1 WHAT IS

ECONOMICS?
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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 and policy advisers
 Describe the jobs available to a graduate with a major
in economics

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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.
Two microeconomic questions:
Why are people streaming more movies?
Would a tax on online shopping effect Amazon?
Macroeconomics is the study of the performance of the
national and global economies.
Two macroeconomic questions:
Why does the unemployment rate fluctuate?
Can the Federal Reserve make the unemployment rate fall
by keeping interest rates low?
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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.
What?
In the United States, agriculture accounts for less than
1 percent of total production, industry (manufactured
goods) for 11 percent, and services for 80 percent.
In low-income Ethiopia, agriculture accounts for
35 percent of total production, industry goods for
22 percent, and services for 44 percent.

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 Two Big Economic Questions

Figure 1.1 shows these

numbers for the United
States, China, and
Ethiopia.
What determines these
patterns of production?
How do choices end up
determining the quantity
of each item produced in
the United States and
around the world?

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 Two Big Economic Questions

How?
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

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 Two Big Economic Questions

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

services are land.
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

Figure 1.2 shows a

measure of the growth
of human capital in the
United States since
1900:
The percentage of the
population that has
completed different
levels of education.
Economics explains
these trends.

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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, 328 million Americans and 7.9 billion 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 and fair
shares.

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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.
Fair Shares and Social Interest
The idea that the social interest requires “fair shares” is a
deeply held one.
But what is a fair share?

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 Two Big Economic Questions

Questions about the social interest are hard ones to

answer and they generate discussion, debate, and
disagreement.
Four topics that generate discussion and that illustrate
tension between self-interest and social interest are:
■ Globalization
■ Information-age monopolies
■ Climate change
■ The Covid pandemic

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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

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 smartphone, 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

Two thirds of the world’s carbon emissions comes from the

United States, China, the European Union, Russia, and
India.
The fastest growing emissions are coming from India and
China.
The amount of global warming caused by economic
activity and its effects are uncertain, but the emissions
continue to grow and pose huge risks.

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 Two Big Economic Questions

Every day, when you make self-interested choices to use

electricity and gasoline, you contribute to carbon
emissions.
You leave your carbon footprint.
You can lessen your carbon footprint by walking, riding a
bike, taking a cold shower, or planting a tree.
But can each one of us be relied upon to make decisions
that affect the Earth’s carbon-dioxide concentration in the
social interest?
Can governments change the incentives we face so that
our self-interested choices are also in the social interest?
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 Two Big Economic Questions

The Covid Pandemic

Covid-19 spreads through close contact and social
interaction.
With no social isolation, one infected person infects more
than one other person, each infected person infects more
than one other, leading to an exponential spread of the
disease?
A person who socially isolates avoids infection, but also
avoids infecting others. People choose their degree of
social isolation in their self-interest.
Do individual choices serve the social interest?
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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.

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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:
1. The things you can’t afford to buy if you purchase the
concert ticket.
2. 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 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
■ Normative statements
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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