CHAPTER
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1
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The Scope and
Method of Economics
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Appendix: How to Read and Understand Graphs
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
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Karl Case, Ray Fair
C H A P T E R 1: The Scope and Method of Economics
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The Study of Economics
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• Economics is the study of how
individuals and societies
choose to use the scarce
resources that nature and
previous generations have
provided.
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C H A P T E R 1: The Scope and Method of Economics
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Why Study Economics?
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• An important reason for
studying economics is to learn
a way of thinking.
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• Three fundamental concepts:
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• Opportunity cost
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• Marginalism, and
• Efficient markets
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C H A P T E R 1: The Scope and Method of Economics
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Opportunity Cost
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• Opportunity cost is the best
alternative that we forgo, or
give up, when we make a
choice or a decision.
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• Nearly all decisions involve
trade-offs.
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C H A P T E R 1: The Scope and Method of Economics
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Marginalism
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• In weighing the costs and
benefits of a decision, it is
important to weigh only the
costs and benefits that arise
from the decision.
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C H A P T E R 1: The Scope and Method of Economics
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Marginalism
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• For example, when a firm decides
whether to produce additional output,
it considers only the additional (or
marginal cost), not the sunk cost.
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• Sunk costs are costs that cannot be
avoided, regardless of what is done in
the future, because they have already
been incurred.
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C H A P T E R 1: The Scope and Method of Economics
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Efficient Markets
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• An efficient market is one in which
profit opportunities are eliminated
almost instantaneously.
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• There is no free lunch! Profit
opportunities are rare because, at
any one time, there are many people
searching for them.
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C H A P T E R 1: The Scope and Method of Economics
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More Reasons to Study Economics
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• The study of economics is an
essential part of the study of society.
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• Economic decisions often have
enormous consequences.
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• During the Industrial Revolution, new
manufacturing technologies and
improved transportation gave rise to the
modern factory system.
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C H A P T E R 1: The Scope and Method of Economics
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More Reasons to Study Economics
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• An understanding of
economics is essential to an
understanding of global affairs.
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• Voting decisions also require a
basic understanding of
economics.
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C H A P T E R 1: The Scope and Method of Economics
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The Scope of Economics
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• Microeconomics is the branch
of economics that examines
the behavior of individual
decision-making units—that is,
business firms and
households.
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C H A P T E R 1: The Scope and Method of Economics
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The Scope of Economics
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• Macroeconomics is the
branch of economics that
examines the behavior of
economic aggregates—
income, output, employment,
and so on—on a national
scale.
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C H A P T E R 1: The Scope and Method of Economics
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The Scope of Economics
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Examples of microeconomic and macroeconomic concerns
Microeconomics
Macroeconomics
Production
Prices
Income
Employment
Production/Output
in Individual
Industries and
Businesses
Price of Individual
Goods and
Services
Distribution of
Income and Wealth
Wages in the auto
industry
Minimum wages
Executive salaries
Poverty
Employment by
Individual
Businesses &
Industries
Jobs in the steel
industry
Number of
employees in a firm
National Income
Total wages and
salaries
Employment and
Unemployment in
the Economy
Total corporate
profits
Total number of
jobs
Unemployment
rate
How much steel
How many offices
How many cars
Price of medical
care
Price of gasoline
Food prices
Apartment rents
National
Production/Output
Aggregate Price
Level
Total Industrial
Output
Gross Domestic
Product
Growth of Output
Consumer prices
Producer Prices
Rate of Inflation
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Karl Case, Ray Fair
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C H A P T E R 1: The Scope and Method of Economics
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The Method of Economics
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• Positive economics studies
economic behavior without
making judgments. It
describes what exists and how
it works.
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C H A P T E R 1: The Scope and Method of Economics
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The Method of Economics
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• Normative economics, also
called policy economics,
analyzes outcomes of
economic behavior, evaluates
them as good or bad, and may
prescribe courses of action.
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C H A P T E R 1: The Scope and Method of Economics
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The Method of Economics
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• Positive economics includes:
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• Descriptive economics, which involves
the compilation of data that describe
phenomena and facts.
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• Economic theory, which involves
building models of behavior.
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• An economic theory is a general statement
of cause and effect, action and reaction.
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C H A P T E R 1: The Scope and Method of Economics
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Theories and Models
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• Theories involve models, and
models involve variables.
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• A model is a formal statement of a
theory. Models are descriptions of
the relationship between two or more
variables.
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C H A P T E R 1: The Scope and Method of Economics
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Theories and Models
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• Ockham’s razor is the
principle that irrelevant detail
should be cut away. Models
are simplifications, not
complications, of reality.
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C H A P T E R 1: The Scope and Method of Economics
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Theories and Models
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• A variable is a measure that can
change from observation to
observation.
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• The ceteris paribus device is part of
the process of abstraction.
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• Using the ceteris paribus, or all else
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equal, assumption, economists study
the relationship between two variables
while the values of other variables
remain constant.
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Karl Case, Ray Fair
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C H A P T E R 1: The Scope and Method of Economics
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Theories and Models
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• Pitfalls to avoid in formulating
economic theory:
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• The post hoc, ergo propter hoc
fallacy refers to a common error made
in thinking about causation: If event A
happened before event B, it is not
necessarily true that A caused B.
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• The fallacy of composition is the
erroneous belief that what is true for a
part is also true for the whole.
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Principles of Economics, 7/e
Karl Case, Ray Fair
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C H A P T E R 1: The Scope and Method of Economics
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The Method of Economics
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• Empirical economics refers to the
collection and use of data to test
economic theories.
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• Many data sets are available to
facilitate economic research. They
are collected by both government
agencies and private companies,
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C H A P T E R 1: The Scope and Method of Economics
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Economic Policy
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Criteria for judging economic outcomes:
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• Efficiency, or allocative efficiency.
An efficient economy is one that
produces what people want at the
least possible cost.
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• Equity, or fairness of economic
outcomes.
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Karl Case, Ray Fair
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C H A P T E R 1: The Scope and Method of Economics
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Economic Policy
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Criteria for judging economic outcomes:
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• Economic growth, or an increase in
the total output of an economy.
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• Economic stability, or the condition
in which output is steady or growing,
with low inflation and full employment
of resources.
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Karl Case, Ray Fair
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C H A P T E R 1: The Scope and Method of Economics
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Review Terms and Concepts
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ceteris paribus
macroeconomics
descriptive economics
microeconomics
economic growth
model
economic theory
normative economics
economics
ockham’s razor
efficiency
opportunity cost
efficient market
positive economics
empirical economics
post hoc, ergo propter hoc
equity
stability
fallacy of composition
sunk costs
Industrial Revolution
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variable
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C H A P T E R 1: The Scope and Method of Economics
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Appendix:
How to Read and Understand Graphs
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• A graph is a twodimensional
representation of a
set of numbers or
data.
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• A time series
graph shows
how a single
variable changes
over time.
Total Disposable Personal Income in
the United States: 1975-2002 (in
billions of dollars)
Total disposable personal income
C H A P T E R 1: The Scope and Method of Economics
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Appendix:
How to Read and Understand Graphs
8000
7500
7000
6500
6000
5500
5000
4500
4000
3500
3000
2500
2000
1500
1000
1975
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1980
1985
1990
1995
2000
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Year
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C H A P T E R 1: The Scope and Method of Economics
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Appendix:
How to Read and Understand Graphs
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• The Cartesian coordinate system is the
most common method of showing the
relationship between two variables.
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• The horizontal line is
the X-axis and the
vertical line the Y-axis.
The point at which the
horizontal and vertical
axes intersect is called
the origin.
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Appendix:
How to Read and Understand Graphs
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• The point at which the
line intersects the YYaxis (point a ) is called
the Y-intercept.
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• The Y-intercept,
intercept, is the
value of Y when X = 0.
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C H A P T E R 1: The Scope and Method of Economics
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Appendix:
How to Read and Understand Graphs
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• The slope of the line
indicates whether the
relationship between
the variables is positive
or negative.
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• The slope of the line is
computed as follows:
b=
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∆Y
Y −Y
= 1 0
∆X X 1 − X 0
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Principles of Economics, 7/e
Karl Case, Ray Fair
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C H A P T E R 1: The Scope and Method of Economics
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Appendix:
How to Read and Understand Graphs
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• This line slopes upward,
indicating that there
seems to be a positive
relationship between
income and spending.
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• Points A and B, above the
45° line, show that
consumption can be
greater than income.
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Principles of Economics, 7/e
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Appendix:
How to Read and Understand Graphs
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An upwardupward-sloping
line describes a
positive relationship
between X and Y.
A downwarddownward-sloping
line describes a
negative relationship
between X and Y.
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Appendix:
How to Read and Understand Graphs
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b=
5
= 0.5
10
b=−
7
= −0.7
10
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b=
0
=0
10
10
b=
=∞
0
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Appendix:
How to Read and Understand Graphs
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Appendix:
How to Read and Understand Graphs
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Cartesian coordinate system
slope
graph
time series graph
negative relationship
X-axis
origin
Y- axis
positive relationship
Y- intercept
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