What is Economics? Understanding Our Changing World

What is Economics? Understanding Our Changing World Chapter 1  Main ideas After studying this chapter, you will be able to: Define economics and distinguish between microeconomics and macroeconomics...

What is Economics? Understanding Our Changing World Chapter 1  Main ideas After studying this chapter, you will be able to: Define economics and distinguish between microeconomics and macroeconomics Explain the two big questions of economics Explain the key ideas that define the economic way of thinking Explain how economists go about their work as social scientists 2 Economics 2ed: Global and Southern African Perspectives © 2013  Definition of Economics Microeconomics is the study of the choices that individuals and businesses make, the way these choices interact in markets, and the influence of governments Macroeconomics is the study of the performance of the national economy and the global economy 3 Economics 2ed: Global and Southern African Perspectives © 2013  Two Big Economic Questions How do choices end up determining what, how, and for whom goods and services are produced? What? The largest part (two-thirds in fact) of what South Africa produces today is services, such as retail and wholesale trade, health care, and education Goods are a small part of total production In 1946, 24 per cent of the South African economy was engaged in the primary sector – agriculture and mining (that proportion has shrunk to 8 per cent today) Over the same period, the contribution of the secondary sector – mining, construction, and manufacturing – has increased from 14 per cent to 24 per cent How? Goods and services are produced by using productive resources that economists call factors of production 4 Economics 2ed: Global and Southern African Perspectives © 2013  Two Big Economic Questions Factors of production are grouped into four categories: Land Labour Capital Entrepreneurship For Whom? People earn their incomes by selling the services of the factors of production they own: Land earns rent Labour earns wages Capital earns interest Entrepreneurship earns profit 5 Economics 2ed: Global and Southern African Perspectives © 2013  Two Big Economic Questions Can the Pursuit of Self-Interest Promote the Social Interest? A choice is in your self-interest if you think that choice is the best one available for you A choice is in the social interest if it leads to an outcome that is the best for society as a whole Questions about the social interest are hard ones to answer and they generate discussion, debate, and disagreement These can be answered by looking at: Globalisation The information-age economy Climate change Economic instability 6 Economics 2ed: Global and Southern African Perspectives © 2013  The Economic Way of Thinking A Choice Is a Trade-off You can think about your choices as trade-offs A trade-off is an exchange – giving up one thing to get something else Making a Rational Choice A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice Benefit: What You Gain The benefit of something is the gain or pleasure that it brings and is determined by preferences – by what a person likes and dislikes and the intensity of those feelings Cost: What You Must Give Up The opportunity cost of something is the highest valued alternative that must be given up to get it It has two components: the things you cannot afford to buy and the things you cannot do with your time 7 Economics 2ed: Global and Southern African Perspectives © 2013  The Economic Way of Thinking ideas How Much? Choosing at the Margin The benefit that arises from an increase in an activity is called marginal benefit The opportunity cost of an increase in an activity is called marginal cost Choices Respond to Incentives Economists take human nature as given and view people as acting in their self-interest The central idea of economics is that we can predict the self-interested choices that people make by looking at the incentives they face Economists see incentives as the key to reconciling self-interest and social interest Economists emphasise the crucial role that institutions play in influencing the incentives that people face as they pursue their self-interest Where these institutions exist, self-interest can indeed promote the social interest 8 Economics 2ed: Global and Southern African Perspectives © 2013  Economics as Social Science and Policy Tool The Economist as Social Scientist Positive Statements Normative Statements Unscrambling Cause and Effect Fallacy of Composition Post Hoc Fallacy The Economist as Policy Adviser All the policy questions on which economists provide advice involve a blend of the positive and the normative Economics cannot help with the normative part – the policy goal But for a given goal, economics provides a method of evaluating alternative solutions – comparing marginal benefits and marginal costs and finding the solution that makes the best use of the available resources 9 Economics 2ed: Global and Southern African Perspectives © 2013  Graphing Data Scatter Diagrams A scatter diagram is a graph that plots the value of one variable against the value of another variable for a number of different values of each variable Breaks in the Axes Breaks indicate that there are jumps from the origin, 0, to the first values recorded Misleading Graphs Breaks can be used to highlight a relationship, but they can also be used to mislead – to make a graph that lies Correlation and Causation A scatter diagram that shows a clear relationship between two variables tells us that the two variables have a high correlation 10 Economics 2ed: Global and Southern African Perspectives © 2013  Graphs Used in Economic Models Variables That Move in the Same Direction A relationship between two variables that move in the same direction is called a positive relationship or a direct relationship A line that slopes upward shows such a relationship Variables That Move in Opposite Directions A relationship between variables that move in opposite directions is called a negative relationship or an inverse relationship Variables That Have a Maximum or a Minimum Many relationships in economic models have a maximum or a minimum Variables That Are Unrelated There are many situations in which no matter what happens to the value of one variable, the other variable remains constant 11 Economics 2ed: Global and Southern African Perspectives © 2013  Graphs Used in Economic Models The Slope of a Relationship The slope of a relationship is the change in the value of the variable measured on the y-axis divided by the change in the value of the variable measured on the x-axis The Slope of a Straight Line The slope of a straight line is the same regardless of where on the line you calculate it The slope of a straight line is constant The Slope of a Curved Line Slope at a Point To calculate the slope at a point on a curve, you need to construct a straight line that has the same slope as the curve at the point in question Slope Across an Arc An arc of a curve is a piece of a curve 12 Economics 2ed: Global and Southern African Perspectives © 2013  Graphing Relationships Among More Than Two Variables Ceteris Paribus Ceteris paribus (often shortened to cet par) means ‘if all other relevant things remain the same’ To isolate the relationship of interest in a laboratory experiment, a scientist holds everything constant except for the variable whose effect is being studied Economists use the same method to graph a relationship that has more than two variables A Linear Equation The equation that describes a straight-line relationship between x and y is: y = a + bx Slope of Line The slope of a relationship is the change in the value of y divided by the change in the value of x 13 Economics 2ed: Global and Southern African Perspectives © 2013  Graphing Relationships Among More Than Two Variables Position of Line The y-axis intercept determines the position of the line on the graph Positive Relationships When the two variables x and y move in the same direction All positive relationships have a slope that is positive Negative Relationships When the two variables x and y move in the opposite direction 14 Economics 2ed: Global and Southern African Perspectives © 2013