PRINCIPLES OF

ECONOMICS
ELEVENTH EDITION

CASE  FAIR  OSTER

PEARSON
Prepared by: Fernando Quijano w/Shelly Tefft
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 PART I INTRODUCTION TO ECONOMICS

The Scope and

Method of Economics 1
CHAPTER OUTLIN
E
Why Study Economics?
To Learn a Way of Thinking
To Understand Society
To Be an Informed Citizen
The Scope of Economics
Microeconomics and Macroeconomics
The Diverse Fields of Economics
The Method of Economics
Theories and Models
Economic Policy
An Invitation
Appendix: How to Read and
Understand Graphs

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 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 this 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.

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 Why Study Economics?

To Learn a Way of Thinking

Three fundamental concepts:

Opportunity cost

Marginalism

Efficient markets

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 Opportunity Cost

opportunity cost The best alternative that we forgo, or give up, when we
make a choice or a decision.

scarce Limited.

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 Marginalism

marginalism The process of analyzing the additional or incremental costs or

benefits arising from a choice or decision.

Efficient Markets—No Free Lunch

efficient market A market in which profit opportunities are eliminated almost

instantaneously.

The study of economics teaches us a way of thinking and helps us

make decisions.

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 To Understand Society

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.

The study of economics is an essential part of the study of society.

To Be an Informed Citizen

To be an informed citizen requires a basic understanding of economics.

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 ECONOMICS IN PRACTICE

iPod and the World

A sticker that says “Made in China” can

often be misleading.
Indeed, for the iPod, which is composed of
many small parts, it is almost impossible to
accurately tell exactly where each piece
was produced without pulling it apart.
From an economics point of view, one
often has to dig a little deeper to see what
is really going on.

THINKING PRACTICALLY
THINKING PRACTICALLY
1.What do you think accounts for where
1.What do you think accounts for where
components of the iPod are made?
components of the iPod are made?

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 The Scope of Economics

Microeconomics and Macroeconomics

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.

macroeconomics The branch of economics that examines the economic

behavior of aggregates—income, employment, output, and so on—on a
national scale.

Microeconomics looks at the individual unit—the household, the firm, the

industry. It sees and examines the “trees.”
Macroeconomics looks at the whole, the aggregate. It sees and analyzes
the “forest.”

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 TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns
Division
of Economics Production Prices Income Employment
Microeconomics Production/output Prices of individual Distribution of Employment by
in individual goods and services income and individual
industries and wealth businesses and
businesses industries

How much steel Price of medical care Wages in the Jobs in the steel
How much office Price of gasoline auto industry industry
space Food prices Minimum wage Number of
How many cars Apartment rents Executive employees in a firm
salaries Number of
Poverty accountants
Macroeconomics National Aggregate price level National income Employment and
production/output unemployment in
the economy

Total industrial Consumer prices Total wages and Total number of

output Producer prices salaries jobs
Gross domestic Rate of inflation Total corporate Unemployment rate
product profits
Growth of output

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 The Diverse Fields of Economics
TABLE 1.2 The Fields of Economics
Behavioral economics uses psychological theories relating to emotions and social context to help
understand economic decision making and policy. Much of the work in
behavioral economics focuses on the biases that individuals have that affect
the decisions they make.

Comparative economic examines the ways alternative economic systems function. What are the
systems advantages and disadvantages of different systems?

Econometrics applies statistical techniques and data to economic problems in an effort to

test hypotheses and theories. Most schools require economics majors to
take at least one course in statistics or econometrics.

Economic development focuses on the problems of low-income countries. What can be done to
promote development in these nations? Important concerns of development
for economists include population growth and control, provision for basic
needs, and strategies for international trade.

Economic history traces the development of the modern economy. What economic and
political events and scientific advances caused the Industrial Revolution?
What explains the tremendous growth and progress of post-World War II
Japan? What caused the Great Depression of the 1930s?

Continued.
..
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 The Diverse Fields of Economics
TABLE 1.2 The Fields of Economics (continued)
Environmental studies the potential failure of the market system to account fully for the
economics impacts of production and consumption on the environment and on natural
resource depletion. Have alternative public policies and new economic
institutions been effective in correcting these potential failures?
Finance examines the ways in which households and firms actually pay for, or
finance, their purchases. It involves the study of capital markets (including
the stock and bond markets), futures and options, capital budgeting, and
asset valuation.
Health economics analyzes the health care system and its players: government, insurers,
health care providers, and patients. It provides insight into the demand for
medical care, health insurance markets, cost-controlling insurance plans
(HMOs, PPOs, IPAs), government health care programs (Medicare and
Medicaid), variations in medical practice, medical malpractice, competition
versus regulation, and national health care reform.

The history of economic which is grounded in philosophy, studies the development of economic ideas
thought, and theories over time, from Adam Smith in the eighteenth century to the
works of economists such as Thomas Malthus, Karl Marx, and John
Maynard Keynes. Because economic theory is constantly developing and
changing, studying the history of ideas helps give meaning to modern theory
and puts it in perspective.

Continued.
..
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 The Diverse Fields of Economics
TABLE 1.2 The Fields of Economics (continued)
Industrial organization looks carefully at the structure and performance of industries and firms
within an economy. How do businesses compete? Who gains and who
loses?
International economics studies trade flows among countries and international financial institutions.
What are the advantages and disadvantages for a country that allows its
citizens to buy and sell freely in world markets? Why is the dollar strong or
weak?
Labor economics deals with the factors that determine wage rates, employment, and
unemployment. How do people decide whether to work, how much to work,
and at what kind of job? How have the roles of unions and management
changed in recent years?
Law and economics analyzes the economic function of legal rules and institutions. How does the
law change the behavior of individuals and businesses? Do different liability
rules make accidents and injuries more or less likely? What are the
economic costs of crime?
Public economics examines the role of government in the economy. What are the economic
functions of government, and what should they be? How should the
government finance the services that it provides? What kinds of government
programs should confront the problems of poverty, unemployment, and
pollution? What problems does government involvement create?
Urban and regional studies the spatial arrangement of economic activity. Why do we have
economics cities? Why are manufacturing firms locating farther and farther from the
center of urban areas?
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 The Method of Economics

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.

normative economics An approach to economics that analyzes outcomes

of economic behavior, evaluates them as good or bad, and may prescribe
courses of action. Also called policy economics.

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 Theories and Models

model A formal statement of a theory, usually a mathematical statement of a

presumed relationship between two or more variables.

variable A measure that can change from time to time or from observation to
observation.

Ockham’s razor The principle that irrelevant detail should be cut away.

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 All Else Equal: Ceteris Paribus

ceteris paribus, or all else equal A device used to analyze the relationship
between two variables while the values of other variables are held
unchanged.

Using the device of ceteris paribus is one part of the process of abstraction.
In formulating economic theory, the concept helps us simplify reality to focus
on the relationships that interest us.

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 Expressing Models in Words, Graphs, and Equations

We use both graphs and equations to capture the quantitative side of our
economic observations and predictions.

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 Cautions and Pitfalls

What Is Really Causal?

post hoc, ergo propter hoc Literally, “after this (in time), therefore because
of this.”

A common error made in thinking about causation: If Event A happens before

Event B, it is not necessarily true that A caused B.

The Fallacy of Composition

fallacy of composition The erroneous belief that what is true for a part is
necessarily true for the whole.

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 Testing Theories and Models: Empirical Economics

empirical economics The collection and use of data to test economic

theories.

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 ECONOMICS IN PRACTICE

Does Your Roommate Matter for Your Grades?

If you choose mischievous friends and you misbehave, are your friends causing
your misbehavior or does an inclination toward mischief cause your choice of
friends?
Several recent economics studies of the effect of roommates on college grades
help to sort out causality in peer effects.
Bruce Sacerdote, a professor at Dartmouth college—one of many schools that
randomly assign roommates to freshmen—used data on freshmen academic
and social performance, combined with their background data, to test the peer
effects from different types of roommates.
He found strong roommate effects on grade point average, effort in school, and
fraternity membership.

THINKING PRACTICALLY
THINKING PRACTICALLY
1.Would you expect college seniors who choose their own roommates to have more or
1.Would you expect college seniors who choose their own roommates to have more or
less similar grades than college freshmen who are assigned as roommates?
less similar grades than college freshmen who are assigned as roommates?
Why or why not?
Why or why not?

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 Economic Policy

Four criteria in judging economic outcomes:

1.Efficiency

2.Equity

3.Growth

4. Stability

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 Efficiency

efficiency In economics, allocative efficiency. An efficient economy is one that

produces what people want at the least possible cost.

Equity

equity Fairness.

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 Growth

economic growth An increase in the total output of an economy.

Stability

stability A condition in which national output is growing steadily, with low

inflation and full employment of resources.

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 An Invitation

You cannot begin to understand how a society functions without knowing

something about its economic history and its economic system.

Learning to think in this very powerful way will help you better understand
the world.

As you proceed, it is important that you keep track of what you have
learned in earlier chapters. This book has a plan; it proceeds step-by-step,
each section building on the last. Make sure you understand where it all fits
in the big picture.

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 REVIEW TERMS AND CONCEPTS

ceteris paribus, or all else equal microeconomics

economic growth model
economics normative economics
efficiency Ockham’s razor
efficient market opportunity cost
empirical economics positive economics
equity post hoc, ergo propter hoc
fallacy of composition scarce
Industrial Revolution stability
macroeconomics variable
marginalism

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 CHAPTER 1 APPENDIX

How to Read and Understand Graphs

A graph is a two-dimensional representation of a set of numbers, or data.

Time Series Graphs

A time series graph shows how a single measure or variable changes over
time.

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 TABLE 1A.1 Total Disposable Personal  FIGURE 1A.1 Total Disposable Personal Income in the
Income in the United States, 1975–2012 United States: 1975–2012 (in billions of dollars)
(in billions of dollars)
Total Total
Disposable Disposable
Personal Personal
Year Income Year Income
1975 1,187.3 1994 5,184.3
1976 1,302.3 1995 5,457.0
1977 1,435.0 1996 5,759.6
1978 1,607.3 1997 6,074.6
1979 1,790.8 1998 6,498.9
1980 2,002.7 1999 6,803.3
1981 2,237.1 2000 7,327.2
1982 2,412.7 2001 7,648.5
1983 2,599.8 2002 8,009.7
1984 2,891.5 2003 8,377.8
1985 3,079.3 2004 8,889.4
1986 3,258.8 2005 9,277.3
1987 3,435.3 2006 9,915.7
1988 3,726.3 2007 10,423.6
1989 3,991.4 2008 11,024.5
1990 4,254.0 2009 10,772.4
1991 4,444.9 2010 11,127.1
1992 4,736.7 2011 11,549.3
1993 4,921.6 2012 11,930.6

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 Graphing Two Variables

X-axis The horizontal line against which a variable is plotted.

Y-axis The vertical line against which a variable is plotted.

origin The point at which the horizontal and vertical axes intersect.

Y-intercept The point at which a graph intersects the Y-axis.

X-intercept The point at which a graph intersects the X-axis.

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 Plotting Income and Consumption Data for Households

TABLE 1A.2 Consumption Expenditures

and Income, 2008
Average Average
Income Consumption
Before Taxes Expenditures
Bottom fifth $ 10,263 $ 22,304
2nd fifth 27,442 31,751
3rd fifth 47,196 42,659
4th fifth 74,090 58,632
Top fifth 158,652 97,003

 FIGURE 1A.2 Household Consumption and Income

A graph is a simple two-dimensional geometric representation of data.
This graph displays the data from Table 1A.2.
Along the horizontal scale (X-axis), we measure household income.
Along the vertical scale (Y-axis), we measure household consumption.
Note: At point A, consumption equals $22,304 and income equals $10,263.
At point B, consumption equals $31,751 and income equals $27,442.

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 positive relationship A relationship between two variables, X and Y, in which
a decrease in X is associated with a decrease in Y, and an increase in X is
associated with an increase in Y.

negative relationship A relationship between two variables, X and Y, in which

a decrease in X is associated with an increase in Y and an increase in X is
associated with a decrease in Y.

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 Slope

slope A measurement that indicates whether the relationship between

variables is positive or negative and how much of a response there is in Y
(the variable on the vertical axis) when X (the variable on the horizontal axis)
changes.

Y Y2  Y1

X X 2  X 1

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  FIGURE 1A.3 A Curve with (a) Positive Slope and (b) Negative Slope

A positive slope indicates that A negative slope

increases in X are associated indicates the opposite—
with increases in Y and that when X increases, Y
decreases in X are associated decreases; and when X
with decreases in Y. decreases, Y increases.

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  FIGURE 1A.4 Changing Slopes Along Curves

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 Some Precautions

TABLE 1A.3 Aggregate National Income

and Consumption for the
United States, 1930–2012
(in billions of dollars)
Aggregate Aggregate
National Income Consumption
1930 82.9 70.1
1940 90.9 71.3
1950 263.9 192.2
1960 473.9 331.8
1970 929.5 648.3
1980 2433.0 1,755.8
1990 5059.8 3,835.5
2000 8938.9 6,830.4
2005 11,273.8 8,803.5
2006 12,031.2 9,301.0
2007 12,396.4 9,772.3
2008 12,609.1 10,035.5
2009 12,132.6 9,845.9
2010 12,811.4 10,215.7
2011 13,358.9 10,729.0
2012 13,720.9 11,119.5

 FIGURE 1A.5 National Income and Consumption

It is important to think carefully about what is represented by points in the space defined by the axes of a graph.
In this graph, we have graphed income with consumption, as in Figure 1A.2, but here each observation point is
national income and aggregate consumption in different years, measured in billions of dollars.
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 APPENDIX REVIEW TERMS AND CONCEPTS

graph time series graph

negative relationship X-axis

origin X-intercept

positive relationship Y-axis

slope Y-intercept

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