: Fernando Quijano
and Yvonn Quijano
2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
C H A P T E R 1: The Scope and Method of Economics
The Study of Economics
Economics is the study of how

individuals and societies
choose to use the scarce
resources that nature and
previous generations have
provided.
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Why Study Economics?
An important reason for

studying economics is to learn
a way of thinking.
Three fundamental concepts:
Opportunity cost
Marginalism, and
Efficient markets
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Opportunity Cost
Opportunity cost is the best

alternative that we forgo, or
give up, when we make a
choice or a decision.
Nearly all decisions involve
trade-offs.
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Marginalism
In weighing the costs and

benefits of a decision, it is
important to weigh only the
costs and benefits that arise
from the decision.
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Marginalism
For example, when a firm decides
whether to produce additional output,
it considers only the additional (or
marginal cost), not the sunk cost.
Sunk costs are costs that cannot be
avoided, regardless of what is done in

the future, because they have already
been incurred.
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Efficient Markets
An efficient market is one in which
profit opportunities are eliminated
almost instantaneously.
There is no free lunch! Profit
opportunities are rare because, at
any one time, there are many people
searching for them.
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More Reasons to Study Economics

The study of economics is an
essential part of the study of society.
Economic decisions often have
enormous consequences.
During the Industrial Revolution, new
manufacturing technologies and

improved transportation gave rise to the
modern factory system.
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More Reasons to Study Economics
An understanding of
economics is essential to an
understanding of global affairs.
Voting decisions also require a
basic understanding of
economics.
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The Scope of Economics
Microeconomics is the branch

of economics that examines
the behavior of individual
decision-making unitsthat is,
business firms and
households.
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Macroeconomics is the
branch of economics that
examines the behavior of
economic aggregates
income, output, employment,
and so onon a national
scale.
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Examples of microeconomic and macroeconomic concerns
Microeconomics
Macroeconomics
Production
Prices
Income
Employment
Production/Output
in Individual
Industries and
Businesses
Price of Individual
Goods and
Services
Distribution of
Income and Wealth
Employment by
Individual
Businesses &
Industries
Jobs in the steel
industry
Number of
employees in a
firm
How much steel

How many offices
How many cars
Price of medical
care
Price of gasoline
Food prices
Apartment rents
National
Production/Output
Aggregate Price
Level
Total Industrial
Output
Gross Domestic
Product
Growth of Output
Consumer prices
Producer Prices
Rate of Inflation
Wages in the auto

industry
Minimum wages
Executive salaries
Poverty
National Income
Total wages and
salaries
Employment and
Unemployment in
the Economy
Total corporate
profits
Total number of
jobs
Unemployment
rate
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The Method of Economics
Positive economics studies

economic behavior without
making judgments. It
describes what exists and how
it works.
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Normative economics, also

called policy economics,
analyzes outcomes of
economic behavior, evaluates
them as good or bad, and may
prescribe courses of action.
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Positive economics includes:
Descriptive economics, which involves
the compilation of data that describe

phenomena and facts.
Economic theory, which involves
building models of behavior.

An economic theory is a general statement
of cause and effect, action and reaction.
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Theories and Models

Theories involve models, and
models involve variables.
A model is a formal statement of a
theory. Models are descriptions of
the relationship between two or more
variables.
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Theories and Models
Ockhams razor is the

principle that irrelevant detail
should be cut away. Models
are simplifications, not
complications, of reality.
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Theories and Models

A variable is a measure that can
change from observation to
observation.
The ceteris paribus device is part of
the process of abstraction.
Using the ceteris paribus, or all else
equal, assumption, economists study

the relationship between two variables
while the values of other variables
remain constant.
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Theories and Models

Pitfalls to avoid in formulating
economic theory:
The post hoc, ergo propter hoc
fallacy refers to a common error made

in thinking about causation: If event A
happened before event B, it is not
necessarily true that A caused B.
The fallacy of composition is the
erroneous belief that what is true for a

part is also true for the whole.
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Empirical economics refers to the
collection and use of data to test
economic theories.
Many data sets are available to
facilitate economic research. They
are collected by both government
agencies and private companies,
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Economic Policy
Criteria for judging economic outcomes:
Efficiency, or allocative efficiency.
An efficient economy is one that
produces what people want at the
least possible cost.
Equity, or fairness of economic
outcomes.
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Economic Policy
Criteria for judging economic outcomes:
Economic growth, or an increase in
the total output of an economy.
Economic stability, or the condition
in which output is steady or growing,
with low inflation and full employment
of resources.
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Review Terms and Concepts

ceteris paribus
macroeconomics
descriptive economics
microeconomics
economic growth
model
economic theory
normative economics
economics
ockhams razor
efficiency
opportunity cost
efficient market
positive economics
empirical economics
post hoc, ergo propter hoc
equity
stability
fallacy of composition
sunk costs
Industrial Revolution
variable
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Appendix:
How to Read and Understand Graphs
A graph is a twodimensional
representation of a
set of numbers or
data.
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A time series
graph shows
how a single
variable changes
over time.
Total Disposable Personal Income in

the United States: 1975-2002 (in
billions of dollars)
Total disposable personal income
Appendix:
8000
7500
7000
6500
6000
5500
5000
4500
4000
3500
3000
2500
2000
1500
1000
1975
1980
1985
1990
1995
2000
Year
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Appendix:
The Cartesian coordinate system is the
most common method of showing the
relationship between two variables.
The horizontal line is
the X-axis and the
vertical line the Y-axis.
The point at which the
horizontal and vertical
axes intersect is called
the origin.
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Appendix:
The point at which the

line intersects the Y-axis
(point a) is called the Yintercept.
The Y-intercept, is the
value of Y when X = 0.
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Appendix:
The slope of the line

indicates whether the
relationship between
the variables is positive
or negative.
The slope of the line is
computed as follows:
Y
Y1 Y0
b =
X
X 1 X 0
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Appendix:
This line slopes

upward, indicating that
there seems to be a
positive relationship
between income and
spending.
Points A and B, above
the 45 line, show that
consumption can be
greater than income.
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Appendix:
An upward-sloping
line describes a
between X and Y.
A downward-sloping
line describes a
negative relationship
between X and Y.
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Appendix:
b
5
10
0 .5
0
10
10
0 .7
10
b

0
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Appendix:
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Appendix:
Cartesian coordinate system
slope
graph
time series graph
negative relationship
X-axis
origin
Y-axis
Y-intercept
Karl Case, Ray Fair
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CHAPTER

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

The Study of Economics

Economics is the study of how

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

Why Study Economics?

An important reason for

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

Opportunity cost is the best

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

In weighing the costs and

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

avoided, regardless of what is done in

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

More Reasons to Study Economics

manufacturing technologies and

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

More Reasons to Study Economics

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

The Scope of Economics

Microeconomics is the branch

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

The Scope of Economics

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 1: The Scope and Method of Economics

The Scope of Economics

How much steel

2004 Prentice Hall Business Publishing

Wages in the auto

Principles of Economics, 7/e