Economics Today

Nineteenth Edition

Chapter 1
The Nature of Economics

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Introduction
The percentage of women aged 40 to 44 with medical or
doctoral degrees who are childless has fallen from 35
percent two decades ago to 20 percent today.
What accounts for the increased willingness of women
with higher levels of education to bear children?
You will explore this question in this chapter.

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Learning Objectives
• 1.1 Define economics and discuss the difference
between microeconomics and macroeconomics
• 1.2 Identify the three basic economic questions
and the two opposing sets of answers
• 1.3 Evaluate the role that rational self-interest
plays in economic analysis
• 1.4 Explain why economics is a science
• 1.5 Distinguish between positive and normative
economics
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Chapter Outline
• 1.1 The Power of Economic Analysis
• 1.2 The Three Basic Economic Questions and
Two Opposing Sets of Answers
• 1.3 The Economic Approach: Systematic
Decisions
• 1.4 Economics as a Science
• 1.5 Positive versus Normative Economics

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Did You Know That ...
• Married people typically are healthier individuals?
• Young people with good health are more likely to
get married.
• Married couples also benefit from a “protective
effect” of better health.
• In this chapter, you will learn the nature of self-
interested responses to incentives.

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1.1 The Power of Economic Analysis (1 of 10)

• Incentives
– Rewards for engaging in a particular activity
– The nature of self-interested responses to incentives is
the starting point for economic analysis.

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1.1 The Power of Economic Analysis (2 of 10)

• The economic way of thinking is a framework to

analyze solutions to economic problems:
– How much time to study
– Choosing which courses to take
– Whether the U.S. government should encourage or
discourage immigration

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1.1 The Power of Economic Analysis (3 of 10)

• The economic way of thinking gives you the power

to reach informed conclusions about what is
happening in the world.
• Economic analysis helps you make better
decisions and increases your understanding when
watching or reading the news on the Web.

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1.1 The Power of Economic Analysis (4 of 10)

• Economic analysis is a way of thinking about all

decisions.
• These decisions could be about:
– Your education, career, or financing your home
– Your involvement in the business world
– How you cast your ballot as a voter

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1.1 The Power of Economic Analysis (5 of 10)

• Economics
– The study of how people allocate their limited
resources to satisfy their unlimited wants
– The study of how people make choices

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1.1 The Power of Economic Analysis (6 of 10)

• Resources
– Things used to produce other things to satisfy people’s
wants

• Wants
– What people would buy if their incomes were unlimited

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1.1 The Power of Economic Analysis (7 of 10)

• With limited income (resources), people must

make choices to satisfy their wants.
• We never have enough of everything, including
time, to satisfy our every desire.

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1.1 The Power of Economic Analysis (8 of 10)

• Individuals, businesses, and nations face

alternatives, and choices must be made.
• Economics studies how these choices are made.

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1.1 The Power of Economic Analysis (9 of 10)
• Microeconomics
– The study of decision making undertaken by individuals
(or households) and by firms
– Like looking though a microscope to focus on the
smaller parts of the economy:
 The effects of changes in gasoline prices
 A family’s choice of having a baby
 An individual firm’s decision to advertise

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Example: Microeconomic and Macroeconomic
Implications of the Gig Economy
• Today about one-third of the nearly 160 million
people received fixed payments for performing
short-term tasks, or “gigs.”
• The development of this gig economy has altered
the decision-making process for many individuals
and firms.
• The expansion of the gig economy has also
contributed to a rise in the part-time share of
employment from less than 17 percent a decade
ago to above 20 percent today.
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1.1 The Power of Economic Analysis (10 of 10)
• Macroeconomics
– The study of the behavior of the economy as a whole
– Deals with economywide phenomena:
 The national unemployment rate
 The rate of inflation
 The yearly output of goods and services in a nation
– Macroeconomics deals with aggregates, or totals—such as total
output in an economy.
– Modern economic theory blends micro and macro concepts.

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1.2 The Three Basic Economic Questions
and Two Opposing Sets of Answers (1 of 4)
• Economic system
– The institutional mechanism through which resources
are utilized to satisfy human wants

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1.2 The Three Basic Economic Questions
and Two Opposing Sets of Answers (2 of 4)
• Three economic questions:
1. What and how much will be produced?
2. How will items be produced?
3. For whom will items be produced?

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1.2 The Three Basic Economic Questions
and Two Opposing Sets of Answers (3 of 4)
• Two opposing answers in the form of economic
systems:
– Centralized command and control (central planning):
Authority that makes all economic decisions
– Price system (market system): Decentralized decision-
making process, in which prices are terms (signals)
under which people agree to make exchanges

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What If ... the government increases pharmaceutical
companies’ costs but prevents them from raising
their prices?

• The failure of pharmaceutical prices to fully reflect

the rising costs of producing the drugs has
provided a signal to the owners of some
manufacturers that they should reduce or even
halt production.

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1.2 The Three Basic Economic Questions
and Two Opposing Sets of Answers (4 of 4)
• Economic systems of the world’s nations (e.g.,
U.S.) are mixed systems that incorporate aspects
of both centralized command and control and a
decentralized price system.

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1.3 The Economic Approach:
Systematic Decisions (1 of 7)
• Economists assume that individuals act as if
motivated by self-interest and respond predictably
to opportunities for gain.

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1.3 The Economic Approach:
Systematic Decisions (2 of 7)
“It is not from the benevolence of the butcher, the
brewer, or the baker that we expect our dinner, but
from their regard to their own interest.”
—Adam Smith, An Inquiry into the Nature and Causes of
the Wealth of Nations, 1776

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1.3 The Economic Approach:
Systematic Decisions (3 of 7)
• Rationality assumption
– The assumption that people do not intentionally make
decisions that would leave themselves worse off

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1.3 The Economic Approach:
Systematic Decisions (4 of 7)
• Questions:
– Does the fact that some people make apparently
irrational choices invalidate the rationality assumption
in economics?
– Can economic models be applied to situations in which
behavior is at odds with what we expect from rational
people?

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1.3 The Economic Approach:
Systematic Decisions (5 of 7)
• Responding to incentives
– Rationality and the use of incentives:
 Positive incentives
 Negative incentives

– Making choices:
 Balancing costs and benefits

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1.3 The Economic Approach:
Systematic Decisions (6 of 7)
• Some examples of incentives
– Responding to positive incentives:
 Schoolchildren getting gold stars, working to have a “better
life” for yourself

– Responding to negative incentives:

 Penalties, punishments, using credit cards to avoid check
overdrafts

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International Policy Example: Greece Discovers
That Higher Tax Rates Encourage More Tax Evasion

• During the past few years, the government of

Greece implemented gradual increases in several
tax rates.
• However, the government’s tax revenues in fact
declined slightly.
• Residents of Greece responded to the higher tax
rates by raising their efforts to evade paying taxes.

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1.3 The Economic Approach:
Systematic Decisions (7 of 7)
• Defining self-interest
– The pursuit of one’s goals:
 Prestige
 Friendship
 Love

– Does not always mean increasing one’s wealth.

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Behavioral Example: Why Doesn’t Higher Pay
Persuade Some Women to Avoid Traditional Gender
Roles?

• The “gender gap” in earnings remains primarily

because many young women continue to choose
traditionally female occupations, such as
receptionists and housekeepers.
• Behavioral economists have found that many
immigrant women opt for work in predominantly
“female” occupations that reinforce their stereo-
typical gender roles.

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1.4 Economics as a Science (1 of 7)
• Economics is a social science that employs the
same kinds of methods used in other sciences,
such as biology.
• Economics uses models to explain economic
phenomena in the real world.

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1.4 Economics as a Science (2 of 7)
• Models or theories
– Simplified representations of the real world used as the
basis for predictions or explanations
– Should capture only the essential relationships that are
sufficient to analyze a problem
– Cannot be faulted as unrealistic simply because they
do not capture all details of the real world
 A map is the quintessential model.

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1.4 Economics as a Science (3 of 7)
• Assumptions
– The set of circumstances in which a model is
applicable
– Every model, or theory, must be based on a set of
assumptions.

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Example: Getting Directions
• A map is a simplifying model of reality.
• The degree of simplification varies across maps;
some contain more detail than others.
• Economic models attempt to focus on what is
relevant to the problem at hand and omit what is
not.

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1.4 Economics as a Science (4 of 7)
• Ceteris paribus [KAY-ter-us PEAR-uh-bus] assumption
– Nothing changes except the factor or factors being
studied.
– “Other things constant”
– “Other things equal”

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1.4 Economics as a Science (5 of 7)
• Economics is an empirical science.
– Real-world data is used to evaluate the usefulness of a
model.
– Models are useful if they predict economic phenomena.
– Economic models predict how people react,
not how they think.

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1.4 Economics as a Science (6 of 7)
• Behavioral economics
– An approach to the study of consumer behavior:
 Emphasizes psychological limitations and complications that
may interfere with rational decision making
– Proponents believe that it is “unrealistic” to assume:
 Unbounded selfishness
 Unbounded willpower
 Unbounded rationality

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1.4 Economics as a Science (7 of 7)
• Bounded rationality
– Hypothesis that people are nearly, not fully, rational:
 They cannot examine every choice available to them.
 They appear to use rules of thumb to sort alternatives.

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1.5 Positive versus Normative
Economics
• Positive economics
– Purely descriptive statements or scientific predictions,
such as “If A, then B”
– A statement of what is
• Normative economics
– Analysis involving value judgments; relates to whether
things are good or bad
– A statement of what ought to be

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You Are There: The Incentive to
Understand Chickens’ “Speech”
• Wayne Daley, a researcher at the Georgia
Institute of Technology, has developed apps to
allow farmers to monitor chickens’ “speech” for
signs of discomfort or distress.
• It might be a humanitarian motive to discern
chickens’ levels of comfort.
• However, it might also be a profit motive because
comfortable and healthy chickens lay more and
larger eggs, which translates to higher profits for
chicken farmers.
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Issues & Applications: Why More Highly
Educated Women Are Having More Children
• Child bearing is an economic decision that
involves a woman’s self-interest.
• Figure 1-1 on the next slide shows that the
percentages of highly educated women opting to
have children are larger today than 20 years ago.
• The incentives for those women to have children
include more assistance with child rearing today
and the enjoyment derived from being a parent.

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Figure 1-1 Percentages of Women Aged 40 to 44 with at
Least One Child by Educational Attainment, 1997 versus
2017

Source: Pew Research Center.

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Summary Discussion of Learning
Objectives (1 of 5)
• 1.1 Define economics and discuss the difference
between microeconomics and macroeconomics
– Economics is the study of how individuals make
choices to satisfy wants.
– Microeconomics is the study of decision making by
individual households and individual firms.
– Macroeconomics is the study of nationwide
phenomena, such as inflation and unemployment
levels.

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Summary Discussion of Learning
Objectives (2 of 5)
• 1.2 Identify the three basic economic questions
and the two opposing sets of answers
– The basic economic questions are what, how, and for
whom items will be produced.
– The two sets of answers are provided by the type of
economic system: centralized command and control or
the price system.

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Summary Discussion of Learning
Objectives (3 of 5)
• 1.3 Evaluate the role that rational self-interest
plays in economic analysis
– Rational self-interest is the assumption that individuals
behave in a reasonable (rational) way in making
choices to further their interests.

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Summary Discussion of Learning
Objectives (4 of 5)
• 1.4 Explain why economics is a science
– Economists use models, or theories, that are simplified
representations of the real world to analyze and make
predictions about the real world.

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Summary Discussion of Learning
Objectives (5 of 5)
• 1.5 Distinguish between positive and normative
economics
– Positive economics deals with what is, whereas
normative economics deals with what ought to be.
– Positive statements are of the “if…then” variety, while
normative statements ask what “should” or “could” be.

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Appendix A: Reading and Working with
Graphs
• Independent variable
– A variable whose value is determined independently of, or outside,
the equation under study

• Dependent variable
– A variable whose value changes according to changes in the
value of one or more independent variables

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Appendix A: Direct and Inverse
Relationships
• Direct relationship
– A relationship between two variables that is positive, meaning that
an increase in one variable is associated with an increase in the
other, and a decrease in one variable is associated with a
decrease in the other

• Inverse relationship
– A relationship between two variables that is negative, meaning
that an increase in one variable is associated with a decrease in
the other, and a decrease in one variable is associated with an
increase in the other

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Table A-1 Gas Mileage as a Function of Driving
Speed

Miles per Hour Miles per Gallon

45 25
50 24
55 23
60 21
65 19
70 16
75 13

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Figure A-1 Direct and Inverse Relationships

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Appendix A: Constructing a Graph
• Number line
– A line that can be divided into segments of equal length, each
associated with a number

• y axis
– The vertical axis in a graph

• x axis
– The horizontal axis in a graph

• Origin
– The intersection of the y axis and the x axis in a graph

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Figure A-2 Horizontal Number Line

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Figure A-3 Vertical Number Line

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Figure A-4 A Set of Coordinate Axes

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Table A-2 T-Shirts Purchased

(1) Price of (2) Number of T-Shirts

T-Shirts Purchased per Week
$10 20
9 30
8 40
7 50
6 60
5 70

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Figure A-5 Graphing the Relationship between T-
Shirts Purchased and Price

Panel (a)
Price per T-Shirts Purchased
T-Shirt per Week Point on Graph
$10 20 I (20, 10)
9 30 J (30, 9)
8 40 K (40, 8)
7 50 L (50, 7)
6 60 M (60, 6)
5 70 N (70, 5)

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Figure A-6 Connecting the Observation Points

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Figure A-7 A Positively Sloped Curve

Panel (a)
Price per Pairs of Shoes Point on
Pair Offered per Week Graph
$100 400 A (400, 100)
80 320 B (320, 80)
60 240 C (240, 60)
40 160 D (160, 40)
20 80 E (80, 20)

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Appendix A: The Slope of a Line (A
Linear Curve)
• Slope
– The change in the y value divided by the corresponding
change in the x value of a curve
– The “incline” of the curve
– “Rise” over “run”

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Figure A-8 Figuring Positive Slope

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Figure A-9 Figuring Negative Slope

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Figure A-10 The Slope of a Nonlinear Curve

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Copyright

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