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CASE FAIR OSTER
P R I N C I P L E S O F
MICROECONOMICST E N T H E D I T I O N
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CASE FAIR OSTER
1
PART I INTRODUCTION TO ECONOMICS
The Scope andMethod of conomicsCHAPTER OUTLINE
Why Study Economics?To Learn a Way of Thinking
To Understand Society
To Understand Global Affairs
To Be an Informed Citizen
The Scope of EconomicsMicroeconomics and
Macroeconomics
The Diverse Fields of Economics
The Method of EconomicsDescriptive Economics and
Economic Theory
Theories and Models
Economic Policy
An Invitation
Appendix: How to Read
and Understand Graphs
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economics The study of howindividuals and societies choose to usethe scarce resources that nature andprevious generations have provided.
Economics is the study of how individuals and societies chooseto use the scarce resources that nature and previous generationshave provided. The key word in this definition is choose.
Economics is a behavioral, or social, science. In large measure, itis the study of how people make choices. The choices that peoplemake, when added up, translate into societal choices.
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Three fundamental concepts:
Opportunity cost
Marginalism
Efficient markets
To Learn a Way of Thinking
Why Study Economics?
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To Learn a Way of Thinking
Why Study Economics?
Opportunity Cost
opportunity cost The best alternative thatwe forgo, or give up, when we make achoice or a decision.
Scarce resources are the reason for the
existence of opportunity costs.
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To Learn a Way of Thinking
Why Study Economics?
Marginalism
marginalism The process of analyzing theadditional or incremental costs or benefitsarising from a choice or decision.
sunk costs Costs that cannot be avoided
because they have already been incurred.
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To Learn a Way of Thinking
Why Study Economics?
Efficient MarketsNo Free Lunch
efficient market A market in whichprofit opportunities are eliminatedalmost instantaneously.
The study of economics teaches us a wayof thinking and helps us make decisions.
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To Understand Society
Why Study Economics?
Economic dynamics greatly alter thecomposition of society.
Agrarian societyIndustrial RevolutionIntegrated CircuitsInternetdot com eraInformation Economy
The study of economics is an essential part of the study of society.
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To Understand Global Affairs
Why Study Economics?
An understanding of economics is essentialto an understanding of global affairs.
To Be an Informed Citizen
To be an informed citizen requires a basicunderstanding of economics.
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"Economics is the science of choice. It began with Aristotle but got mixed up
with ethics in the Middle Ages. Adam Smith separated it from ethics, andWalrus mathematized it. Alfred Marshall tried to narrow it, and Keynesmade is fashionable. Robbins widened it, and Samuelson dynamized it,but modern science made it statistical and tried to confine it again.
But the science won't stay put. It keeps cropping up all over the place. There isan economics of money and trade, of production and consumption, ofdistribution and development. There is also an economics of welfare,manners, language, industry, music, and art. There is an economics ofwar and an economics of power. There is even an economics of love.
Economics seems to apply to every nook and cranny of human experience. Itis an aspect of all conscious action. Whenever decisions are made, thelaw of economy is called into play. Whenever alternatives exist, life takeson an economic aspect. It has always been so. But how can it be?
It can be because economics is more than just the most developed of thesciences of control. It is a way of looking at things, an ordering principle,a complete part of everything. It is a system of thought, a life game, anelement of pure knowledge.
Robert Mundell
Why Study Economics?
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Microeconomics and Macroeconomics
The Scope of Economics
microeconomics The branch of economics thatexamines the functioning of individual industriesand the behavior of individual decision-makingunitsthat is, firms and households.
Microeconomics looks at the individual unitthe household,the firm, the industry. It sees and examines the trees.
Macroeconomics looks at the whole, the aggregate. It seesand analyzes the forest.
macroeconomics The branch of economicsthat examines the economic behavior ofaggregatesincome, employment, output, andso onon a national scale.
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Microeconomics and Macroeconomics
The Scope of Economics
TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns
Divisions
of Economics Production Prices Income Employment
Microeconomics Production/output in
individual industries and
businesses
How much steelHow much office
spaceHow many cars
Price of individual
goods and services
Price of medical carePrice of gasolineFood pricesApartment rents
Distribution of
income and
wealth
Wages in the autoindustry
Minimum wageExecutive salariesPoverty
Employment by
individual businesses
and industries
Jobs in the steelindustry
Number of employeesin a firm
Number ofaccountants
Macroeconomics National
production/output
Total industrial outputGross domestic
productGrowth of output
Aggregate price level
Consumer pricesProducer pricesRate of inflation
National income
Total wages andsalaries
Total corporateprofits
Employment and
unemployment inthe economy
Total number of jobsUnemployment rate
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The Diverse Fields of Economics
The Scope of Economics
TABLE 1.2 The Fields of Economics
Behavioral economics uses psychological theories relating to emotions and social context to helpunderstand economic decision making and policy. Much of the work in behavioraleconomics focuses on the biases that individuals have that affects the decisionsthey make.
Comparative economic
systems
examines the ways alternative economic systems function. What are the
advantages and disadvantages of different systems?
Econometrics applies statistical techniques and data to economic problems in an effort to testhypotheses and theories. Most schools require economics majors to take at leastone course in statistics or econometrics.
Economic development focuses on the problems of low-income countries. What can be done to promotedevelopment in these nations? Important concerns of development for economistsinclude population growth and control, provision for basic needs, and strategies forinternational trade.
Economic history traces the development of the modern economy. What economic and political eventsand scientific advances caused the Industrial Revolution? What explains thetremendous growth and progress of post-World War II Japan? What caused theGreat Depression of the 1930s?
Continued...
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The Diverse Fields of Economics
The Scope of Economics
TABLE 1.2 The Fields of Economics (continued)
Environmental economics studies the potential failure of the market system to account fully for the impacts ofproduction and consumption on the environment and on natural resource depletion.Have alternative public policies and new economic institutions been effective incorrecting these potential failures?
Finance examines the ways in which households and firms actually pay for, or finance, their
purchases. It involves the study of capital markets (including the stock and bondmarkets), futures and options, capital budgeting, and asset valuation.
Health economics analyzes the health care system and its players: government, insurers, health careproviders, and patients. It provides insight into the demand for medical care, healthinsurance markets, cost-controlling insurance plans (HMOs, PPOs, IPAs),government health care programs (Medicare and Medicaid), variations in medicalpractice, medical malpractice, competition versus regulation, and national healthcare reform.
The history of economic
thought,
which is grounded in philosophy, studies the development of economic ideas andtheories over time, from Adam Smith in the eighteenth century to the works ofeconomists such as Thomas Malthus, Karl Marx, and John Maynard Keynes.Because economic theory is constantly developing and changing, studying thehistory of ideas helps give meaning to modern theory and puts it in perspective.
Industrial organization looks carefully at the structure and performance of industries and firms within aneconomy. How do businesses compete? Who gains and who loses?
Continued...
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The Diverse Fields of Economics
The Scope of Economics
TABLE 1.2 The Fields of Economics (continued)
International economics studies trade flows among countries and international financial institutions. What arethe advantages and disadvantages for a country that allows its citizens to buy andsell freely in world markets? Why is the dollar strong or weak?
Labor economics deals with the factors that determine wage rates, employment, and unemployment.How do people decide whether to work, how much to work, and at what kind of job?
How have the roles of unions and management changed in recent years?
Law and economics analyzes the economic function of legal rules and institutions. How does the lawchange the behavior of individuals and businesses? Do different liability rules makeaccidents and injuries more or less likely? What are the economic costs of crime?
Public economics examines the role of government in the economy. What are the economic functionsof government, and what should they be? How should the government finance theservices that it provides? What kinds of government programs should confront theproblems of poverty, unemployment, and pollution? What problems doesgovernment involvement create?
Urban and regional
economics
studies the spatial arrangement of economic activity. Why do we have cities? Whyare manufacturing firms locating farther and farther from the center of urban areas?
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The Method of Economics
positive economics An approach to economics thatseeks to understand behavior and the operation ofsystems without making judgments. It describes whatexists and how it works.
normative economics An approach to economicsthat analyzes outcomes of economic behavior,evaluates them as good or bad, and may prescribecourses of action. Also calledpolicy economics.
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Descriptive Economics and Economic Theory
The Method of Economics
descriptive economics The compilation ofdata that describe phenomena and facts.
economic theory A statement or set ofrelated statements about cause and effect,action and reaction.
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Theories and Models
The Method of Economics
model A formal statement of a theory, usuallya mathematical statement of a presumedrelationship between two or more variables.
variable A measure that can change from timeto time or from observation to observation.
Ockhams razorThe principle that irrelevantdetail should be cut away.
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All Else Equal: Ceteris Paribus
ceter is par ibu s, orall else equal A device
used to analyze the relationship betweentwo variables while the values of othervariables are held unchanged.
Theories and Models
The Method of Economics
Using the device of ceteris paribus is one part of the process of
abstraction. In formulating economic theory, the concept helpsus simplify reality to focus on the relationships that interest us.
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Expressing Models in Words, Graphs, and Equations
Theories and Models
The Method of Economics
Methods of expressing the quantitative relationship between two variables:
Graphing (as presented in appendix)
Equations, for example:
C= .90 Y and S= .10Y
If over time U.S. households collectively spend, or consume, 90percent of their income and save 10 percent of their income, wecould then write:
where Cis consumption spending, Yis income, and S is saving.
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Cautions and Pitfalls
Theories and Models
The Method of Economics
The Post Hoc Fallacy
post ho c, ergo p ropter hocLiterally, afterthis (in time), therefore because of this. A
common error made in thinking aboutcausation: If Event A happens before EventB, it is not necessarily true that A caused B.
The Fallacy of Composition
fallacy of composition The erroneousbelief that what is true for a part isnecessarily true for the whole.
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Testing Theories and Models: Empirical Economics
Theories and Models
The Method of Economics
empirical economics The collection and use
of data to test economic theories.
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Economic Policy
The Method of Economics
Criteria for judging economic outcomes:
1. Efficiency
2. Equity3. Growth
4. Stability
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Efficiency
Economic Policy
The Method of Economics
Equity
efficiency In economics, allocative efficiency. An
efficient economy is one that produces whatpeople want at the least possible cost.
equity Fairness.
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Growth
Economic Policy
The Method of Economics
Stability
economic growth An increase in the total
output of an economy.
stability A condition in which nationaloutput is growing steadily, with low inflationand full employment of resources.
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You cannot begin to understand how a societyfunctions without knowing something about itseconomic history and its economic system.
Learning to think in this very powerful way will
help you better understand the world.
As you proceed, it is important that you keep trackof what you have learned in earlier chapters. Thiscourse has a plan; it proceeds step-by-step, eachsection building on the last. Make sure you
understand where it fits in the big picture.
An Invitation
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A graph is a two-dimensional representationof a set of numbers, or data.
How to Read and Understand Graphs
CHAPTER 1 APPENDIX
A time series graph shows how a singlemeasure or variable changes over time.
Time Series Graphs
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How to Read and Understand Graphs
Time Series Graphs
TABLE 1A.1 Total Disposable
Personal Income in the United States,
19752009 (in billions of dollars)
Year
Total
Disposable
Personal
Income Year
Total
Disposable
Personal
Income
19751976197719781979198019811982198319841985198619871988198919901991
1992
1,187.31,302.31,435.01,607.31,790.82,002.72,237.12,412.72,599.82,891.53,079.33,258.83,435.33,726.33,991.44,254.04,444.9
4,736.7
19931994199519961997199819992000200120022003200420052006200720082009
4,921.65,184.35,457.05,759.66,074.66,498.96,803.37,327.27,648.58,009.78,377.88,889.49,277.39,915.7
10,403.110,806.410,923.6
FIGURE 1A.1 Total Disposable PersonalIncome in the United States: 19752009 (in
billions of dollars)
CHAPTER 1 APPENDIX
Appendix
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Graphing Two Variables on a Cartesian Coordinate System
Appendix
FIGURE 1A.2 A Cartesian CoordinateSystem
A Cartesian coordinate system is
constructed by drawing two
perpendicular lines: a vertical
axis (the Y-axis) and a horizontalaxis (theX-axis). Each axis is a
measuring scale.
How to Read and Understand Graphs
CHAPTER 1 APPENDIX
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A graph is a simple two-dimensional geometric
representation of data.
This graph displays the data from Table 1A.2.
Along the horizontal scale (X-axis), we measure
household income. Along the vertical scale (Y-
axis), we measure household consumption.
Note: At pointA, consumption equals $22,304
and income equals $10,263.
At point B, consumption equals $31,751 and
income equals $27,442.
TABLE 1A.2 Consumption Expenditures
and Income, 2008
Average Income
before Taxes
Average
Consumption
Expenditures
Bottom fifth2nd fifth3rd fifth4th fifthTop fifth
$ 10,26327,44247,19674,090
158,652
$ 22,30431,75142,65958,63297,003
FIGURE 1A.3 Household Consumption andIncome
Plotting Income and Consumption Data for Households
How to Read and Understand Graphs
CHAPTER 1 APPENDIX
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Slope
FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope
2 1
2 1
Y YY
X X X
How to Read and Understand Graphs
Apositive slope indicates that increases inXare
associated with increases in Yand that decreases
inXare associated with decreases in Y.
A negative slope indicates the opposite
whenXincreases, Ydecreases; and when
Xdecreases, Yincreases.
CHAPTER 1 APPENDIX
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FIGURE 1A.5 Changing Slopes along Curves
How to Read and Understand Graphs
Slope
CHAPTER 1 APPENDIX
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TABLE 1A.3 Aggregate National Income and
Consumption for the United States,19302009 (in billions of dollars)
Aggregate National Income Aggregate Consumption
193019401950196019701980
1990200020052006200720082009
82.990.9
263.9473.9929.5
2433.0
5059.88938.911,273.812,031.212,448.212,635.212,280.0
70.171.3
192.2331.8648.3
1,755.8
3,835.56,830.48,819.09,322.79,826.4
10,129.910,089.1
FIGURE 1A.6 National Income andConsumption
Some Precautions
It is important to think carefully about what is
represented by points in the space defined by the
axes of a graph.
In this graph, we have graphed income with
consumption, as in Figure 1A.3, but here each
observation point is national income and aggregate
consumption in different years, measured in billions
of dollars
CHAPTER 1 APPENDIX