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CHAPTER 1
THE NATURE AND METHODOF ECONOMICS
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The R!es " Ecn#ics
• Economics is concerned with the efficient useof limited
productive resources for the purposeof attaining the maimum
satisfaction of ourmaterial wants!
• Why study economics? "ohn #aynard $eynesoffered this
response%
‘&he ideas of economists and political philosophers, both
when theyare right and when they are wrong, are more powerful than
iscommonly understood! Indeed the world is ruled by little
else!'ractical men, who believe themselves to be quite eempt from
anyintellectual influences, are usually the slaves of some
defuncteconomist!’
$eynes, ()*+
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The Age " The Ecn#ists
• dam -mith
• .avid /icardo
• "ohn -tuart #ill
• $arl #ar
• "on #aynard $eynes
• Plus many modern contributors
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The R!es " Ecn#ics
• Economics for citi0enship1 &o create well2informed members
of society
• Economics in business1 &o provide business with strategic
information
and interpretations
• 'ersonal applications
1 &o assist individuals, as wor3ers and incomereceivers,to
gain and retain economic security
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The Ecn#ic Pers$ective
• -carcity and choice1 /esources are limited and this
necessitates choices!
1 /esources can only be used for one purpose at a
time!
1 -carcity requires that choices be made! we have todecide 5make
a choice6 what we will have and
what we will forgo!
1 &he cost of any good, service, or activity is the valueof
what must be given up to obtain it 5opportunitycost6!
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• /ational behaviour1 7ehaviour that involves decisions and
actions in
order to achieve the greatest satisfaction ormaimum fulfilment
of goals!
1 We ma3e different decisions under
differentcircumstances!
1 8ur decisions may change as costs and benefitschange
1 /ational self2interest is not the same as selfishness!
The Ecn#ic Pers$ective %cnt&'
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The Ecn#ic Pers$ective %cnt&'
• #arginalism% benefits and costs1 Whether the decision is
personal or one made by
business or government, the principle is the same%
1 The marginal cost of an action should notexceed its marginal
benefits!
1 ;onflicts between long and short2run ob
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(h) St*+) Ecn#ics,-
• Economics helps people to make sense of every
dayactivity they observe around them.
• &he study of economics helps to develop anindividual’s
analytical s3ills and allows students to better predict the
logical consequences of theiractions!
• Economic principles enable business managers toma3e more
intelligent decisions!
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• Economics can help individuals ma3e better buying
decisions, better employment choices, and better financial
investments!
• Economics is mainly an academic, not a vocational sub
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Ecn#ic Meth+!g)
Economists use the scientific method to establishtheories, laws,
and principles!
• &he scientific method consists of% &he observation of
facts 5real data6 &he formulations of eplanations of cause
and
effect relationships 5hypotheses6 based upon thefacts!
&he testing of the hypotheses! &he acceptance, re
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• &heoretical economics% &he systematic arranging
offacts, interpretation of the facts, ma3inggenerali0ations!
• 'rinciples% used to eplain and=or predict the
behavior
of individuals and institutions!
• &erminology% principles, laws, theories, and
modelsare all terms that refer to generali0ations about
economic behavior• >enerali0ation% Economic principles
are epressed as
the tendencies of the typical or average consumer, wor3er,
or business firm!
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• Induction1 method of reasoning that proceeds from
facts
to generalisations
• .eduction1 /easoning from assumptions to conclusions bytesting
a hypothesis
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Micrecn#ics an+ Macrecn#ics
• Macroeconomics eamines the economy as a whole!
It includes measures of total output, totalemployment, total
income, aggregateependitures, and the general price level!
• Microeconomics loo3s at specific economicunits!
It is concerned with the individual industry, firmor household
and the price of specific products
and resources!
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P!ic) Ecn#ics- Psitive an+ Nr#ative• 'ositive
economics deals with facts 5and theories about these
facts6
and avoids value
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Ecn#ic .a!s
(! Economic growth
@! Aull employment
*! Economic efficiency B! 'rice2level stability
C! Economic freedom
+! n equitable distribution of income
D! Economic security
! Eternal balance
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Ecn#ic ga!s %cnt&'
• Interpretation1 &he basic economic goals inevitably entail
problems
of interpretation F what are ‘si0eable’, ‘high degree’and
‘equitable’?
• ;omplementary goals1 -ome of the goals are
complementary
• ;onflicting goals1 #any goals are conflicting or mutually
eclusive,
and involve trade-offs
• 'riorities1 When goals conflict, society has to
prioritise
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Pit"a!!s T Objective Thin/ing• 7ias• Goaded terminology •
.efinitions• Aallacy of composition
1 What is true for the individual or part is
notnecessarily true for the group or whole
• ;ause and effect1 'ost2hoc fallacy 1 ;orrelation versus
causation
• Economic quac3ery
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Direct an+ in+irect re!atinshi$s
• >raphing relationships between variables1 Direct
relationship
where the values of two related variable changein the
same direction e!g! consumption andincome
1 Inerse relationship
where the values of two related variables move inopposite
directions e!g! tic3et prices andattendance
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Direct re!atinshi$
0
$500
$400
$300
$200
$100
$100 $200 $300 $400
C o n s u m
p t i o n ( C )
Income (Y )
ConsumptionC = 50 + 0.5Y
a
b
c
d
e
As Y increases, C increases
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Inverse re!atinshi$
0
$25
$20
$15
$10
$5
4 8 12 16 20
T i c k e
t P r i c e ( P )
Atten!nce in t"ous!ns (Q )
Ticket demand
a
b
c
d
f
As P incre!ses# Q ecre!ses
e
P = 25 – 1.25Q
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De$en+ent an+ in+e$en+ent variab!es
• .ependent variable1 &he variable which changes as a
consequence
of a change in some other 5independent6 variable
• Independent variable1 &he variable which causes a change
in some
other 5dependent6 variable
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Other variab!es he!+ cnstant
• When economists plot the relationship betweenany two
variables, they assume that ‘other things
being equal’: that is, all other factors that mightaffect
consumption, are presumed to be constant
or unchanged
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S!$e " a straight !ine• &he ratio of the vertical change
5the rise or fall6
to the corresponding hori0ontal change involved
in moving between two points
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Psitive s!$e
o
a
b
c
d
e
$100 $200 $300 $400Income (Y )
$500
$400
$300
$200
$100
C o n s
u m p t i o n ( C )
Consumption
horizontal change = +100
vertical change = +50
C = 50 + 0.5Y
5.0
100
50
changehorizontal
changeverticalSlope +=
+
+==
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Negative s!$e
– 5
+ 4
0 4 8 12 16 20
$25
$20
$15
$10
$5
T i c k e
t p r i c e ( P )
a
b
c
d
f
Atten!nce in t"ous!ns (Q )
Ticket demand
P = 25 – 1.25Q
25.14
5
changehorizontal
changeverticalSlope −=
+
−==
e
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S!$e " a !ine
&hree addenda%
• #easurement units1 &he slope of a line is affected by the
choice of units
for either variable
• #arginal analysis1 &he slope of a line measures marginal
changes
• Infinite and 0ero slopes1 ariables that are unrelated or
independent of one another will be represented by a line
parallel to the vertical orhori0ontal ais, and will have a slope
ofinfinity or 0ero, respectively
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S!$e " a !ine %cnt&'
• Intercept1 &he ertical intercept is the point at
which the
linemeets the vertical ais
• Equation form1 Ginear equation
y ! a " bx
where: y = the dependent variable a = the vertical
intercept
b = the slope of the line x = the independent
variable
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S!$e " a nn!inear re!atinshi$ r c*rve
a
a
P A
A
Tangent
X
Y
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S! " % t '
10 20 30 40 X
Y
40
30
20
10
0
P
