On Economics

1. The Nature & Significance of Economics

 A social science – like the other social sciences, is concerned with reaching
generalizations about human behavior.
 Studies the choices people make in a world of limited resources. Economics asserts
that there is not enough to go around – wants are too great and the resources too
small. There is not enough money, time, or talent.
 Many issues in our lives are at least partly economic in character.

The economic approach to human behavior sheds light on social problems such as,
discrimination, education, crime, divorce, political favoritism, and many more. Economics is
front-page news almost every day, whether it involves politicians talking about the budget,
taxes, government spending, unemployment; business executives talking about restructuring
their companies to cut costs; or the average citizen trying to figure out how to make ends meet
each month. Economics is all of these and more.

Microeconomics is concerned with some particular segment of the economy. It studies the
choices made by consumers, firms, and government and how these decisions affect the
market for a particular good or service.
Macroeconomics is concerned with the entire economic system.

2. Scarcity – describes the ubiquitous condition in which our wants (material desires and non-
material desires) are greater than the limited resources (inputs used to produce goods and
services) available to satisfy the unlimited wants.
 Something is said to be scarce if people want more of that thing (demand) than is
available (supply) when it’s price is zero (free). Now when demand is greater than
supply in a market price rises. Therefore, if something is scarce it will have a price that is
greater than zero. Hence, if anything has positive price, however small, it must be
scarce. [Look around to find the material things that do not have a price, however
low. Your observation should give you a hint as to how pervasive is the economic
problem of scarcity.]

Scarcity → choice → opportunity cost (the most highly valued opportunity or alternative
forfeited when a choice is made) i.e.
Scarcity forces us to choose, and choices are costly because we must give up other
opportunities that we value.

At its very core, opportunity cost is determined by asking yourself, in any situation “What could
I be doing right now if I wasn’t _____ (fill in the activity)?” Or “What could I have bought if I
didn’t buy this _____ (fill in the good or service you bought)?”

3. Economists assume that individuals act (choose) as if they are motivated by self-interest (or
what is called economic rationality) and respond in predictable ways to changing
circumstances.
 For example, to a worker, self-interest means pursuing a higher paying job and better working
conditions. To a consumer, it means gaining a greater level of satisfaction from their limited
income and time.

4. Scarcity and Resources

The scarce resources (also called factors of production, inputs) used in the production of goods
and services are
Land includes the “gifts of nature” or the natural resources used in the production of
goods and services. e.g., trees, animals, water, minerals and so on.
Labor is the total of both physical and mental effort expended by people in the
production of goods and services.
Physical Capital is the equipment and structures used to produce goods and services.
Office buildings, tools, machines, and factories are all considered capital goods. When we invest
in factories, machines, research and development, or education, we increase the potential to
create more goods and services in the future.
Human Capital is the productive knowledge and skill received from education and on-
the-job training.

5. The Economic Way of Thinking: Propositions that serve as the basis for a chain of reasoning
How People Make Decisions
A. Choices are necessary because resources are scarce.
B. Opportunity cost arises from choice. Changes in opportunity cost affect behavior. The
higher the opportunity cost of doing something, the less likely it will be done.
C. According to economists, for most choices (decisions) you think in terms of additional, or
marginal costs and benefits, not total costs and benefits. That’s because most decisions
deal with making a small, or additional, change.
Marginal thinking requires decision makers to evaluate whether the benefit of one more
unit of something is greater than its cost.
e.g. 1. If you take on a part-time job while in school, you probably wrestle with the question
of how many hours to work. If you work a little more, you can earn additional income. If you
work a little less, you have time to study. Working more has tangible benefit (more money)
and a tangible cost (lower grades). The work-study trade-off affects how much money you
have and what kind of grades you earn.
D. People usually respond to incentives - exploiting opportunities to make themselves better
off. This is known as rational self-interest.
Incentives are factors that motivate a person to act or exert effort.
 policies set by government to encourage individuals and firms to act in certain ways.
E.g., Tax policy; patent system, copyright laws & innovation.
 businesses to encourage consumers to change their consumption habits. E.g., bonus
frequent flier miles for flying during slow travel season. Restaurants early-bird discounts
to those willing to eat at 5:00 p.m. rather than 7:30 p.m. Movie theaters offering
matinee pricing.
Positive incentives encourage action by offering rewards or payments. Negative incentives
discourage action by providing undesirable consequences.
Incentives can also be direct or indirect. If one gas station lowers its prices, it most likely will
get business from customers who would not usually stop there. This is a direct incentive.
Lower gasoline prices also work as an indirect incentive, because lower prices might
encourage consumers to use more gas (or drive bigger cars).
 Or consider the incentives at work in welfare programs. Almost everyone agrees that
societies should provide a safety net for those without employment or whose income isn’t
enough to meet their basic needs. In other words, a society has a direct incentive to
alleviate suffering caused by poverty. But how does a society provide this safety net without
taking away the incentive to work? If the amount of welfare a person receives is higher than
the amount that person can hope to make from a job, the welfare recipient might decide to
stay on welfare rather than go to work. The indirect incentive to stay on welfare creates an
unintended consequence: people who were supposed to use government assistance as a
safety net until they can find a job use it instead as a permanent source of income.

How People Interact

E. Decision makers interact (trade) in markets. There are gains from trade. Trade can make
everyone better off. The economy, as a whole, can produce more when each person
specializes in a task and trades with others.
People and nations do business with one another because all expect to gain from the
transactions. Many people assume that trade between nations is a zero-sum game – a game
in which, for one party to gain, another party must lose. This is how poker games work. If
one player walks away from the table a winner, someone else must have lost money. But
this is not how voluntary trade works. Voluntary trade is a positive-sum game. Both parties
to a transaction score positive gains. After all, who would voluntarily enter into an exchange
if he or she did not believe there was some gain from it.
F. Markets move toward equilibrium, an economic situation when no individual would be
better off doing something different.
G. Resources should be used as efficiently as possible; that is, used in a way that has fully
exploited all opportunities to make everyone better off.
H. Markets usually lead to efficiency because people usually exploit the gains from trade. The
incentives built into the market economy ensure that resources are usually put to good use
and that opportunities to make people better off are not wasted.
I. Market failure. The disadvantage of a market has to do with issues of equity. Some people
do not have the same abilities that the market rewards with success; or may have
disabilities that prevent them from succeeding. When markets do not achieve efficiency,
government can improve society’s welfare through regulation.
Economy-wide Interactions
J. Expenditure = Income One person’s spending is another person’s income.
K. Overall spending sometimes gets out of line with the economy’s productive capacity.
Recessions occur when spending falls short of productive capacity. Inflations occur when
spending exceeds productive capacity.
L. Government policies can change spending.
 Chapter Learning Objectives

After completing this chapter, students should be able to

1. Explain the concept of scarcity
2. Understand that if there was no scarcity there would be no such thing as economics.
3. Understand that scarcity exists because we are unable to produce as much as we would like
(our wants are unlimited while our means of production are limited).
4. Define the term economics and explain its scope.
5. Understand why scarcity forces individuals and societies to make choices
6. List the resources or factors of production a society has that enable it to produce goods and
services.
7. Distinguish “macro” from “micro”
8. Understand what is meant by an opportunity cost and give some examples
9. Explain marginal analysis and why it can give rise to more rational decisions

Critical Thinking
1. Why isn’t money a resource?
2. Does economics help to teach us how to approach problems, or does it provide us with a set
of answers to problems?

Quick Check – Test Your Understanding

(You do not have to submit it for grading)

1. (T/F) The opportunity cost of going to a concert is the price of the concert ticket.
2. When we have two soft drinks on a hot day and turn down the offer of a free third soft drink
because we feel this might be too much and leave us waterlogged, we are
a. Thinking irrationally because it is free.
b. Helping alleviate scarcity by leaving something for someone else.
c. Thinking on the margin.
d. Using information to gain an advantage in the market.
3. (T/F) Only people who are not rich are forced to make tradeoffs.
4. Microeconomics focuses on
a. What causes unemployment
b. What causes inflation around the world
c. Decisions by firms
d. Government deficits
5. Efficiency
a. Reflects how often economists make assumptions about important variables
b. Reflect how well resources are allocated
c. Reflects the fact that all labor is equally productive
d. Is an assumption used by economists that holds important variables constant.