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Chapter 1
The Principles
and Practice of
Economics
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1 The Principles and Practice of Economics
Chapter 1 Outline
1.1 The Scope of Economics
1.2 Three Principles of Economics
1.3 The First Principle of Economics: Optimization
1.4 The Second Principle of Economics: Equilibrium
1.5 The Third Principle of Economics: Empiricism
1.6 Is Economics Good for You?
Key Ideas
1. Economics is the study of people’s choices.
2. The first principle of economics is that people try to optimize; they try to choose the
best available option.
3. The second principle of economics is that economic systems tend to be in
equilibrium, a situation in which nobody would benefit by changing his or her own
behavior.
4. The third principle of economics is empiricism—analysis that uses data. Economists
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use data to test theories and to determine what is causing things to happen in the real
world.
1 The Principles and Practice of Economics
Evidenced-Based Economics Example:
Is Facebook free? $0 but there is no free
lunch
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1.1 The Scope of Economics
 Economic Agent = Any
group or individual that
makes choices, such as
consumers, firms,
parents, politicians, etc.
What does it mean if
something is “scarce”?
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1.1 The Scope of Economics
Economics studies how agents make choices among
scarce resources and how those choices affect
society.
Positive Economics
Propositions that can be verified
Normative economics
Propositions that cannot be verified
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1.1 The Scope of Economics
Positive Economics
Some people took more than one and not
everyone got a piece
Normative economics
Each student should just take one so that
everyone gets a piece
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1.1 The Scope of Economics
Microeconomics
The study of individuals,
firms, government
Macroeconomics
The study of the whole
economy
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1.2 Three Principles of Economics
Three Principles of Economics:
1. Optimization = making the best choice possible
with given information
2. Equilibrium = when everyone is optimizing; no
one would be better off with a different choice
3. Empiricism = using data to figure out answers to
interesting questions
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1.3 The First Principle of Economics: Optimization
Opportunity Cost
You want to buy a $20
book. If you drive 3
miles, you can buy it for
$10.
You want to buy a
$1,000 computer. If you
drive 3 miles, you can
buy it for $990.
Put this in the context of opportunity cost: if you didn’t make the drive, how much would it
cost you if you were in the market for the book? ($10). If you didn’t make the drive, what
would it cost you if you were in the market for a computer? ($10). The value of what9 you
gave up is the same.
1.3 The First Principle of Economics: Optimization
Cost-Benefit Analysis
Costs
Benefits
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1.4 The Second Principle of Economics: Equilibrium
Equilibrium
A situation in which no one benefits by
changing his/her behavior
The Free Rider Problem
-- Exists when an individual or group is able to enjoy the benefits of a
situation without incurring the costs
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1.4 The Second Principle of Economics: Equilibrium
Which one is
experiencing
equilibrium?
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1.4 The Second Principle of Economics: Equilibrium
Is there an incentive
for him to change his
behavior?
The free rider is clearly in an equilibrium situation—there is
no incentive for him/her to change his or her behavior.
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1.4 The Second Principle of Economics: Equilibrium
Is this an equilibrium?
But the group is not in equilibrium because one of their roommates is not pulling his/her own
weight. To eliminate the free rider problem, two things need to occur. First the group needs to
decide what is “fair”, and some sort of pressure needs to be brought to bear on the free rider
to get him/her to conform—to encourage him/her to conform to a group equilibrium. Markets
have no mechanism for deciding what is “fair”. Also the size of the group can change14whether a
free rider gets away with it. With a small group, it’s easy to see who is not pulling his/her own
weight, but in a larger group, that becomes more difficult.
1.5 The Third Principle of Economics: Empiricism
 Crowded beaches
and hot temperatures
go together.
So if we want to make it cooler, keep
people from going to the beach!
Question: what’s wrong with that conclusion. Point out
that sorting out cause and effect is an important part of
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1.6 Is Economics Good for You?
What are the costs and benefits of this course?
Costs
• Tuition- only if they are not taking another
course
• Other courses
• Sleep?
• Stress?
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1.6 Is Economics Good for You?
BENEFITS
Costs
•
•
•
•
Tuition
Other courses
Sleep?
Stress?
Benefit—the major benefit of economics
is that they will begin to see the world
through “economists’ eyes”.
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