Chapter 1 An economic model is a simplified, small-scale

Unlock access to all the studying documents.

View Full Document

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.