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A Lecture Presentation
to accompany
Exploring Economics
3rd Edition
by Robert L. Sexton
Copyright © 2005 Thomson Learning, Inc.
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Printed in the United States of America
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Chapter 1
The Role and Method
of Economics
1.1 Economics: A Brief Introduction
Many issues in our lives are at least partly economic in
character:
 Why do 10 AM classes fill up faster than 8 AM classes during
registration?
 Why is it difficult to find a cab after a play on a rainy night in
in New York City?
 Why is it hard to find an apartment in cities like, San
Francisco, Berkeley and New York?
 Why is teenage unemployment higher than adult
unemployment?
 Will higher taxes on cigarettes reduce the amount people
smoke? If so, by how much?
 Why do professional athletes make so much money?
 Why do US auto producers like tariffs (taxes) on imported
cars?




Another reason to study economics is that it may
teach you how to think better.
The economic way of thinking is a set of problem–
solving tools that may prove to be valuable in
your professional and personal life.
Much of economic life involves making choices
between conflicting wants in a world of limited
resources
Economics gives us clues on how to intelligently
evaluate out options.


The economic approach sheds light on
many social issues such as
discrimination, education, crime and
divorce.
Many front page stories are filled with
articles relating to economics.




Economics is the study of the allocation of
our limited resources to satisfy our unlimited
wants.
Resources are inputs that are used to
produce goods and services.
Scarcity forces us to make choices on how
to best use our limited resources.
The economic problem: Scarcity forces us
to choose, and choices are costly because we
must give up other opportunities that we
value.

Living in a world of scarcity means
facing tradeoffs—a trip to the
grocery store versus the mall;
finishing a research paper or going to
the beach or a movie; sleep or class.
1.2 Economics as a Science


Economics, like the other social
sciences, is concerned with reaching
generalizations about human
behavior.
Conventionally, we distinguish
between two main branches of
economics:


macroeconomics, and
microeconomics.


Macroeconomics is the study of the
aggregate, or total economy.
It looks at economic problems as
they influence the whole of society,
including the topics of inflation,
unemployment, business cycles,
and economic growth.



Microeconomics deals with the
smaller units within the economy.
It attempts to understand the
decision making behavior of firms
and households and their interaction
in markets for particular goods or
services.
Microeconomics looks at the trees;
Macroeconomics looks at the forest.
1.3 Economic Behavior



Economists assume that individuals act as
if they are motivated by self-interest and
respond in predictable ways to changing
circumstances.
To a worker, self-interest means pursuing
a higher paying job and/or better working
conditions.
To a consumer, self-interest means
gaining a greater level of satisfaction from
their limited income and time.


Most economists believe that it is rational
for people to try to anticipate the likely
future consequences of one's behavior
before choosing it—like driving with a
suspended driver’s license or choosing to
take up smoking.
Actions have consequences—even
inactions, which are choices not to do
something or not to make changes, have
consequences—failing to study for an
exam.


In mainstream economics, to say that
people are rational is not to assume that
they never make mistakes. It is merely to
say that they do NOT make systematic
mistakes.
And when economists talk of self-interest,
they are not just referring to satisfaction
of material wants but to a broader idea of
“preferences” that can easily encompass
the welfare of others.
1.4 Economic Theory



Theories are statements or propositions
used to explain and predict behavior in the
real world.
Because of the complexity of human
behavior, economists must abstract to
focus on the most important components
of a particular problem.
This is similar to maps that highlight the
important information (and assume away
many of the minor details) to help people
get from here to there.



A hypothesis in economic theory is a
testable prediction about how people will
behave or react to a change in economic
circumstances.
For example, if the price of CDs increase,
we can hypothesize that fewer CDs would
be sold.
Empirical analysis, the use of data to test
hypotheses, is applied to determine
whether or not a hypothesis fits well with
the facts. If an economic hypothesis is
supported by the data, we can tentatively
accept as an economic theory.
1.5 Problems to Avoid in
Scientific Thinking



Virtually all theories in economics are
expressed using a ceteris paribus (“holding
everything else constant”) assumption.
An example of ceteris paribus: The theory
that if I study harder, I will perform better on
a test must carefully hold other things
constant.
These other things might include—what if
you studied so hard you overslept or you
were too sleepy to think clearly? Or what if
you studied the wrong stuff?



One must always be careful not to confuse
correlation with causation.
The fact that two events usually occur
together (correlation) does not necessarily
mean that one caused the other to occur
(causation) .
Does a roosters crowing cause the sun to
rise? Why are ice cream sales and crime
positively correlated? People drive slowly
when roads are icy—are lower speeds the
cause of increased accidents? Or do icy roads
lead to lower speeds and more accidents.


Fallacy of composition—the incorrect
view that what is true for the individual is
always true for the group.
For example, standing up at a football
game or a concert to see better only works
if others do not do the same thing. How
about getting to school early to get a
better parking place? What if everybody
gets up early to get a better parking spot?
1.6 Positive and
Normative Analysis



Positive analysis--an objective testable
statement. Positive statements are attempts
to describe what happens and why it
happens.
Normative analysis--a subjective nontestable item about what should be or what
ought to happen. Normative statements are
attempts to prescribe what should be done.
For example, should the government give
“free” prescription drugs to seniors? Or
should the government increase spending in
the space program?



Disagreement is common in most
disciplines.
The majority of disagreements in
economics stem from normative
issues.
However, there is some disagreement
over positive analysis—there may be
mixed empirical evidence or
insufficient information.

Most economists agree on a wide
range of issues including the effects
of rent control, import tariffs, export
restrictions, the use of wage and price
controls to curb inflation, and the
minimum wage.
Appendix: Working with Graphs
Graphs are an important economic tool.
They:
allow economists to better understand
the workings of the economy, and
 enhance the understanding of important
economic relationships.


The most useful graph for our
purposes is one that merely connects
a vertical line (the Y-axis) with a
horizontal line (the X-axis).
Exhibit 1: Plotting a Graph
Y
50
40
30
20
10
-50 -40 -30 -20 -10
-10
-20
-30
-40
-50
10
20
30
40
50
X
Three common types of graphs are:
pie charts,
 bar graphs,
 and time series graphs.

Exhibit 2:
Exhibit 2:
Exhibit 2:



Graphs can be used to show the
relationship between two variables.
A variable is something that is
measured by a number–like your
height.
Relationships between two variables
can be expressed in a simple
two-dimensional graph.


A positive relationship means that
two variables move in the same
direction.
That is, an increase in one variable
(practice time) is accompanied by an
increase in another variable (overall
score) or a decrease in one variable is
accompanied by a decrease in
another variable.
Exhibit 3: A Positive Relationship
D
Scores at Z Games
10
9
8
7
6
5
4
3
2
1
0
(40, 10)

C
(30, 8)
B
(20, 6)

A
(10, 4)
10
20
30
40
Practice Time per Week
The graph shows
an example of a
positive
relationship.
The skaters who
practiced the
most scored the
highest.


When two variables move in different
directions, there is a negative
relationship between the two
variables.
When one variable rises, the other
variable falls.


A downward-sloping line, the demand
curve, shows the different combinations
of price and quantity purchased.
The higher you go up on the vertical
(price) axis, the smaller the quantity
purchased on the horizontal axis, and
the lower you go down along the vertical
(price) axis, the greater the quantity
purchased.
Exhibit 4: Emily’s Demand Curve
A Negative Relationship
Price of CDs
$25
20
15
10
5
0
Demand Curve
(1, $25)
A
B
(2, $20)
C
(3, $15)
D
The downward
slope of the curve
means that price
and quantity are
inversely, or
negatively related.
 As price falls,
quantity purchased
increases and vice
versa.

(4, $10)
E
(5, $5)
1
2
3
4
5
6
Quantity of CDs Purchased



Even when only two variables are shown
on the axes, graphs can be used to show
the relationship between three variables.
For example, a rise in income may increase
the quantity of CDs purchased at each
possible price.
This would shift the whole demand curve
for CDs outward to a new position.
Price of CDs
Price of CDs
Exhibit 5: Shifting a Curve
D
D
D
(with lower income)
(with higher income)
0
Quantity of CDs Purchased
D
0
Quantity of CDs Purchased



It is important to remember the difference
between a movement up and down along a
curve and a shift in the whole curve.
A change in one of the variables on the
graph, like price or quantity purchased, will
cause a movement along the curve.
A change in one of the variables not shown,
like income in our example, will cause the
whole curve to shift.
Exhibit 6: Shifts vs. Movements
Price of CDs
 Going
from
Point A to B
indicates
movement
along a
demand curve.
A

B
0
D0
D1
Quantity of CDs Purchased
Going from D0
to D1 is a shift.



The slope, or steepness, of curves can
be either positive (upward sloping) or
negative (downward sloping).
A curve that is downward sloping
represents an inverse, or negative,
relationship between the two variables.
A curve that is upward sloping
represents a direct, or positive
relationship between the two variables.
Exhibit 7: Downward-Sloping
Linear Curves

25
20
Downward
sloping
15
10
5
0
5
10
15
20
25
A downwardsloping curve
represents a
negative
relationship
between two
variables.
Exhibit 7: Upward-Sloping
Linear Curves
25

20
15
Upward
sloping
10
5
0
5
10
15
20
25
An upwardsloping curve
represents a
positive
relationship
between two
variables.


The slope of a linear curve between
two points measures the relative
rates of change of two variables.
The slope of a linear curve can be
defined as the ratio of the change in
the Y value to the change in the X
value, or the ratio of the rise to the
run.
Exhibit 8: Slopes of Positive
and Negative Linear Curves
8
7
6
5 Positive
4 slope
+1/2 B
3 A
1 Rise
2
2 Run
1
0
A
10
9
1 2 3 4 5 6
X-axis
Y-axis
Y-axis
10
9
8
7
6
5
4
3
2
1
0
-8
Rise
Negative
slope
-4
B
+2 Run
1 2 3 4 5 6
X-axis


Along a nonlinear curve, the slope
varies from point to point.
However, we can find the slope of
such a curve at any point by finding
the slope of the tangent to that curve
at that point.
Exhibit 9: The Slope of a
Nonlinear Curve
5
Y-axis
4
Slope=0
B
3
A
C
2
1
0
1
2
3
4
X-axis
5
6
7