Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Part I/Lecture Notes
PART I
LECTURE NOTES
Chapter 1/What Is Economics?
CHAPTER 1
WHAT IS ECONOMICS?
Chapter 1 introduces students to the subject of economics in two principal ways—by presenting
several “ideas for beyond the final exam,” and by discussing the concepts of abstraction and
modeling. The appendix introduces some of the techniques of graphic analysis—tools students
will use throughout the book and, more important, very likely throughout their careers.
CHAPTER OUTLINE
IDEAS FOR BEYOND THE FINAL EXAM
These are the most important ideas in the book, all of which will be picked up and discussed in
greater detail in later chapters. All of the ideas are in the combined text, and several are excluded
in each of the micro and macro texts.
1. How Much Does it Really Cost?
2. Attempts to Repeal the Laws of Supply and Demand—The Market Strikes Back
3. The Surprising Principle of Comparative Advantage
4. Trade Is a Win-Win Situation
5. The Importance of Thinking at the Margin
INSIDE THE ECONOMIST’S TOOLKIT
Economics as a Discipline
Economics is the most scientific of the social sciences, yet much more social than the natural
sciences.
The Need for Abstraction
Because the real economic world is so complex, economists must abstract from details in
order to focus on the most important details.
Much of the art of economics involves finding the most useful degree of abstraction.
The Role of Economic Theory
A theory is a deliberate simplification of factual relationships that attempts to explain how
Chapter 1/What Is Economics?
What Is an Economic Model?
An economic model is a simplified, small-scale version of some aspect of the economy.
Economic models are often expressed in equations, by graphs, or in words.
Reasons for Disagreements: Imperfect Information and Value Judgments
Economists agree on more than the public gives them credit for.
APPENDIX: USING GRAPHS: A REVIEW
Graphs Used in Economic Analysis
Graphs are useful visual aids that help us see relationships between variables.
Two-Variable Diagrams
A two-dimensional graph simultaneously represents the behavior of two variables.
The Definition and Measurement of Slope
The slope of a straight line is the ratio of the vertical change to the corresponding horizontal
change as we move right along the line.
Rays through the Origin and 45º Lines
Along a ray from the origin, the ratio of the variables on the two axes is constant.
MARGIN DEFINITIONS AND KEY TERMS
Opportunity cost: the value of the next best alternative that must be given up because of that
decision.
Abstraction: ignoring many details so as to focus on the most important elements of a problem.
Theory: a deliberate simplification of relationships whose purpose is to explain how those
relationships work.
Chapter 1/What Is Economics?
Variable: something measured by a number; it is used to analyze what happens to other things
when the size of that number changes (varies).
The origin: the “0” point in the lower left-hand corner of a graph where the axes meet.
Diagram: abstraction from many details, some of which may be quite interesting, so as to focus
on the two variables of primary interest.
MAJOR IDEAS
1. Pick a few. Many economists would emphasize Idea 1, opportunity cost; Idea 4,
voluntary exchange; and Idea 5, marginal analysis.
2. A model is required if one is to make sense out of an infinitely complicated real world.
3. Because graphs are used so often to portray economic models, it is important for students
to acquire some understanding of their construction and use.
4. Often, the most important property of a line or curve drawn on a diagram will be its
slope, which is defined as the ratio of the “rise” over the “run,” or the vertical change
Chapter 1/What Is Economics?
ON TEACHING THE CHAPTER
Instructors who are pressed for time may skip most of this chapter, leaving it for the students to
read on their own. If you can find time for it, however, an investment in this chapter will pay
dividends later in the course, because it should succeed in exciting students about the subject.
All of the ten ideas can lead to interesting classroom discussions. Instructors can enhance
these discussions by showing that there are major puzzles underlying each one of them. It is
often unclear, for example, whether market exchanges really do benefit both parties (Idea 4), or
what the opportunity cost of a given decision really is (Idea 1). As students confront these
puzzles, they will be drawn intuitively to an understanding of the usefulness of economic
concepts.
One of the central points of the chapter’s discussion of methods—that theory is necessary for
policy analysis—can be illustrated by picking a current issue of public policy out of the news.
Students can be asked to see what model is being used as the basis for specific policy
recommendations.
DISCUSSION QUESTIONS
Instructors who want to spend some time with this chapter can ask discussion questions that
relate to any or all of the “Ideas for Beyond the Final Exam.” Students may be most interested in
questions that come from today’s newspaper. Some other questions, each one corresponding to
one of the ten ideas, could be:
1. The text argues that because exchange of goods and services is voluntary, both the buyer
and the seller benefit (otherwise they would not agree to the exchange), and therefore
most laws that prohibit exchanges are misguided. Do you think the government should
prohibit the exchange of a) crack cocaine, b) prostitution, c) the labor of children?
Suggested Answer: Critics of prohibition may point out that one of the most fundamental
Chapter 1/What Is Economics?
2. What are the opportunity costs of the United States maintaining a large and
technologically sophisticated military force? What are the benefits to the country? Do
you think the benefits are worth the cost?
Suggested Answer: Opportunity costs include those products that otherwise could have
been produced and consumed but weren’t because those resources were instead devoted
to the military. Benefits include protection from external (national as well as terrorist)
3. You may be worried about the cost of housing in your community. Rising rents make it
increasingly difficult for low- and moderate-income people to find adequate shelter.
Students often have trouble finding lodging they can afford. Would it be a good idea for
your local government to put a legal ceiling on rents, in order to ensure the affordability
of housing?
Suggested Answer: Student answers may vary. Attempts to repeal the laws of supply and
demand usually backfire and sometimes produce results virtually the opposite of those
4. For many years in the middle of the 20th century, the United States was one of the
world’s most efficient producers of manufactured goods such as iron and steel,
automobiles, household appliances, and clothing. In recent years, American companies
have lost much of their advantage and are having difficulty competing against foreign
companies. Do you think the U.S. government should restrict the imports of
manufactured goods from other countries, in order to preserve markets for American
companies?
Suggested Answer: Individuals who are not familiar with the concept of comparative
5. You are a bank manager, faced with the following problem. You know that at the present
time, on average, each dollar of deposits that the bank holds will cost the bank eight cents
a year—three cents interest paid to the depositor and five cents to pay the wages and the
other expenses of the bank. The bank makes its income by lending out the money that
people have deposited and charging interest on those loans. So on average it must
currently charge more than 8 percent a year to make a profit. You have just discovered an
opportunity for lending a substantial sum of money, but the maximum interest rate you
can charge on this deal is 6 percent. Should you try to get new deposits into your bank, to
provide the funds to make those loans? Upon what does your answer depend?
Suggested Answer: The answer would depend on marginal cost. You should try to get
new deposits as long as your marginal cost is less than the interest rate spread of 3
Chapter 1/What Is Economics?
6. An external cost is a cost imposed upon a third party, someone who neither buys nor sells
the product. For example, a manufacturer who sends wastes up through the smokestack
may impose the cost of dirty air upon the citizens—but under the ordinary market
mechanism, the manufacturer does not have to pay for this cost. In this case, do you think
the government should intervene, and if so how?
Suggested Answer: Externalities escape the control of the market mechanism because no
financial incentive motivates polluters to minimize the damage they do. The government
7. Government policies designed to increase the country’s output often make people’s
incomes less equal. Similarly, policies designed to reduce the inequality of income often
reduce output. In each of the following cases, show why you think there is or is not a
trade-off between output and equality, and if so what should be done.
a) The government raises the tax rate on corporations, using the revenue to increase
welfare payments to mothers with dependent children.
b) The government permits owners of companies to reduce their tax payments, provided
that they invest a portion of their income in new plant and equipment.
c) The government starts a large training program to provide useful job-market skills to
the unemployed.
Suggested Answers:
a) Trade-off exists between output and equality. When the government re-distributes
income through taxation, it reduces the reward to work hard and as a result people
8. Suppose it is true that the way to stop high inflation is to increase unemployment. Is it
fair? Inflation is a problem faced by everyone in the country. Do we have the right to say
that a small proportion of us, those who are among the most disadvantaged, the
unemployed, will pay the cost of solving this problem?
Suggested Answer: Students should discuss the trade-off between inflation and
unemployment. Policies aimed at reducing inflation may increase unemployment.
9. Do you believe that productivity in the United States should grow? The text states that
improvements in our standard of living depend upon productivity growth, as does our
ability to improve hospitals, schools, and social amenities. But some people argue that
our standard of living is too high, that we are using up the world’s scarce resources,
Chapter 1/What Is Economics?
spoiling our natural environment and increasing average world temperatures by
continuing our economic growth. Can you resolve this conflict?
Suggested Answer: Productivity should grow in the long run. Nothing has as great an
effect on our material well-being and the amounts society can afford to spend on
hospitals, schools, and social amenities as the rate of growth of productivity. Small
PROBLEMS
The Study Guide contains several excellent problems that can be used to reinforce the student’s
understanding of graphs.
