CHAPTER 1
THE ART AND SCIENCE OF ECONOMIC ANALYSIS
In this chapter, you will find:
Learning Outcomes
INTRODUCTION
This chapter has two purposes: to introduce students to some of the basic language of economics and
to stimulate student interest in the subject. It conveys to students that economics is not only found on
Learning Outcomes
1-1 Explain the economic problem of scarce resources and unlimited wants
The problem is that, although your wants, or desires, are virtually unlimited, the resources available to
1-2 Describe the forces that shape economic choices
An economy results from the choices that millions of individuals make in attempting to satisfy their un-
1-3 Explain the relationship between economic theory and economic reality
An economic theory is a simplification of economic reality that is used to make predictions about the real
1-4 Identify some pitfalls of economic analysis
Economic analysis, like other forms of scientific inquiry, is subject to common mistakes in reasoning that
1-5 Describe several reasons to study economics
The economics profession thrives because its models usually do a better job of making economic sense
out of a confusing world than do alternative approaches. Studies show that economics majors earn more
than most and they experienced no pay difference based on gender.
Chapter 1 The Art and Science of Economic Analysis 2
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
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THE ECONOMIC PROBLEM: Scarce Resources, Unlimited Wants
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Resources: The inputs, or factors of production, used to produce the goods and services that
humans want. Resources are divided into four categories:
• Labor: Human effort, both physical and mental
• Capital:
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Goods and Services: Resources are combined to produce goods and services.
• A good is something we can see, feel, and touch (i.e., corn). It requires scarce resources to
produce and is used to satisfy human wants.
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Economic Decision Makers: There are four types of decision makers:
• Households
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Chapter 1 The Art and Science of Economic Analysis 3
Markets:
• Buyers and sellers carry out exchanges in markets.
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A Simple Circular Flow Model:
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THE ART OF ECONOMIC ANALYSIS
Rational Self-Interest
• Economics assumes that individuals, in making choices, rationally select alternatives they
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Choice Requires Time and Information: Time and information are scarce and therefore valuable.
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Economic Analysis Is Marginal Analysis
• Economic choice is based on a comparison of the expected marginal cost and the expected
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Microeconomics and Macroeconomics
• Microeconomics: The study of individual economic choices (e.g., your economic behavior).
• Macroeconomics: The study of the performance of the economy as a whole.
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Chapter 1 The Art and Science of Economic Analysis 4
The Science of Economic Analysis
The Role of Theory: An economic theory is a simplification of economic reality that is used to
make predictions about the real world. An economic theory captures the important elements of the
problem under study.
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The Scientific Method: A four-step process of theoretical investigation:
• Identify the question and define relevant variables.
• Specify assumptions:
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Normative vs. Positive
• A positive economic statement concerns what is; it can be supported or rejected by reference to
facts.
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Predicting Average Behavior: The task of an economic theory is to predict the impact of an
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Some Pitfalls of Faulty Economic Analysis
• The fallacy that association is causation: The fact that one event precedes another or that two
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If economists are so smart, why aren’t they rich?: College Major and Annual Earnings:
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Chapter 1 The Art and Science of Economic Analysis 5
APPENDIX: UNDERSTANDING GRAPHS
Drawing Graphs
• Origin: The point of departure, the point from which all variables are measured.
• Horizontal axis: The value of the x variable increases as you move along this axis to the right of
the origin; a straight line to the right of the origin.
The Slopes of Straight Lines
• The slope of a line measures how much the vertical variable (y) changes for each 1-unit change
in the horizontal variable (x).
• The slope of a line is a convenient device for measuring marginal effects. Slope reflects the
change in y for each one unit change in (x).
The Slope, Units of Measurement, and Marginal Analysis
The Slopes of Curved Lines
Curve Shifts: A change in an underlying assumption is expressed by a shift in the curve.
CHAPTER SUMMARY
Economics is the study of how people choose to use their scarce resources to produce, exchange, and
Chapter 1 The Art and Science of Economic Analysis 6
Whereas microeconomics examines the individual pieces of the puzzle, macroeconomics steps back
to consider the big picture—the performance of the economy as a whole as reflected by such
measures as total production, employment, the price level, and economic growth.
Economists use theories, or models, to help understand the effects of an economic change, such as a
change in price or income, on individual choices and how these choices affect particular markets and
the economy as a whole. Economists employ the scientific method to study an economic problem by
(a) formulating the question and isolating relevant variables, (b) specifying the assumptions under
TEACHING POINTS
1. This course will provide the first exposure to the economic way of thinking for many of
your students. Although it seems natural to you, economic analysis presents a formidable
2. Students are generally eager and very fresh at the beginning of the semester. Chapters 1 and
2 can be assigned during the first week, and you can move almost immediately into
3. One point to stress in discussing the role and importance of economic analysis is that while
individual responses to changes in an economic environment are not always predictable, the
Chapter 1 The Art and Science of Economic Analysis 7
4. From a purely analytical perspective, the most important concept introduced in this chapter
5. Some terminology in the text may deviate from your own lecture notes. If you intend to use
6. Some students think that economics is synonymous with business. You may wish to explain
the difference, since many of your students will be studying business administration.
7. Many students will be apprehensive about the mathematics used in the course. A good way
for students to master the few mathematical tools needed in class is by through application
8. Many beginning students do not understand what economists mean by the statement
SOLUTIONS TO PROBLEMS APPENDIX
1. (Definition of Economics) What determines whether or not a resource is scarce? Why is the
concept of scarcity important to the definition of economics?
2. (Rational Self-Interest) Discuss the impact of rational self-interest on each of the following
decisions:
a. Whether to attend college full time or enter the workforce full time
b. Whether to buy a new textbook or a used one
c. Whether to attend a local college or an out-of-town college
a. Individuals will compare the expected benefits of attending college full time with the ex-
Chapter 1 The Art and Science of Economic Analysis 8
3. (Rational Self-Interest) If behavior is governed by rational self-interest, why do people make
charitable contributions of time and money?
Rational self-interest is not blind materialism, pure selfishness, or greed. Rational self –
4. (Marginal Analysis) The owner of a small pizzeria is deciding whether to increase the radius
of delivery area by one mile. What considerations must be taken into account if such a
decision is to increase profitability?
By increasing its delivery radius, the store will have greater sales. However, these marginal
5. (Time and Information) It is often costly to obtain the information necessary to make good
decisions. Yet your own interests can best be served by rationally weighing all options
available to you. This requires informed decision making. Does this mean that making
uninformed decisions is irrational? How do you determine how much information is the right
amount?
Rational decision makers will continue to acquire information as long as the benefit of the
6. (Role of Theory) What good is economic theory if it can’t predict the behavior of a specific
individual?
This question highlights the fact that economics, like all social sciences, attempts to describe
7. (Pitfalls of Economic Analysis) Review the discussion of pitfalls in economic thinking in this
chapter. Then identify the fallacy, or mistake in thinking, in each of the following statements:
a. Raising taxes always increases government revenues.
b. Whenever there is a recession, imports decrease. Therefore, to stop a recession, we should
increase imports.
c. Raising the tariff on imported steel helps the U.S. steel industry. Therefore, the entire
economy is helped.
Chapter 1 The Art and Science of Economic Analysis 9
d. Gold sells for about $900 per ounce. Therefore, the U.S. government could sell all the
gold in Fort Knox at $900 per ounce and reduce the national debt.
a. This assertion is a mistake because the secondary effects of taxes on production and the
8. (Association Versus Causation) Suppose I observe that communities with lots of doctors
tend to have relatively high rates of illness. I conclude that doctors cause illness. What’s
wrong with this reasoning?
there is a lot of disease and therefore a greater need for medical care.
9. (Studying Economics)According to the text, economics majors on average earn more money
than most other majors and have more job opportunities. Are these the primary motivations
one might have for studying economics? What are your motivations for studying
economics?