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Introduction to Economics
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Methodology of Economics Problem of Scarcity Production-Possibility Frontier Principle of Increasing Costs Scarcity and the Market System True or False Questions Solved Problems
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Economics is a social science that studies individuals and organizations engaged in the production, distribution, and consumption of goods and services. The goal is to predict economic occurrences and to develop policies that might prevent or correct such problems as unemployment, in ation, or waste in the economy. Economics is subdivided into macroeconomics and microeconomics. Macroeconomics studies aggregate output, employment, and the general price level. Microeconom-
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2 PRINCIPLES OF ECONOMICS
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ics studies the economic behavior of individual decision makers such as consumers, resource owners, and business rms. The discipline of economics has developed principles, theories, and models that isolate the most important determinants of economic events. In constructing a model, economists make assumptions to eliminate unnecessary detail to reduce the complexity of economic behavior. Once modeled, economic behavior may be presented as a relationship between dependent and independent variables. The behavior being explained is the dependent variable; the economic events explaining that behavior are the independent variables. The dependent variable may be presented as depending upon one independent variable, with the in uence of the other independent variables held constant (the ceteris paribus assumption). An economic model will also specify whether the dependent and independent variables are positively or negatively related, i.e., moving in the same or opposite directions.
Note!
Ceteris paribus is Latin for other things being equal. This phrase is used often by economists in modeling to isolate the relationship between speci c dependent and independent variables.
Example 1.1 We shall assume that the amount a consumer spends (C) is positively related to her disposable income (Yd), i.e., C = f (Yd). Table 1.1 presents data on consumer spending for ve individuals with different levels of income. As seen in the table, consumption and disposable income display a positive relationship. The data from Table 1.1 are plotted in Figure 1-1 and labeled C1. The dependent variable, consumer spending, is plotted on the vertical axis and the independent variable, disposable income, is plotted on the horizontal axis. Graphs are used to present data and the positive or negative relationship of the dependent and independent variables visually.
CHAPTER 1: Introduction to Economics Table 1.1 (in $)
Problem of Scarcity
Economics is the study of scarcity the study of the allocation of scarce resources to satisfy human wants. People s material wants, for the most part, are unlimited. Output, on the other hand, is limited by the state of
Figure 1-1
4 PRINCIPLES OF ECONOMICS
technology and the quantity and quality of the economy s resources. Thus, the production of each good and service involves a cost. A good is usually de ned as a physical item such as a car or a hamburger, and a service is something provided to you such as insurance or a haircut. Scarcity is a fundamental problem for every society. Decisions must be made regarding what to produce, how to produce it, and for whom to produce. What to produce involves decisions about the kinds and quantities of goods and services to produce. How to produce requires decisions about what techniques to use and how economic resources (or factors of production) are to be combined in producing output. The economic resources used to produce goods and services include: Land. The economy s natural resources such as land, trees, and minerals. Labor. The mental and physical skills of individuals in a society. Capital. Goods such as tools, machines, and factories used in production or to facilitate production.
The for whom to produce involves decisions on the distribution of output among members of a society.
Remember
Economics helps to solve the three important questions of what to produce, how to produce it, and for whom to produce.
These decisions involve opportunity costs. An opportunity cost is what is sacri ced to implement an alternative action, i.e., what is given up to produce or obtain a particular good or service. For example, the opportunity cost of expanding a country s military arsenal is the decreased production of nonmilitary goods and services. Opportunity costs are found in every situation in which scarcity necessitates decision making. Opportunity cost is the value monetary or otherwise of the next
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