The nature of economics

Learning Objectives• Discuss the difference between microeconomics and macroeconomics • Evaluate the role that rational self-interest plays in economic analysis • Explain why the study

Chapter 1

The Nature

of Economics

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.

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

Chapter Outline

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?

The Power of Economic Analysis

• Incentives

 Rewards for engaging in a

particular activity

• 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

The Power of Economic

Analysis (cont'd)

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

The Power of Economic

Defining Economics

• Economics

 The study of how people allocate

their limited resources to satisfy their

unlimited wants

 The study of how people make choices

Defining Economics (cont'd)

• Resources

 Things used to produce other things to

satisfy people’s wants

• Wants

 What people would buy if their incomes

were unlimited

Defining Economics (cont'd)

• With limited income (resources),

people must make choices to satisfy

their wants.

• We never have enough of everything, including time, to satisfy our

every desire.

Defining Economics (cont'd)

• Individuals, businesses, and nations

face alternatives, and choices must

be made

• Economics studies how these choices are made.

versus Macroeconomics

• Microeconomics

 The study of decision making undertaken

by individuals (or households) and by firms

 Like looking though a microscope to focus

on the smaller parts of the economy

 Decision of a worker to work overtime or not

 Deals with economywide phenomena

 The national unemployment rate

 The rate of growth in the money supply

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.

The Economic Person:

Rational Self-Interest

• Economists assume that individuals

act as if motivated by self-interest and

respond predictably to opportunities

for gain.

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

The Economic Person:

Rational Self-Interest (cont'd)

• Rationality Assumption

 The assumption that people do not

intentionally make decisions that would

leave them worse off

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 system (governing emotions)

and the prefrontal cortex (associated with reason

and calculation).

• There is evidence the brain attempts to factor in

The Economic Person:

Rational Self-Interest (cont'd)

• Questions

 Does the fact that some people make

apparently irrational choices invalidate the rationality assumption in economics?

 Can economic models be applied to

situations in which behavior is at odds with

The Economic Person:

Rational Self-Interest (cont'd)

The Economic Person:

Rational Self-Interest (cont'd)

• Some examples of incentives

 Responding to positive incentives

 Schoolchildren getting gold stars, working to have a “better life” for yourself

 Responding to negative incentives

 Penalties, punishments, using credit cards to

E-Commerce Example: Playing the Float with Plastic Instead of Checks

• Checks used to take up to several days to clear.

• People would rush to make deposits to avoid

overdraft charges.

• Technological developments enhanced digital

imaging, and banks have reduced check float.

• This has provided incentives for more credit card

purchases—as they allow for deferred payment.

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

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 value

 Should we substitute gift certificates for

physical gifts?

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

Economics as a Science (cont'd)

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

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”

Economics as a Science (cont'd)

• Economics is an empirical science.

 Real-world data is used to evaluate the

Economics as a Science (cont'd)

Economics as a Science (cont'd)

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

Issues and Applications:

Do People Engage in

Conspicuous Consumption? (cont'd)

• Is conspicuous consumption for

real or just a rational response to

higher income?

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

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

about the real world.

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”

End of

Chapter 1

The Nature

of Economics