The nature of economics

Chapter The Nature of Economics Introduction Rhesus monkeys are willing to forgo 10% of their “income” of cherry juice to examine photos of leading and attractive members of their group This behavior mirrors our willingness to purchase celebrity magazines Nevertheless, economists who study making choices in response to rewards or inducements, propose some are willing to pay to be viewed by others as leading and attractive members of our society What can economists tell us about why people purchase items that attract attention such as flashy sports cars or designer clothing? Copyright © 2008 Pearson Addison Wesley All rights reserved 1-2 Learning Objectives • Discuss the difference between microeconomics and macroeconomics • Evaluate the role that rational self-interest plays in economic analysis • Explain why the study of economics is a science • Distinguish between positive and normative economics Copyright © 2008 Pearson Addison Wesley All rights reserved 1-3 Chapter Outline • The Power of Economic Analysis • Defining Economics • Microeconomics versus Macroeconomics • The Economic Person: Rational Self-Interest • Economics as a Science • Positive versus Normative Economics Copyright © 2008 Pearson Addison Wesley All rights reserved 1-4 Did You Know That • Six of seven main U.S railroad lines meet in Chicago? • The bottlenecks these lines caused created incentives to lay more track? • Incentives are the underpinnings for all the decisions you and others make? Copyright © 2008 Pearson Addison Wesley All rights reserved 1-5 The Power of Economic Analysis • Incentives  Rewards for engaging in a particular activity Copyright © 2008 Pearson Addison Wesley All rights reserved 1-6 The Power of Economic Analysis (cont'd) • The economic way of thinking is a framework to analyze solutions to economic problems  How much time to study  Choosing which courses to take  Whether troops should be sent abroad Copyright © 2008 Pearson Addison Wesley All rights reserved 1-7 The Power of Economic Analysis (cont'd) • The economic way of thinking gives you the power—the power to reach informed conclusions about what is happening in the world • Economic analysis helps you make better decisions, and increases your understanding when watching or reading the news on the Web Copyright © 2008 Pearson Addison Wesley All rights reserved 1-8 The Power of Economic Analysis (cont'd) • Economic analysis is a way of thinking about all decisions  Your education, career, financing your home, family  Your involvement in the business world, or in politics as a voter Copyright © 2008 Pearson Addison Wesley All rights reserved 1-9 Defining Economics • Economics  The study of how people allocate their limited resources to satisfy their unlimited wants  The study of how people make choices Copyright © 2008 Pearson Addison Wesley All rights reserved 1-10 Economics as a Science • Models or Theories  Simplified representations of the real world used as the basis for predictions or explanations  A map is the quintessential model Copyright © 2008 Pearson Addison Wesley All rights reserved 1-27 Economics as a Science (cont'd) • Assumptions  The set of circumstances in which a model is applicable  Every model, or theory, must be based on a set of assumptions Copyright © 2008 Pearson Addison Wesley All rights reserved 1-28 Example: Getting Directions • A map is a simplifying model of reality • The degree of simplification varies across maps; some contain more detail than others • Economic models attempt to focus on what is relevant to the problem at hand and omit what is not Copyright © 2008 Pearson Addison Wesley All rights reserved 1-29 Economics as a Science (cont'd) • Ceteris Paribus Assumption [KAY-ter-us PEAR-uh-bus]  Nothing changes except the factor or factors being studied  “Other things constant”  “Other things equal” Copyright © 2008 Pearson Addison Wesley All rights reserved 1-30 Economics as a Science (cont'd) • 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 Copyright © 2008 Pearson Addison Wesley All rights reserved 1-31 Economics as a Science (cont'd) • Behavioral Economics  Approach to the study of consumer behavior  Emphasizes psychological limitations and complications which may interfere with rational decision making Copyright © 2008 Pearson Addison Wesley All rights reserved 1-32 Economics as a Science (cont'd) • Bounded Rationality  Hypothesis that people are nearly, not fully, rational  They cannot examine every choice available to them  Use simple rules of thumb to sort alternatives Copyright © 2008 Pearson Addison Wesley All rights reserved 1-33 Positive versus Normative Economics • Positive Economics  Purely descriptive statements or scientific predictions; “If A, then B,” a statement of what is • Normative Economics  Analysis involving value judgments; relates to whether things are good or bad, a statement of what ought to be Copyright © 2008 Pearson Addison Wesley All rights reserved 1-34 Issues and Applications: Do People Engage in Conspicuous Consumption? • In 1902, economist Thorstein Veblin coined the phrase conspicuous consumption • Ori Heffetz of Princeton University looked for empirical evidence to support Veblin’s idea • Evidence showed higher-income people buy visible items Copyright © 2008 Pearson Addison Wesley All rights reserved 1-35 Issues and Applications: Do People Engage in Conspicuous Consumption? (cont'd) • Is conspicuous consumption for real or just a rational response to higher income? Copyright © 2008 Pearson Addison Wesley All rights reserved 1-36 Summary Discussion of Learning Objectives • Microeconomics versus macroeconomics  Economics is the study of how individuals make choices to satisfy wants  Microeconomics is the study of decision making by individual households and individual firms  Macroeconomics is the study of nationwide phenomena, such as inflation and unemployment levels Copyright © 2008 Pearson Addison Wesley All rights reserved 1-37 Summary Discussion of Learning Objectives (cont'd) • Self-interest in economic analysis  Rational self-interest is the assumption that individuals behave in a reasonable (rational) way in making choices to further their interests Copyright © 2008 Pearson Addison Wesley All rights reserved 1-38 Summary Discussion of Learning Objectives (cont'd) • Economics as a science  Economists use models, or theories, that are simplified representations of the real world to analyze and make predictions about the real world Copyright © 2008 Pearson Addison Wesley All rights reserved 1-39 Summary Discussion of Learning Objectives (cont'd) • The difference between positive and normative economics  Positive economics deals with what is, whereas normative economics deals with what ought to be  Positive statements are of the “if…then” variety, while normative ask what “should, or could” be Copyright © 2008 Pearson Addison Wesley All rights reserved 1-40 End of Chapter The Nature of Economics [...]... microscope to focus on the smaller parts of the economy  Decision of a worker to work overtime or not  A family’s  An choice of having a baby individual firm advertising Copyright © 2008 Pearson Addison Wesley All rights reserved 1-14 Microeconomics versus Macroeconomics (cont'd) • Macroeconomics  The study of the behavior of the economy as a whole  Deals with economywide phenomena  The national unemployment... Wesley All rights reserved 1-17 The Economic Person: Rational Self-Interest (cont'd) “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” —Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 Copyright © 2008 Pearson Addison Wesley All rights reserved 1-18 The Economic Person: Rational... reserved 1-24 The Economic Person: Rational Self-Interest (cont'd) • Defining self-interest  The pursuit of one’s goals, does not always mean increasing one’s wealth  Prestige  Friendship  Love Copyright © 2008 Pearson Addison Wesley All rights reserved 1-25 Example: The Perceived Value of Gifts • The perceived value of gifts  Often, the recipient of the gift places a value on it far less than the market... 1-26 Economics as a Science • Models or Theories  Simplified representations of the real world used as the basis for predictions or explanations  A map is the quintessential model Copyright © 2008 Pearson Addison Wesley All rights reserved 1-27 Economics as a Science (cont'd) • Assumptions  The set of circumstances in which a model is applicable  Every model, or theory, must be based on a set of. .. The rate of growth in the money supply  The national government’s budget deficit Copyright © 2008 Pearson Addison Wesley All rights reserved 1-15 Microeconomics versus Macroeconomics (cont'd) • Macroeconomics deals with aggregates, or totals—such as total output in an economy • Modern economic theory blends micro and macro concepts Copyright © 2008 Pearson Addison Wesley All rights reserved 1-16 The. .. Assumption  The assumption that people do not intentionally make decisions that would leave them worse off Copyright © 2008 Pearson Addison Wesley All rights reserved 1-19 Example: “Neuroeconomics” Explores the Rationality Assumption • Economists want to know which parts of the brain play the greatest role in determining an individual’s choices • Brain scans reveal considerable coordination between the limbic... available to them  Use simple rules of thumb to sort alternatives Copyright © 2008 Pearson Addison Wesley All rights reserved 1-33 Positive versus Normative Economics • Positive Economics  Purely descriptive statements or scientific predictions; “If A, then B,” a statement of what is • Normative Economics  Analysis involving value judgments; relates to whether things are good or bad, a statement of what... factors being studied  “Other things constant”  “Other things equal” Copyright © 2008 Pearson Addison Wesley All rights reserved 1-30 Economics as a Science (cont'd) • 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 Copyright © 2008... 2008 Pearson Addison Wesley All rights reserved 1-12 Defining Economics (cont'd) • Individuals, businesses, and nations face alternatives, and choices must be made • Economics studies how these choices are made Copyright © 2008 Pearson Addison Wesley All rights reserved 1-13 Microeconomics versus Macroeconomics • Microeconomics  The study of decision making undertaken by individuals (or households)... reserved 1-31 Economics as a Science (cont'd) • Behavioral Economics  Approach to the study of consumer behavior  Emphasizes psychological limitations and complications which may interfere with rational decision making Copyright © 2008 Pearson Addison Wesley All rights reserved 1-32 Economics as a Science (cont'd) • Bounded Rationality  Hypothesis that people are nearly, not fully, rational  They cannot