Chapter 01 – Economics and Life
CHAPTER 1
ECONOMICS AND LIFE
Chapter Overview
Economists approach problems differently from many other people. A basic
principle of human behavior underlies economics—the idea that people
typically make choices to achieve their goals in the most effective way
possible, subject to the constraints they face.
In this chapter we have introduced the basic concepts economists use, as
well as four questions they ask to break down problems. Throughout this
book, you will see these concepts and questions over and over again:
1. Scarcity: What are the wants and constraints of those involved?
2. Opportunity cost: What are the trade-os?
3. Incentives: How will others respond?
4. efficiency: Why isn’t someone already doing it?
In later chapters, as we progress to more complicated problems, try using
these four questions to break down problems into manageable pieces. Then
you can tackle those smaller pieces using the four fundamental concepts
presented in this chapter.
Learning Objectives
LO 1.1: Explain the economic concept of scarcity.
LO 1.2: Explain the economic concepts of opportunity cost and marginal
decision making.
LO 1.3: Explain the economic concept of incentives.
LO 1.4: Explain the economic concept of efficiency.
LO 1.5: Distinguish between correlation and causation.
LO 1.6: List the characteristics of a good economic model.
LO 1.7: Distinguish between positive and normative analysis.
Chapter Outline
OPENING STORY: MAKING AN IMPACT WITH SMALL LOANS
The Basic Insights of Economics
Scarcity (LO 1.1)
Opportunity Cost and Marginal Decision Making (LO 1.2)
BOX FEATURE: WHAT DO YOU THINK? – THE OPPORTUNITY COST OF A LIFE
Incentives (LO 1.3)
efficiency (LO 1.4)
An Economist’s Problem-Solving Toolbox
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Chapter 01 – Economics and Life
Correlation and Causation (LO 1.5)
BOX FEATURE: FROM ANOTHER ANGLE – DOES ICE CREAM CAUSE POLIO?
Models (LO 1.6)
BOX FEATURE: REAL LIFE – TESTING MODELS AGAINST HISTORY
Positive and Normative Analysis (LO 1.7)
BOX FEATURE: WHAT DO YOU THINK? – THE COST OF COLLEGE CASH
Beyond the Lecture
Class Discussion: Scarcity (LO 1.1)
Have students review this recent TED talk by Peter Diamandis. Peter
highlights the impact of human ingenuity on scarcity and argues that we
should be optimistic about the use of technology to address problems in the
future. This is a great springboard for discussion.
1. Do students think that technology will continue to improve living
standards and mitigate the problems associated with scarcity?
2. Despite the fact that technology advancements have greatly improved
quality of life and consumption for most people, will we ever eliminate
scarcity?
Writing Assignment: Opportunity Cost and Marginal Decision Making
(LO 1.2)
Have students review this article by Russell Roberts on opportunity cost. It
highlights some basic examples that are familiar to students. Require
students to write a brief essay on the opportunity costs associated with
decisions in their lives, decisions that Brm’s make, or government decisions.
This can be used as a catalyst for class discussion as well.
Class Discussion: Opportunity Cost and Marginal Decision Making
(LO 1.2)
Your class that you teach is most likely 50 or 75 minutes in length. Poll the
students (perhaps informally, or using software such as Poll Anywhere or
clickers) and ask them what they would be doing during this hour if they
were not in class. Some possible answers may include sleeping (especially
for an early AM class), working out, studying for another course, watching
TV, eating, or many others. This is a great introduction to opportunity cost –
the cost of attending class is giving up the next best alternative of your time.
Questions to ask include:
1. Is your opportunity cost the same as other students’ opportunity cost?
2. Does the fact that you chose to attend class today mean that sitting in
this economics lecture is the best use of your time during this hour?
Class Discussion: Incentives (LO 1.3)
In order to highlight the importance of incentives, consider discussing
Chapter 3 of Freakonomics by Steven Levitt and Stephen Dubner with your
students. The chapter provides insight into the career of an individual who is
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Chapter 01 – Economics and Life
involved in the illegal drug market. You could also ask students to review this
Los Angeles Times commentary on the chapter, also written by Levitt and
Dubner.
1. Ask students to consider why an individual would be willing to endure
the risks associated with the illegal drug market given the relatively
low pay and poor working conditions that many workers endure.
Students really enjoy this interesting discussion.
2. How does this market compare to other markets? There are surprising
similarities and differences between legal markets and the black
market.
Clicker Questions
There are three main purposes to clicker questions. First, they are a great
way to do a quick and instant “on demand” test of student understanding of
the material. You can cover material, and instantly get feedback on student
comprehension. You can see whether you need to explain certain topics
again, or move on to the next subject. Second, they are a great method to
break up the class and take a moment away from lecture. It gets the
students actively involved. Finally, certain clicker questions can be framed in
a “discussion” manner, in which you can invite students to talk about the
possible right answer with their peers. You can instruct students to convince
their classmate of a right or wrong answer.
1. What is the result of scarcity of goods and services? [LO 1.1]
A. People can have all the goods they desire at any price
Feedback: With scarcity, we don’t have enough goods to freely be given to
everyone to satisfy all wants. Thus, a method to allocate goods must be
used. This could include prices, or other methods. Note that poverty isn’t a
direct result of scarcity – scarcity affects all people, both rich and poor.
2. “Children eat more ice cream in the summer. Children are more likely to
drown in the summer. We can conclude that ice cream consumption causes
drowning.” The previous statement is an example of____________. [LO 1.5]
A. Normative economic statements
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Chapter 01 – Economics and Life
3. Which of the following do you think is most likely necessary to create a
good economic model? [LO 1.6]
A. Identical to the real world and no simpliBcations
Feedback: Remember that models by deBnition are a simpliBcation of
reality. We can’t have a model that is identical to the real world economy. It
would require billions of variables, trillions of data points, and multiple
supercomputers to analyze the data!
4. Which of the following is an incentive your instructor could provide to get
more students to attend class? [LO 1.3]
A. Giving extra credit to students who attend more than 90% of classes
Feedback: Remember that incentives can be positive or negative. We don’t
want to ask which incentives we would personally agree with. We just want
to ask if the incentive would change behavior.
5. A rational person should only do an activity as long as [LO 1.2]
A. The marginal beneBts are greater than the marginal costs
Feedback: People do activities even if opportunity costs are high. One
example is going to college and not working for four years during your time
as a student!
Solutions to End-of-Chapter Questions and Problems
Review Questions
1. Suppose you are shopping for new clothes to wear to job interviews,
but you’re on a tight budget. In this situation, what are your wants and
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Chapter 01 – Economics and Life
constraints? What does it mean to behave rationally in the face of scarcity?
[LO 1.1]
Answer: If you are deciding what to buy for a job interview, your want is
to buy clothing that looks clean and professional, so you can present the
2. You are a student with a demanding schedule of classes. You also work
part time and your supervisor allows you to determine your schedule. In this
situation, what is your scarce resource? How do you decide how many hours
to work? [LO 1.1]
Answer: Your scarce resource is time. You need both time to study and
3. Think about the deBnition of scarcity that you learned in this chapter.
Name three ways that you confront scarcity in your own life. [LO 1.1]
Answer: People face scarcity in many aspects of their lives. Some people
love to travel and explore new places, so they face scarcity in both time
4. When shopping for your interview clothes, what are some trade-offs
you face? What is the opportunity cost of buying new clothes? What are the
beneBts? How do you balance the two? [LO 1.2]
Answer: The money you spend on clothes for a job interview could be
spent on other things instead, so it is one opportunity cost. Another
5. You have an 8:30 class this morning but you are feeling extremely
tired. How do you decide whether to get some extra sleep or go to class?
[LO 1.2]
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Chapter 01 – Economics and Life
Answer: If you are behaving rationally, you decide by comparing the
trade-offs. The opportunity cost of going to class is missing out on some
6. It’s Friday night. You already have a ticket to a concert, which cost you
$30. A friend invites you to go out for a game of paintball instead. Admission
would cost you $25, and you think you’d get $25 worth of enjoyment out of
it. Your concert ticket is nonrefundable. What is your opportunity cost (in
dollars) of playing paintball? [LO 1.2]
Answer: The opportunity cost of going to play paintball is whatever
amount of enjoyment (in dollars) you would get out of going to the
7. Suppose you have two job offers and are considering the trade-offs
between them. Job A pays $45,000 per year and includes health insurance
and two weeks of paid vacation. Job B pays $30,000 per year; it includes four
weeks of paid vacation but no health insurance. [LO 1.2]
a. List the beneBts of Job A and the beneBts of Job B.
b. List the opportunity cost of Job A and the opportunity cost of Job B.
Answer:
a. The beneBts of Job A are the extra pay and health insurance. For Job B,
b. The opportunity cost of Job A is losing out on the extra two weeks of
8. Your former neighbor gave you his lawnmower when he moved. You are
thinking of using this gift to mow lawns in your neighborhood this summer
for extra cash. As you think about what to charge your neighbors and
whether this idea is worth your effort, what opportunity costs do you need to
consider? [LO 1.2]
Answer: You need to consider the opportunity cost of your time. Your
lawn mowing business would need to cover the opportunity cost of what
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Chapter 01 – Economics and Life
9. Think of a few examples of incentives in your daily life. How do you
respond to those incentives? [LO 1.3]
Answer: An incentive is something that causes people to behave in a
certain way by changing the trade-offs they face. No parking signs
10. You supervise a team of salespeople. Your employees already receive a
company discount. Suggest a positive incentive and a negative incentive you
could use to improve their productivity. [LO 1.3]
Answer: For a positive incentive, you could offer a reward such as a
bonus, a gift certiBcate, or an extra discount on company merchandise to
11. Your boss decides to pair workers in teams and offer bonuses to the
most productive team. Why might your boss offer team bonuses instead of
individual bonuses? [LO 1.3]
Answer: Your boss is creating a reward system for a project that requires
group effort. Even if you are not motivated to compete for an individual
12. Think of a public policy—a local or national law, tax, or public service—
that offers an incentive for a particular behavior. Explain what the incentive
is, who is offering it, and what they are trying encourage or discourage. Does
the incentive work? [LO 1.3]
Answer: The U.S. government places a subsidy on growing corn. This
provides an incentive for farmers to plant corn on more of their land
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Chapter 01 – Economics and Life
13. Why do individuals or Brms usually provide the goods and services
people want? [LO 1.4]
Answer: If Brms didn’t produce goods that people want, no one would
14. You may have seen TV advertisements for products or programs that
claim to teach a sureBre way to make millions on the stock market. Apply the
Why isn’t someone already doing it? test to this situation. Do you believe
the ads? Why or why not? [LO 1.4]
Answer: Guessing which stocks are going to perform well and which are
going to tank is a hard if not impossible task, which makes it very hard to
15. Describe an innovation in technology, business, or culture that had a
major economic impact in your lifetime. [LO 1.4]
Answer: The Internet has completely changed the way people do
16. Why do people confuse correlation with causation? [LO 1.5]
Answer: Correlation means that two events occur together. Since the two
often occur together, people often believe that one causes the other, but
17. Name two things that are positively correlated and two things that are
negatively correlated. [LO 1.5]
Answer: Events that are positively correlated tend to occur together, or
move in the same direction. For example, more people tend to carry an
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Chapter 01 – Economics and Life
18. Why is it important for a good economic model to predict cause and
effect? [LO 1.6]
Answer: A good model must predict cause and effect so that it can
19. Why is it important for a good economic model to make clear
assumptions? [LO 1.6]
Answer: A good model must make clear assumptions so we know when
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