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Chapter 1 Introducing the Economic

Way of Thinking• Key Concepts• Summary• Practice Quiz• Internet Exercises

©2000 South-Western College Publishing

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In this chapter, you will learn to solve these economic puzzles:

Can you prove there is no person worth a

trillion dollars?

Why would you purchase more Coca-Cola when the

price increases?

How can we explain the relationship between the Super Bowl winner and

changes in the stock market?

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What is theEconomic Problem?Providing for people’s

wants and needs in a world of scarcity

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What is meant by Scarcity?

The condition in which wants are forever greater than the available supply of time, goods, and resources

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What does Scarcity force us to do?It forces us to make choices

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What are Resources?The basic categories of inputs used to produce goods and services

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What are the three categories of Resources?

LandLaborCapital

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What is aLand Resource?

A shorthand expression for any natural resource provided by nature

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What is Labor?The mental and physical

capacity of workers to produce goods and services

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What is Capital?The physical plants,

machinery, and equipment used to produce other goods

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What isFinancial Capital?The money used to purchase capital

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What is Entrepreneurship?The creative ability of

individuals to seek profits by combining resources to produce innovative products

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LandLabor

Capital

Entrepreneurship organizesresources to produce goods

and services

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What is Economics?The study of how society

chooses to allocate its scarce resources to the production of goods and services in order to satisfy unlimited wants

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What is Macroeconomics?

The branch of economics that studies decision-making for the economy as a whole

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What is Microeconomics?

The branch of economics that studies decision-making by a single individual, household, firm, industry, or level of government

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What is theScientific Method?

• Problem identification• Model development• Testing a theory

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What is the purpose of an Economic Model?To forecast or predict

the results of various changes in variables

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Identify the problem

Develop a model basedon simplified assumptions

Collect data andtest the model

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What assumption is always made when

testing a model?Ceteris Paribus

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What isCeteris Paribus?

A Latin phrase that means that while certain variables can change, “all other things remain unchanged”

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What is the difference between Association

and Causation?We cannot always assume

that when one event follows another, the first caused the second

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What isPositive Economics?

An analysis limited to statements that are verifiable

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What isNormative Economics?

An analysis based on value judgement

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Key Concepts

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• What is the Economic Problem?• What is meant by Scarcity?• What are resources?• What are the three categories of Resources?• What is Entrepreneurship?• What is Economics?• What is Macroeconomics?• What is Microeconomics?

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• What is the Scientific Method?• What assumption is always made when

testing a model?• What is Ceteris Paribus?• What is the purpose of model

building?• What is Positive Economics?• What is Normative Economics?

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Summary

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Scarcity is the fundamental economic problem that human wants exceed the availability to time, goods, and resources. Individuals and society therefore can never have everything they desire.

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Resources are factors of production classified as land, labor, and capital. Entrepreneurship is a special type of labor. An entrepreneur combines resources to produce innovative products.

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Economics is the study of how individuals and society choose to allocate scarce resources. In order to satisfy unlimited wants. Faced with unlimited wants and scarce resources, we must make choices among alternatives.

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Unlimitedwants

Scarcity

Society Chooses

Resources

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Macroeconomics applies an economy wide perspective that focuses on such issues as inflation, unemployment, and the growth rate of the economy.

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Microeconomics examines individual decision-making units within an economy. Microeconomics studies such topics as a consumer’s response to changes in the price of coffee and the reasons for changes in the market price of personal computers.

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Models are simplified descriptions of reality used to understand and predict economic events. An economic model can be stated verbally or in a table, graph, or equation. If the evidence is not consistent with the model, the model is rejected.

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Microeconomics examines individual decision-making units within an economy. Microeconomics studies such topics as a consumer’s response to changes in the price of coffee and the reasons for changes in the market price of personal computers.

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Microeconomics examines individual decision-making units within an economy. Microeconomics studies such topics as a consumer’s response to changes in the price of coffee and the reasons for changes in the market price of personal computers.

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Identifythe

problem

Developa model based

on assumptions

Collect dataand test

the model

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Ceteris paribus holds “all other factors unchanged” that might affect a particular relationship. If this assumption is violated, a model cannot be tested. Another reasoning pitfall is to think association means causation.

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Use of positive versus normative economic analysis is a major reason for disagreement among economists. Positive economics uses testable statements. Often a positive argument is expressed as an “if-the” statement. Normative economics is based on value judgments or opinions and uses words such as good, bad, ought to, and ought not to.

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Chapter 1 Quiz

©2000 South-Western College Publishing

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1. Scarcity existsa. when people consume beyond their

needs.b. only in rich nations.c. in all countries in the world.d. only in poor nations.

C. No matter what economic system a country has, it is always faced with the problem of scarcity.

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2. Which of the following would eliminate scarcity as an economic problem?a. Moderation of people’s competitive

instincts.b. Discovery of large new energy

reserves.c. Resumption of steady productivity

growth.d. None of the above because scarcity can

not be eliminated.D. Because it is impossible to provide

everyone with everything they want, we will always have scarcity.

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3. Which of the following is not a resource?a. Land.b. Labor.c. Money.d. Capital.

C. Money is not a resource because it has no intrinsic value. Money that is used to make an investment is called financial capital.

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4. Economics is the study ofa. how to make money.b. how to operate a business.c. people making choices because of the

problem of scarcity.d. the government decision-making

process.C. Economics is the study of how people must

decide among alternatives to meet their wants and needs in this world of scarcity.

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5. Microeconomics approaches the study of economics from the viewpoint ofa. individuals or specific markets.b. the operation of the Federal Reserve.c. economy wide effectsd. the national economy.

A. Microeconomics is the study of the decision- making process for individuals, business owners, and government.

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6. A review of the performance of the U.S. economy during the 1990’s is primarily the concern ofa. macroeconomics.b. microeconomics.c. both macroeconomics and

microeconomics.d. neither macroeconomics nor

microeconomics.

A. Macroeconomics is the study of the economy as a whole.

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7. An economic theory claims that a rise in gasoline prices will cause gasoline purchases to fall, ceteris paribus. The phrase “ceteris paribus” means that

a. other relevant factors like consumer incomes must be held constant.b. the gasoline prices must first be adjusted

for inflation.c. the theory is widely accepted, but cannot

be accurately tested.d. consumers need for gasoline remains the

same regardless of price.A. Anytime price changes we always make

the assumption that nothing else changes.

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8. An economist notices that sunspot activity is high just prior to recessions and concludes that sunspots cause recessions. The economist has

a. confused association with and causation.b. misunderstood the ceteris paribus

assumption. c. Used normative economics to answer a

positive question.d. built an untestable model.

A. Just because one action follows another, does not mean that the first caused the second.

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9. Which of the following is a statement of positive economics?a. The income tax system collects a lower

percentage of the incomes of the poor.b. A reduction in the tax rates of the rich

makes the tax system more fair.c. Taxes ought to be raised to finance

health care.d. All of the above are primarily

statements of positive economics.A. Positive economic statements are testable

by facts and explain the world as it is without making value judgements.

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10. Which of the following is a statement of positive economics?a. An unemployment rate of greater than 8

percent is good because prices will fall.b. An unemployment rate of 7% is a serious

problem.c. If the overall unemployment rate is 7%,

black unemployment rates will average 15%.d. Unemployment is a more severe problem

than inflation.C. Other answers are based on a value

judgement concerning the relationship between black and white unemployment rates.

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11. Which of the following is a statement of normative economics?a. A minimum wage is good because it

raises wages for the working poor.b. The minimum wage is supported by

unions.c. The minimum wage reduces jobs for

unskilled workers.d. The minimum wage encourages firms

to substitute capital for labor.A. Even though the minimum wage reduces

jobs for some working poor, it is a value judgement that the minimum wage is good for the economy overall.

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12. Select the normative statement that completes the following sentence: If the minimum wage is raised rapidly, thena. inflation increases.b. workers will gain their rightful share of

total income.c. profits will fall.d. unemployment will rise.

B. To say that workers have right to a certain part of total income entails a value judgement.

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Internet ExercisesClick on the picture of the book,

choose updates by chapter for the latest internet exercises

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END