ECONOMICS

Twelfth Edition, Global Edition

Chapter 1
What is
Economics?

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 Chapter Outline and Learning Objectives

1.1 Define economics and

distinguish between
microeconomics and
macroeconomics
1.2 Explain the two big questions
of economics
1.3 Explain the key ideas that
define the economic way of
thinking
1.4 Explain how economists go
about their work as social
scientists and policy advisers

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 Definition of Economics

• All economic questions arise because we want more than

we can get.
• Our inability to satisfy all our wants is called scarcity.
• Because we face scarcity, we must make choices.
• The choices we make depend on the incentives we face.
• An incentive is a reward that encourages an action or a
penalty that discourages an action.

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 Definition of Economics

• Economics is the social science that studies the choices

that individuals, businesses, governments, and entire
societies make as they cope with scarcity and the
incentives that influence and reconcile those choices.
• Economics divides in two main parts:
‒ Microeconomics
‒ Macroeconomics

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 Definition of Economics

• Microeconomics is the study of choices that individuals

and businesses make, the way those choices interact in
markets, and the influence of governments.
• Example: What factors determine the price of a specific brand of
smartphone? single market

• Macroeconomics is the study of the performance of

the national and global economies.
• Example: What factors contribute to fluctuations in the
unemployment rate? GDP, price, income, full employment,
international balance

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 Two Big Economic Questions

• Two big questions summarize the scope of economics:

‒ How do choices end up determining what, how, and for whom
goods and services get produced?
‒ When do choices made in the pursuit of self-interest also
promote the social interest?

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 Two Big Economic Questions

• What, How, and For Whom?

– Goods and services are the objects that people value and
produce to satisfy human wants.
– P, Q, R,

• What?
– What should we produce?
– A society (or country) might decide to produce candy or cars,
computers or combat boots.

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 Two Big Economic Questions

•How?
– How should we produce it?
– Goods and services are produced by using productive resources
that economists call factors of production.
– Factors of production are grouped into four categories:
 Land
 Labor
 Capital
 Entrepreneurship

 New factor of production, data

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 Two Big Economic Questions
https://data.stats.gov.cn/easyquery.htm?cn=C01

• The “gifts of nature” that we use to produce goods and

services are land. data
• The work time and work effort that people devote to
producing goods and services is labor.
• The quality of labor depends on human capital, which is
the knowledge and skill that people obtain from education,
on-the-job training, and work experience.
• The tools, instruments, machines, buildings, and other
constructions that businesses use to produce goods and
services are capital.
• The human resource that organizes land, labor, and capital
is entrepreneurship.

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 Two Big Economic Questions

•For Whom?
– Who gets the goods and services depends on the incomes that
people earn.
 Land earns rent.
 Labor earns wages.
 Capital earns interest.
 Entrepreneurship earns profit.

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 Two Big Economic Questions

• Do Choices Made in the Pursuit of Self-Interest also

Promote the Social Interest?
– Every day, billions of people in other countries make economic
choices that result in What, How, and For Whom goods and
services are produced.
– These choices are made by people who are pursuing their self-
interest.
– Are they promoting the social interest?

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 Two Big Economic Questions

• Self-Interest
‒ You make choices that are in your self-interest—choices that you
think are best for you.
• Social Interest
‒ Choices that are best for society as a whole are said to be in the
social interest.
‒ Social interest has two dimensions:
 Efficiency
 Equity

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 Two Big Economic Questions

• Efficiency and Social Interest

• Resource use is efficient if it is not possible to make someone
better off without making someone else worse off.
• Equity is fairness, but economists have a variety of views about
what is fair.
• Fair Shares and Social Interest
• The idea that the social interest requires “fair shares” is a deeply
held one.
• But what is fair?

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 Two Big Economic Questions

• Four topics that generate discussion and that illustrate

tension between self-interest and social interest are:
‒ Globalization
‒ The information-age monopolies
‒ Climate change
‒ Economic instability

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 Two Big Economic Questions

• Globalization
‒ Globalization means the expansion of international trade,
borrowing and lending, and investment.
‒ Globalization is in the self-interest of consumers who buy low-cost
imported goods and services.
‒ Globalization is also in the self-interest of the multinational firms
that produce in low-cost regions and sell in high-price regions.
‒ But is globalization in the self-interest of low-wage workers in
other countries and U.S. firms that can’t compete with low-cost
imports?
‒ Is globalization in the social interest?

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 Two Big Economic Questions

• The Information-Age Monopolies

‒ The technological change of the past forty years has been called
the Information Revolution.
‒ The information revolution has clearly served your self-interest: It
has provided your cell-phone, laptop, loads of handy applications,
and the Internet.
‒ It has also served the self-interest of Bill Gates of Microsoft and
Gordon Moore of Intel, both of whom have seen their wealth soar.
‒ But did the information revolution serve the social interest?

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 Two Big Economic Questions

• Climate Change
– Climate change is a huge political issue today.

– Every serious political leader is acutely aware of the problem and

of the popularity of having proposals that might lower carbon
emissions.

– Burning fossil fuels to generate electricity and to power airplanes,

automobiles, and trucks pours a staggering 28 billion tons—4 tons
per person—of carbon dioxide into the atmosphere each year.

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 Two Big Economic Questions

• Economic Instability
– In 2008, banks were in trouble. They had made loans that
borrowers couldn’t repay and they were holding securities the
values of which had crashed.

– Banks’ choices to take deposits and make loans are made in self-
interest, but does this lending and borrowing serve the social
interest?

– Do banks lend too much in the pursuit of profit?

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 Economic Way of Thinking

• Six key ideas define the economic way of thinking:

‒ A choice is a tradeoff.
‒ People make rational choices by comparing benefits and costs.
‒ Benefit is what you gain from something.
‒ Cost is what you must give up to get something.
‒ Most choices are “how-much” choices made at the margin.
‒ Choices respond to incentives.

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 Economic Way of Thinking

•A Choice Is a Tradeoff
– The economic way of thinking places scarcity and its implication,
choice, at center stage.
– You can think about every choice as a tradeoff—an exchange—
giving up one thing to get something else.
– On Saturday night, will you study or have fun?
– You can’t study and have fun at the same time, so you must make
a choice.
– Whatever you choose, you could have chosen something else.
Your choice is a tradeoff.

• tradeoff examples
– gun vs. butter
– efficiency vs. equity
–2016
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 • “Every gun that is made, every warship launched, every
rocket fired signifies, in the final sense, a theft from those
who hunger and are not fed, those who are cold and not
clothed. This world in arms is not spending money alone. It
is spending the sweat of its laborers, the genius of its
scientists, the hopes of its children. This is not a way of life
at all in any true sense. Under the cloud of threatening war,
it is humanity hanging from a cross of iron.”

Dwight D. Eisenhower
34th president of US 1953-1961 (1890 - 1969)
From a speech before the American Society of Newspaper Editors, April
16, 1953

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 Economic Way of Thinking

• 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.
‒ Only the wants of the person making a choice are relevant to
determine its rationality.
‒ The idea of rational choice provides an answer to the first
question: What goods and services will be produced and in what
quantities?
‒ The answer is: Those that people rationally choose to buy!

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 The Economic Way of Thinking

• How do people choose rationally?

– The answers turn on benefits and costs.

– Benefit: What you Gain

– The benefit of something is the gain or pleasure that it

brings and is determined by preferences

• Preferences are what a person likes and dislikes and the

intensity of those feelings.

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 The Economic Way of Thinking

•Cost: What you Must Give Up

– The opportunity cost of something is the highest-valued
alternative that must be given up to get it.
– What is your opportunity cost of going to a live concert?
– Opportunity cost has two components:
 The things you can’t afford to buy if you purchase the concert ticket.
 The things you can’t do with your time if you attend the concert.

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 The Economic Way of Thinking

• How Much? Choosing at the Margin

– You can allocate the next hour between studying and instant
messaging your friends.

– The choice is not all or nothing, but you must decide how many
minutes to allocate to each activity.

– To make this decision, you compare the benefit of a little bit more
study time with its cost—you make your choice at the margin.

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 The Economic Way of Thinking

• To make a choice at the margin, you evaluate the

consequences of making incremental changes （增量成本） in
the use of your time.
• The benefit from pursuing an incremental increase in an
activity is its marginal benefit.
• The opportunity cost of pursuing an incremental increase
in an activity is its marginal cost.
• If the marginal benefit from an incremental increase in an
activity exceeds its marginal cost, your rational choice is
to do more of that activity.

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 The Economic Way of Thinking

• Choices Respond to Incentives

‒ A change in marginal cost or a change in marginal benefit
changes the incentives that we face and leads us to change our
choice.

‒ The central idea of economics is that we can predict how choices

will change by looking at changes in incentives.

‒ Incentives are also the key to reconciling self-interest and the

social interest.

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 Economics: A Social Science and Policy
Tool
• Economist as Social Scientist
‒ Economists distinguish between two types of statement:
 Positive statements （实证）
 Normative statements （规范）
‒ A positive statement can be tested by checking it against facts.
‒ A normative statement expresses an opinion and cannot be
tested.

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 • Positive Economics: 实证经济学
 Will high interest rates lower economic growth rate and inflation?
 Does free trade raise or lower the wages of most Americans?
 What is the impact of computers on productivity?

• Normative economics: 规范经济学

 Should poor people be required to work if they are to get
government assistance?
 Should unemployment be raised to ensure that price inflation does
not become too rapid?

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 Economics: A Social Science and Policy
Tool
• Unscrambling Cause and Effect
‒ The task of economic science is to discover positive statements
that are consistent with what we observe in the world and that
enable us to understand how the economic world works.

‒ Economists create and test economic models.

‒ An economic model is a description of some aspect of the

economic world that includes only those features that are needed
for the purpose at hand.

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 Economics: A Social Science and Policy
Tool
• A model is tested by comparing its predictions with the
facts.
• But testing an economic model is difficult, so economists
also use:
‒ Natural experiments

‒ Statistical investigations

‒ Economic experiments

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Copyright © 2016 Pearson Education, Ltd. All Rights Reserved.
 Economics: A Social Science and Policy
Tool
• Economist as Policy Adviser
‒ Economics is a toolkit for advising governments and businesses
and for making personal decisions.

‒ All the policy questions on which economists provide advice

involve a blend of the positive and the normative.

‒ Economics can’t help with the normative part—the goal.

‒ But for a given goal, economics provides a method of evaluating

alternative solutions—comparing marginal benefits and marginal
costs.

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 Key Points
• Definition of economics
– scarcity; micro vs. macro
• Two Big Questions of Economics
– what, how and for whom
– self interest vs. social interest
• The Economic Way of Thinking
– tradeoff, rationality, benefit, cost, incentives, margin
• Economics as Social Science and Policy Tool

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