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Learning Objectives

Discuss the difference between microeconomics and macroeconomics

Evaluate the role that rational self-interest plays in economic analysis

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Learning Objectives

Explain why the study of economics is a science

Distinguish between positive and normative economics

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The economic way of thinking is a framework to analyze solutions to economic problems, such as:– Staying in school

– Choosing what course to take

– What to have for break

The Power of Economic Analysis

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Economics is a way of thinking about all decisions, such as:– Voting and public policy

– Choosing a career

– Buying a home

– Trade policy

The Power of Economic Analysis

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Defining Economics

Economics– The study of how people allocate

their limited resources to satisfy their unlimited needs and wants

– The study of how people make choices

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Defining Economics

With limited income (resources), people must make choices to satisfy their wants.

Economics studies how these choices are made.

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Microeconomicsversus Macroeconomics

Microeconomics

The study of decision making undertaken by individuals (or households) and by firms

Macroeconomics– The study of the behavior of the economy as

a whole

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Macroeconomics vs. Microeconomics

To understand the scope and sweep of macroeconomics, let’s begin by looking more carefully at the difference between microeconomic and macroeconomic questions.

MICROECONOMIC QUESTION

MACROECONOMIC QUESTION

Go to school or take a job? How many people are employed in the economy as a whole?

What determines the salary offered by MQC to Mr. Danan, a new MA Graduate?

What determines the overall salary levels paid to workers in a given year?

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Macroeconomics vs. Microeconomics

MICROECONOMIC QUESTION

MACROECONOMIC QUESTION

What determines the cost to a university or college of offering a new course?

What determines the overall level of prices in the economy as a whole?

What government policies should be adopted to make it easier for low-income students to attend college?

What government policies should be adopted to promote full employment and growth in the economy as a whole?

What determines whether Citibank opens a new office in Shanghai?

What determines the overall trade in goods, services and financial assets between the US and the rest of the world?

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Microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions.

Ex.: How much it would cost for a university or college to offer a new course ─ the cost of the instructor’s salary, the classroom facilities, the class materials, and so on. Having determined the cost, the school can then decide whether or not to offer the course by weighing the costs and benefits.

Macroeconomics vs. Microeconomics

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Macroeconomics examines the aggregate behavior of the economy (i.e. how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performance as a whole).

Ex.: Overall level of prices in the economy (how high or how low they are relative to prices last year) rather than the price of a particular good or service.

Macroeconomics vs. Microeconomics

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Macroeconomics or Microeconomics

How will Ms. Martin’s tips change when a large manufacturing plant near the restaurant where she works closes?

What will happen to spending by consumers when the economy enters a downturn?

How will the price of tomatoes change if the town is flooded?

What will happen to our exports as the peso becomes less expensive in terms of other currencies?

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“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from the regard to their own interest.”

—Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776

The Economic Person:Rational Self-Interest

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Economists assume that people make choices in their own self-interest and in a rational manner.

The Economic Person:Rational Self-Interest

Rationality Assumption– The assumption that people do not

intentionally make decisions that would leave them worse off

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The Economic Person:Rational Self-Interest

Rationality and the use of incentives– Positive incentives

– Negative incentives

Making choices– Balancing cost and benefits

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Defining self-interest– The pursuit of one’s goals

• Humanitarian• Prestige• Wealth• Power• Friendship

The Economic Person:Rational Self-Interest

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Economics as a Science

Models or Theories– Simplified representations of the

real world used as the basis for predictions or explanations• A map and getting directions are

examples of models

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Economics as a Science

Assumptions– The set of circumstances in which

a model is applicable The Ceteris Paribus Assumption

– Holding other things constant– Nothing changes except the factor

or factors being studied

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Economics as a Science Economics is an empirical science.

– Real-world data is used to evaluate the usefulness of a model.

– Models are useful if they predict economic phenomena.

Economic models predict how people react, not how they think.

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Positive versus Normative Economics

Positive Economics– Purely descriptive statements or

scientific predictions—a statement of what is

Normative Economics– Analysis involving value judgments—a

statement of what ought to be