The Scope and Method of Economics

1.1 Why Study Economics?

Economics is the study of how individuals and societies allocate scarce resources to satisfy unlimited wants. Understanding economics helps explain decision-making, societal trends, and policy outcomes.

• Definition: Economics is the study of choices—how people and societies decide to use scarce resources left by nature and past generations.

• It is a behavioral/social science focused on individual and societal choices.

Scarce Resources

• Money: Limited by income and spending power.

• Time: People must choose how to use it.

• Natural resources: Land, air, water.

Reasons to Study Economics

1. To Learn a Way of Thinking

   • Opportunity Cost: The best alternative forgone when making a choice. All decisions involve trade-offs.

     • Excludes things already spent (e.g., rent).

     • Example: Cost of leisure is wages forgone if not working.

   • Marginalism: Weighing additional costs and benefits.

     • Marginal Cost: Additional cost of producing one more unit.

     • Marginal Benefit: Extra satisfaction/value from consuming one more unit.

     • Law of Diminishing Marginal Utility: Marginal benefit usually declines as consumption increases.

     • Sunk Cost: Past expense that cannot be recovered—should be ignored in decision-making.

   • Efficient Markets: Profit opportunities are rare and quickly eliminated.

     • "No such thing as a free lunch."

     • Example: Shorter checkout line.

2. To Understand Society

   • Economics affects environment, well-being, and jobs.

   • Example: Industrial Revolution—Increased productivity, new technology, urban migration. Agricultural workers dropped from 2.3 to

     • Economic forces drive social change.

3. To Understand Global Affairs

   • Knowledge of economics helps citizens understand recessions, policies, trade, immigration, and the role of government in stabilization.

1.2 The Scope of Economics

Economics is divided into two main branches: microeconomics and macroeconomics. Each focuses on different levels of analysis and types of questions.

Microeconomics

• Studies individuals, households, and firms.

• Examples: pricing, household spending, firm production decisions, employment in specific industries.

Macroeconomics

• Studies the economy as a whole.

• Aggregates: income, output, employment, inflation.

• Examples: unemployment rates, total output, aggregate price level, national income.

Comparison Table

1.3 The Method of Economics

Economists use models and variables to analyze and predict economic behavior. These tools help simplify complex realities and focus on essential relationships.

Models & Variables

• Model: A simplified, formal theory (often mathematical) showing relationships between variables.

• Variable: A measure that changes (income, price, etc.).

• Models highlight essentials and simplify reality.

• Abstractions: Like maps—simplified but useful.

• Occam’s Razor: Irrelevant detail should be cut away.

Limits of Models

• Possible to oversimplify (removing too much social/political context).

• Correct level of abstraction depends on use.

Ceteris Paribus

• All else equal assumption—isolates effect of one variable.

Causation vs Correlation

• Important distinction in economics.

• Fallacy: post hoc, ergo propter hoc—assuming sequence means causation.

Empirical Economics

• Uses data to test theories.

• Sources:

  • Surveys (since 1940s).

  • NBER (National Bureau of Economic Research).

  • Private firms (Google, Amazon, Uber).

Criteria for Judging Outcomes

1. Efficiency:

   • Producing what people want at lowest cost.

   • Best example: voluntary exchange.

   • Inefficiency often results from poor policy, taxes, or regulation.

2. Equity:

   • Fairness in distribution.

3. Growth:

   • Result of new technology, knowledge, production methods.

   • Occurs when total output increases faster than population.

   • Raises standard of living.

   • Can be influenced by policy: subsidizing research, encouraging investment, tax laws, risks if wealth is invested abroad.

4. Stability:

   • National output grows steadily with low inflation and full employment.

   • U.S. history: periods of inflation & unemployment—macroeconomics studies causes and stabilization policies.

1.4 An Invitation

To understand economics, one must also know history and institutions.

1.5 Economics Skills and Careers

Economic principles are used to make decisions in careers, investments, and daily life.

• Business managers: Use economics for pricing, investments, resource allocation.