What is Economics?

I. Economics: the study of how individuals and societies choose to use the scarce resources that
nature and previous generations have provided. The key word in the definition is choose.
Economics is a behavioral, or social, science. In large measure, it is the study of how people
make choices. The choices that people make, when added up, translate into societal choices.
II. Why Study Economics?
a. To learn a way of thinking, to understand society, to understand global affairs, and to be
an informed citizen.
i. To Learn A Way of Thinking
1. Opportunity Cost – The best alternative that we forgo, or give up, when
we make a choice or decision.
a. The full “cost” of making a specific choice includes what we
give up by not making the alternative choice.
2. Scarce – opportunity costs arise because resources are scarce. Limited
supply.
3. Marginalism – The process of analyzing the additional or incremental
costs or benefits arising from a choice or decision.
4. Sunk costs – Costs that cannot be avoided because they have already
been incurred.
5. Marginal cost – The incremental cost of producing one more unit of a
good or service
6. Efficient Markets – A market in which profit opportunities are
eliminated almost instantaneously.
a. Profit opportunity exists at the checkout lines when one line is
shorter than the others. Such profit opportunities are rare – at
any time, many people are searching for them; as a
consequence, few exist.
b. “There’s no such thing as a free lunch.”
ii. To Understand Society
1. Past and present economic decisions have an enormous influence on
the character of life in a society. The current state of the physical
environment, the level of material well-being, and the nature and
number of jobs are all products of the economic system.
2. Economic decisions not only have shaped the physical environment but
also have determined the character of society.
3. Industrial Revolution – The period in England during the late
eighteenth and early nineteenth centuries in which new manufacturing
technologies and improved transportation gave rise to the modern
factory system and a massive movement of the population from the
countryside to the cities.
a. Increases in the productivity of agriculture, new
manufacturing technologies, and development of more
efficient forms of transportation.
b. Discipline of economics began to take shape during this
period.
c. Adam Smith, David Ricardo, Karl Marx, Thomas Malthus
i. Each tried to make sense of what was happening.
Who was building the factories? Why? What
determined the level of wages paid to workers or the
price of food? What would happen in the future, and
what should happen?
iii. To Understand Global Affairs
1. Some claim that economic considerations dominate international
relations. Politicians place the economic well-being of their citizens
near the top of their priority lists. Thus, economic consequences of
 things such as environmental policy, free trade, and immigration play a
huge role in international negotiations and policies.
2. Another important issue in today’s world is the widening gap between
rich and poor nations.
a. 2007 – world population was over 6.5 billion, 2.4 billion lived
in low income (less than $900 annually per capita) countries
and just over 1 billion lived in high-income (over $11,000 per
capita per year) countries.
b. The 37 % of the world’s population that lives in the low-
income countries receives less than 3.3 percent of the world’s
income.
c. The 15% of the population in high-income countries earn 75%
of the world’s income.
iv. To Be an Informed Citizen
1. 1973-1974 (OPEC) SUCCEEDED IN RAISING THE PRICE OF
CRUDE OIL BY 400%.
a. A sequence of events in the world food market drove food
prices up by 25% - by mid-1974, prices in the United States
were rising across the board at a very rapid rate.
b. Partially as a result of government policy to fight runaway
inflation, the economy went into a recession in 1975 
slowed down price increases, but millions found themselves
unemployed.
2. From 1979 through 1983, it happened all over again. Prices rose
rapidly, the government reacted with more policies designed to stop
prices from rising, and the US ended up with an even worse recession
in 1982. By the end of that year, 10.8 percent of the world force was
unemployed.
3. Mid -1990 US economy went into another recession – GDP fell &
unemployment rose.
4. Second quarter of 1991 – early 2000s: longest expansion in its history.
More than 24 million new jobs, unemployment below 4% by 2000,
stock market boomed.
5. Bush – economy slipped into a recession and economic conditions were
made worse by 9/11. The stock market, which suffered losses as early
as 2000, fell for 3 consecutive years. Total employment dropped by
nearly 2.7 million. But by 2002, the economy began to grow again,
and by 20005, nearly 3.5 million jobs had been created.
6. Housing market boom – 2001: expansion of mortgage credit to
borrowers who in early years would not have been qualified.
(subprime loans) & mortgage loans that carried low monthly payments
for a few years that were later followed by substantially higher
payments became prevalent.
7. Summer 2007 – housing market stalled, prices began to fall, and the
huge amount of mortgage debt outstanding (over $10 trillion by 2007)
experiences rising delinquency and default.
III. The Scope of Economics
a. Economics has deep roots in and close ties to social philosophy (ex. Distributional
justice).
i. Microeconomics – The branch of economics that examines the functioning of
individual industries and the behavior of individual decision-making units – that
is, firms and households. (trees)
ii. Macroeconomics – The branch of economics that examines the economic
behavior of aggregates – income, employment, output, and so on – on a national
scale. (forest)
 b. The diverse fields of economics
i. Comparative economic systems, econometrics, economic development,
economic history, economics of race and gender, environmental economics,
finance, the history of economic thought, industrial organization, international
economics, labor economics, law and economics, public economics, urban and
regional economics.
IV. The Method of Economics
i. Positive economics – An approach to economics that seeks to understand
behavior and the operation of systems without making judgments. It describes
what exists and how it works.
ii. Normative economics – An approach to economics that analyzes outcomes of
economic behavior, evaluates them as good or bad, and may prescribe courses of
action (policy economics).
b. Descriptive Economics and Economic Theory
i. Descriptive Economics – The compilation of data that describe phenomena and
facts. (Statistical Abstract of the United States, a large volume of data published
by the Deparment of Commerce every year that describes many features of the
US economy.
1. Survey of Consumer Expenditure
2. National Longitudinal Survey of Labor Force Behavior
ii. Economic Theory – A statement or set of related statements about cause and
effect, action and reaction.
1. Law of demand (Alfred Marshall in 1890): When the price of a product
rises, people tend to buy less of it; when the price of a product falls,
people tend to buy more.
c. Theories and Models
i. Model – formal statement of a theory, usually a mathematical statement of a
presumed relationship between two or more variables.
ii. Variable – A measure that can change from time to time or from observation to
observation.
iii. Abstractions – models simplify reality by stripping part of it away (topography).
– strip away detail to expose only those aspects of behavior that are important to
the question being asked.
iv. Ockham’s razor – The principle that irrelevant detail should be cut away.
v. All Else Equal: Ceteris Paribus
1. To isolate the impact of one single factor, we use the cevice of ceteris
paribus. (What is the impact of a change in gasoline price on driving
behavior, ceteris paribus, or assuming that nothing else changes?
vi. Expressing Models in Words, Graphs, and Equations
vii.