Chapter 1
The Scope and Method of Economics
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
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.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Why Study Economics?
1. Probably the most important reason for
studying economics is to learn a way of
thinking.
• Three fundamental concepts:
• Opportunity cost
• Marginalism, and
• Efficient markets
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Opportunity Cost
• Opportunity cost is the best alternative
that we forgo, or give up, when we make a
choice or a decision.
• Opportunity costs arise because time and
resources are scarce. Nearly all decisions
involve trade-offs.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Marginalism
• In weighing the costs and benefits of a decision, it
is important to weigh only the costs and benefits
that arise from that decision.
• For example, when deciding whether to produce
additional output, a firm 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.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
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.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
More Reasons to Study Economics
2. Economics involves the study of societal and global
affairs concerning resource allocation.
3. Economics helps us understand global affairs
4. Economics helps us to be informed voters. Voting
decisions require a basic understanding of
economics.
• Money and financial systems are an important
component of the economic system, but are not the
most fundamental issue in economics.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Scope of Economics
• Microeconomics is the branch of economics
that examines the functioning of individual
industries and the behavior of individual
decision-making units—that is, business firms
and households.
• Macroeconomics is the branch of economics
that examines the economic behavior of
aggregates— income, output, employment, and
so on—on a national scale.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Diverse Fields of Economics
Examples of microeconomic and macroeconomic concerns
Production Prices Income Employment
Microeconomics Production/Output Price of Individual Distribution of Employment by
in Individual Goods and Services Income and Wealth Individual
Industries and Businesses &
Businesses Price of medical Wages in the auto Industries
care industry Jobs in the steel
How much steel Price of gasoline Minimum wages industry
How many offices Food prices Executive salaries Number of
How many cars Apartment rents Poverty employees in a
firm
Macroeconomics National Aggregate Price National Income Employment and
Production/Output Level Total wages and Unemployment in
salaries the Economy
Total Industrial Consumer prices
Output Producer Prices Total corporate Total number of
Gross Domestic Rate of Inflation profits jobs
Product Unemployment
Growth of Output rate
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Method of Economics
• Normative economics, also called policy
economics, analyzes outcomes of economic
behavior, evaluates them as good or bad, and
may prescribe courses of action.
• Positive economics studies economic behavior
without making judgments. It describes what
exists and how it works.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Method of Economics
• Positive economics includes:
• Descriptive economics, which involves the
compilation of data that describe phenomena and
facts.
• Economic theory that involves building models of
behavior. A theory is a statement or set of related
statements about cause and effect, action and
reaction.
• Empirical economics refers to the collection and
use of data to test economic theories.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Theories and Models
• A theory is a general statement of cause and effect,
action and reaction. Theories involve models, and
models involve variables.
• A model is a formal statement of a theory; they are
usually mathematical statement of a presumed
relationship between two or more variables.
• A variable is a measure that can change from
observation to observation.
• Using the ceteris paribus, or all else equal, assumption,
economists study the relationship between two variables
while the values of other variables are held unchanged.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Theories and Models
• Ockham’s Razor- The principle that irrelevant details
should be cut away (termed after the 14th century
philosopher William of Ockham).
• Cautions and Pitfalls in formulating theories and
models:
a. The Post Hoc Fallacy: If event A happens before
event B, it is not necessarily true that A caused B.
b. Fallacy of Composition: The erroneous belief that
what is true for a part is necessarily true for the
whole.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
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.
• Growth, or an increase in the total output of an
economy.
• Stability, or the condition in which output is steady or
growing, with low inflation and full employment of
resources.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
