1

What Is Economics?
Why does public discussion of economic policy so
often show the abysmal ignorance of the
participants? Whey do I so often want to cry at
what public figures, the press, and television
commentators say about economic affairs?
Robert M. Solow
Contents
Contents
♦♦Ideas
Ideas for
for Beyond
Beyond the
the Final
Final Exam
Exam

♦♦Inside
Inside the
the Economist’s
Economist’s Toolkit
Toolkit

♦♦Appendix:
Appendix: Using
Using Graphs:
Graphs: A
A Review
Review

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 1:
1: How
How Much
Much Does
Does ItIt Really
Really Cost?
Cost?
♦♦Opportunity
Opportunity cost
cost == value
value of
of the
the best
best forgone
forgone
alternative
alternative to
to any
any decision
decision
♦♦All actions ⇒
All actions ⇒ opportunity
opportunity costs
costs
♦♦Opportunity costs ⇒
Opportunity costs ⇒ true
true economic
economic costs
costs

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 2:
2: The
The Market
Market Strikes
Strikes Back
Back
♦♦Markets
Markets set
set prices.
prices.
♦♦Government
Government may
may intervene.
intervene.
♦♦Markets
Markets may
may “strike
“strike back.”
back.”
■■Example:
Example: rent
rent control
control reduces
reduces the
the supply
supply of
of
housing.
housing.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 3:
3: The
The Surprising
Surprising Principle
Principle of
of
Comparative
Comparative Advantage
Advantage
♦♦When
When two
two nations
nations trade,
trade, both
both benefit.
benefit.
♦♦Comparative
Comparative advantage
advantage == thethe production
production of
of
goods
goods with
with the
the lowest
lowest opportunity
opportunity cost
cost
♦♦Comparative advantage ⇒
Comparative advantage ⇒ specialization
specialization

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 4:
4: Trade
Trade is
is aa Win-Win
Win-Win Situation
Situation
Trade ⇒
♦♦Trade ⇒ benefits
benefits for
for both
both buyers
buyers && sellers
sellers
♦♦Restrictions
Restrictions on trade ⇒
on trade ⇒ ↓↓benefits
benefits
♦♦Intervention
Intervention into markets ⇒
into markets ⇒ ↑↑costs
costs

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 5:
5: The
The Importance
Importance of
of Thinking
Thinking at
at the
the
Margin
Margin
♦♦Marginal
Marginal == small
small change
change
♦♦Marginal
Marginal costs
costs == change
change in
in costs
costs
♦♦Rational
Rational decisions
decisions == comparison
comparison ofof costs
costs to
to
benefits
benefits at
at the
the margin
margin

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 6:
6: Externalities:
Externalities: Shortcoming
Shortcoming of
of the
the
Market
Market Cured
Cured by
by Market
Market Methods
Methods
♦♦Externalities
Externalities == effects
effects of
of transactions
transactions on
on third
third
parties
parties
Externalities ⇒
♦♦Externalities ⇒ social
social costs
costs
♦♦Market failure ⇒
Market failure ⇒ need
need for
for government
government
intervention
intervention

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 7:
7: The
The Trade-off
Trade-off between
between Efficiency
Efficiency
and
and Equality
Equality
♦♦More efficiency ⇒
More efficiency ⇒ more
more output
output &
& jobs
jobs
♦♦More equality ⇒
More equality ⇒ less
less efficiency
efficiency
♦♦Labor
Labor markets
markets distribute
distribute income
income efficiently,
efficiently,
not
not equally.
equally.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 8:
8: The
The Short-Run
Short-Run Trade-off
Trade-off between
between
Inflation
Inflation and
and Unemployment
Unemployment
♦♦Low unemployment ⇒
Low unemployment ⇒ rising
rising prices
prices
♦♦High unemployment ⇒
High unemployment ⇒ falling
falling prices
prices

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Ideas
Ideas for
for Beyond
Beyond the
the Final
Final
Exam
Exam
●●Idea
Idea 9:
9: Productivity
Productivity Growth
Growth Is
Is (Almost)
(Almost)
Everything
Everything in
in the
the Long
Long Run
Run
♦♦Productivity growth ⇒
Productivity growth ⇒ more
more output
output
♦♦More output ⇒
More output ⇒ higher
higher living
living standards
standards
♦♦In
In the
the long
long run,
run, productivity
productivity growth
growth isis (almost)
(almost)
everything.
everything.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Inside
Inside the
the Economist’s
Economist’s
Toolkit
Toolkit
●●Economics
Economics as
as aa Discipline
Discipline
♦♦Economics
Economics isis the the most
most scientific
scientific ofof the
the social
social
sciences.
sciences.
♦♦Yet,
Yet, itit isis much
much more
more social
social than
than the
the natural
natural
sciences.
sciences.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Inside
Inside the
the Economist’s
Economist’s
Toolkit
Toolkit
●●The
The Need
Need for
for Abstraction
Abstraction
♦♦Real
Real world complexity ⇒
world complexity ⇒ simplification
simplification in
in
economic
economic theory
theory
♦♦The
The “art”
“art” of
of economics:
economics: focus
focus on
on the
the essential;
essential;
ignore
ignore the
the trivial.
trivial.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Inside
Inside the
the Economist’s
Economist’s
Toolkit
Toolkit
●●The
The Role
Role of
of Economic
Economic Theory
Theory
♦♦Economic
Economic theory
theory == explanation
explanation of
of why
why
economic
economic events
events occur
occur
Correlation ≠≠ causality
♦♦Correlation causality
♦♦Economic theories ⇒
Economic theories ⇒ predictions
predictions

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Inside
Inside the
the Economist’s
Economist’s
Toolkit
Toolkit
●●What
What Is
Is an
an Economic
Economic Model?
Model?
♦♦Economic
Economic model
model == formal
formal statement
statement of
of
economic
economic theory
theory
♦♦Usually
Usually expressed
expressed in
in mathematics,
mathematics, with
with
equations
equations and
and graphs
graphs

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Inside
Inside the
the Economist’s
Economist’s
Toolkit
Toolkit
●●Reasons
Reasons for
for Disagreements:
Disagreements: Imperfect
Imperfect
Information
Information and
and Value
Value Judgments
Judgments
♦♦Among
Among economists,
economists,
♦♦agreement
agreement >> disagreement
disagreement
■■Imperfect information ⇒
Imperfect information ⇒ disagreements
disagreements
■■Value judgments ⇒
Valuejudgments ⇒ disagreements
disagreements

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Appendix
Using Graphs: A Review
 Graphs
Graphs Used
Used in
in Economic
Economic
Analysis
Analysis
●●Display
Display large
large quantity
quantity of of data
data quickly
quickly
●●Facilitate
Facilitate data
data interpretation
interpretation andand analysis
analysis
●●Important
Important statistical
statistical relationships
relationships more
more
apparent
apparent than
than from
from written
written descriptions
descriptions or
or
long
long lists
lists of
of numbers
numbers

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 Two-Variable
Two-Variable Diagrams
Diagrams

●●Variable
Variable == something
something measured
measured by
by aa
number
number
♦♦ Examples:
Examples: price
price and
and quantity
quantity
●●View
View two
two variables
variables together
together to
to see
see ifif they
they
exhibit
exhibit aa relationship.
relationship.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 TABLE 1-1
TABLE 1-1 Quantities
Quantities of
of Natural
Natural
Gas
Gas Demanded
Demanded at
at Various
Various Prices
Prices

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 FIGURE 1-1
Hypothetical
1-1
Hypothetical
FIGURE
Demand
Demand Curve
Curve for
for Gas
Gas

D
6 6

5 5
Price

4 4

Price
P a P a
3 3
b b
2 2
D
1 1
Q Q
0 20 40 60 80 100 120 140 0 20 40 60 80 100 120 140

Quantity Quantity
(a) (b)

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 The
The Definition
Definition and
and
Measurement
Measurement of of Slope
Slope
●●Slope
Slope == ratio
ratio of
of vertical
vertical change
change to
to
horizontal
horizontal change
change
♦♦Rise/run
Rise/run
♦♦Measure
Measure of
of steepness
steepness of
of the
the line
line

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 The
The Definition
Definition and
and
Measurement
Measurement of of Slope
Slope
●●The
The slope
slope of
of aa straight
straight line
line
♦♦Negative
Negative slope
slope == oneone variable
variable rises
rises while
while the
the
other
other variable
variable falls
falls
■■ The
The two
two variables
variables move
move in
in opposite
opposite directions.
directions.
♦♦Positive
Positive slope
slope == two
two variables
variables rise
rise and
and fall
fall
together
together
■■ The
The two
two variables
variables move
move in
in the
thesame
same direction.
direction.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE 1-2a
FIGURE 1-2a Negative
Negative Slope
Slope
Y

Negative
slope

X
0
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 1-2b
FIGURE 1-2b Positive
Positive Slope
Slope
Y

Positive
slope

X
0 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
 The
The Definition
Definition and
and
Measurement
Measurement of of Slope
Slope
♦♦Zero
Zeroslope
slope == the
thevariable
variableon
onthe
thehorizontal
horizontal axis
axiscancanbe
be
any
anyvalue
valuewhile
whilethe
thevariable
variableon
onthe
thevertical
verticalaxis
axisisisfixed
fixed
■■ Horizontal
Horizontalline
line
♦♦Infinite
Infiniteslope
slope == the
thevariable
variableon
onthe
thevertical
vertical axis
axiscan
canbe
be
any
anyvalue
valuewhile
whilethe
thevariable
variableon
onthe
thehorizontal
horizontalaxis
axisisis
fixed
fixed
■■ Vertical
Verticalline
line

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE 1-2c
FIGURE 1-2c Zero
Zero Slope
Slope
Y

Zero
slope

X
0
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE 1-2d
FIGURE 1-2d Infinite
Infinite Slope
Slope
Y

Infinite
slope

X
0 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
 The
The Definition
Definition and
and
Measurement
Measurement of of Slope
Slope
●●The
The slope
slope of
of aa straight
straight line
line
♦♦Slope
Slope isis constant
constant along
along aa straight
straight line.
line.
♦♦Slope
Slope can
can be be measured
measured between
between any
any two
two
points
points onon one
one axis
axis and
and the
the corresponding
corresponding two
two
points
points onon the
the other
other axis.
axis.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 FIGURE 1-3
FIGURE 1-3
How
How to
to Measure
Measure Slope
Slope

Y Y

—3
Slope = 10
C
11
C
9 1
8 Slope = — 8 B
B 10 A
A

X X
0 3 13 0 3 13

(a) (b)

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 The
The Definition
Definition and
and
Measurement
Measurement of of Slope
Slope
●●The
The slope
slope of
of aa curved
curved line
line
♦♦Slope
Slope changes
changes from
from point
point to
to point
point on
on aa curved
curved
line.
line.
■Curved
■Curvedline
linebowed
bowedtoward
towardthe
theorigin
originhas
hasaanegative
negative
slope.
slope.
●● Variables
Variableschange
changein
inopposite
oppositedirections.
directions.
■Curved
■Curvedline
linebowed
bowedaway
awayfrom
fromthe
theorigin
originhas
hasaa
positive
positiveslope.
slope.
●●Variables
Variableschange
changein
inthe
thesame
samedirection.
direction.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 FIGURE 1-4a
FIGURE 1-4a
Negative
Negative Slope
Slope in
in Curved
Curved Lines
Lines
Y

Negative
slope

X
0
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
 FIGURE 1-4b
FIGURE 1-4b
Positive
Positive Slope
Slope in
in Curved
Curved Lines
Lines
Y

Positive
slope

X
0
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
 The
The Definition
Definition and
and
Measurement
Measurement of of Slope
Slope
●●The
The slope
slope of
of aa curved
curved line
line
♦♦A
A curved
curved cancan have
have both
both aa positive
positive and
and
negative
negative slope
slope depending
depending on on where
where on on the
the
curve
curve isis measured.
measured.
♦♦The
The slope
slope atat aa point
point onon aa curved-line
curved-line isis
measured
measured by by aa line
line tangent
tangent to
to that
that point.
point.

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 FIGURE 1-4c,d
FIGURE Behavior
1-4c,dBehavior of
of Slope
Slope
in
in Curved
Curved Lines
Lines
Y Y

Negative Positive
slope slope

Negative
Positive slope
slope
X X
0 0

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

 FIGURE 1-5
FIGURE 1-5 How
How to
to Measure
Measure
Slope
Slope at
at aa Point
Point on
on aa Curve
Curve
Y
8 r

D
7

6 R
t
F
5
C E
4 G r
T
3
M
2

1 A
B
t
X
0 1 2 3 4 5 6 7 8 9 10

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 Rays
Rays Through
Through the
the Origin
Origin and
and
45-degree
45-degree Lines
Lines
●●Y-intercept
Y-intercept == point
point at
at which
which aa line
line
touches
touches the
the yy axis
axis
●●Ray
Ray through
through the
the origin
origin == straight
straight line
line
graph
graph with
with aa y-intercept
y-intercept of
of zero
zero

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 FIGURE 1-6
FIGURE 1-6
Rays
Rays through
through the
the Origin
Origin
Y

5 Slope = + 2

Slope = + 1
4
B

3 C
A

2 K Slope = + 1
–
2

1 E

D X
0 1 2 3 4 5

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 Squeezing
Squeezing 33 Dimensions
Dimensions
into
into 2:
2: Contour
Contour Maps
Maps
●●Some
Some problems
problems involve
involve more
more than
than two
two
variables
variables
●●Economic
Economic “contour
“contour map”
map” called
called aa
production
production indifference
indifference map
map
♦♦Shows
Shows howhow variable
variable ZZ changes
changes as
as we
we change
change
either
either XX or
or YY

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 FIGURE 1-8
FIGURE 1-8
An
An Economic
Economic Contour
Contour Map
Map
Y

80

70
Yards of Cloth per Day

60

50
A Z = 40
40

30 B Z = 30

20 Z = 20
10
Z = 10
X
0 10 20 30 40 50 60 70 80

Labor Hours per Day

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