Economics

Module 1: Economic Thinking

Understanding Economics and Scarcity

 Scarcity means that there are never enough resources to satisfy all human wants.
Every society, at every level, must make choices about how to use its resources.
 Economics is the study of the trade-offs and choices that we make, given the fact of scarcity.
 Opportunity cost is what we give up when we choose one thing over another.

Goods and Resources

 Economic Goods: goods or services a consumer must pay to obtain; also called scarce
goods.
 Free Goods: goods or services that a consumer can obtain for free because they are abundant
relative to the demand.
 Productive Resources: the inputs used in the production of goods and services to make a
profit: land, economic capital, labor, and entrepreneurship; also called “factors of
production”

Productive Resources

Four productive resources also called factors of production:

 Land: any natural resource, including actual land, but also trees, plants, livestock, wind, sun,
water, etc.
 Economic capital: anything that’s manufactured in order to be used in the production of goods
and services. Note the distinction between financial capital (which is not productive) and
economic capital (which is). While money isn’t directly productive, the tools and machinery
that it buys can be.
 Labor: any human service—physical or intellectual. Also referred to as human capital.
 Entrepreneurship: the ability of someone (an entrepreneur) to recognize a profit opportunity,
organize the other factors of production, and accept risk.

Concept of Opportunity Cost

Opportunity Cost: the value of the next best alternative.

 Individual Decisions: In some cases, recognizing the opportunity cost can alter personal
behavior.
 Societal Decisions: Opportunity cost comes into play with societal decisions. Universal health
care would be nice, but the opportunity cost of such a decision would be less housing,

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 environmental protection, or national defense. These trade-offs also arise with government
policies.

Labor, Markets, and Trade

The Division and Specialization of Labor

 Division of labor: the way in which the work required to produce a good or service is divided
into tasks performed by different workers.
 Specialization: when workers or firms focus on particular tasks for which they are well suited
within the overall production process.

Why the Division of Labor Increases Production?

Economies of scale: when the average cost of producing each individual unit declines as total output
increases.

Trade and Markets

 Specialization only makes sense if workers (and other economic agents such as businesses and
nations) can use their income to purchase the other goods and services they need.
 Specialization requires trade.
 The market allows you to learn a specialized set of skills and then use the pay you receive to buy
the goods and services you need or want.
 This is how our modern society has evolved into a strong economy.

Microeconomics and Macroeconomics

Micro vs. Macro

 Macroeconomics: the branch of economics that focuses on broad issues such as growth,
unemployment, inflation, and trade balance.
 Microeconomics: the branch of economics that focuses on actions of particular agents within
the economy, like households, workers, and businesses. We learn about the theory of consumer
behavior and the theory of the firm.

Understanding Microeconomics

Questions to Ask with Microeconomics (Consumer).

 What determines how households and individuals spend their budgets?

 What combination of goods and services will best fit their needs and wants, given the budget
they have to spend?
 How do people decide whether to work, and if so, whether to work full time or part time?
 How do people decide how much to save for the future, or whether they should borrow to
spend beyond their current means?

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 Questions to Ask with Microeconomics(firm).

 What determines the products, and how many of each, a firm will produce and sell?
 What determines what prices a firm will charge?
 What determines how a firm will produce its products?
 What determines how many workers it will hire?
 How will a firm finance its business?
 When will a firm decide to expand, downsize, or even close?

Understanding Macroeconomics

Macroeconomics: Macroeconomic policy pursues its goals through monetary policy and fiscal
policy.

Monetary Policy: policy that involves altering the level of interest rates, the availability of credit
in the economy, and the extent of borrowing
Fiscal Policy: economic policies that involve government spending and
using economic models

Economic Model: a simplified version of reality that allows us to observe, understand, and
make predictions about economic behavior.

Economic Models and Math

Economic models can be represented using words or using mathematics.

Algebra and graphs are utilized to explain economic models.

Using Economic Models: Examples

Circular Flow Diagram: a diagram

indicating that the economy consists of
households and firms interacting in a
goods-and-services market and a labor
market.
goods-and-services market (also called
the product market), in which firms sell
and households buy.
labor market, in which households sell
labor to business firms or other
employees.

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Note: Economists don’t figure out the solution to a problem and then draw
the graph. Instead, they use the graph to help them discover the answer
real world, there are many different markets for goods and services and markets for many different
types of labor. The circular flow diagram simplifies these distinctions in order to make the
picture easier to grasp.

Purpose of Functions

 Function: a relationship or expression involving one or more variables.

 In economics, functions frequently describe cause and effect.
 The variable on the left-hand side is what is being explained (“the effect”).
 On the right-hand side is what’s doing the explaining (“the causes”).
 Economic models tend to express relationships using economic variables, such as:
 Budget = money spent on econ books + money spent on music

Solving Simple Equations

Order of Operations
When you solve an equation it’s important to do each operation in the following order:
 Simplify inside parentheses and brackets.
 Simplify the exponent.
 Multiply and divide from left to right.
 Add and subtract from left to right.
Lines
 In this course the most common equation you will see is for a line in graphs: y = b+mx

Understanding Variables
 Variable: a quantity that can assume a range of values represented by a letter or a symbol.
 For example: y=9+3x
Working with Variables
 When you’re trying to solve an equation with one or more variables, you need to isolate the
variable.
 What does x equal if y=12?

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Creating and Interpreting Graphs

 intercept: the point on a graph where a line crosses the

vertical axis or horizontal axis.
 slope: the change in the vertical axis divided by the change in
the horizontal axis.
 variable: a quantity that can assume a range of values.
 x-axis: the horizontal line on a graph, commonly represents
quantity (q) on graphs in economics.
 y-axis: the vertical line on a graph, commonly represents
price (p) on graphs in economics.
Equation for a Line: y = mx + b
 In any equation for a line, m is the slope and b is the y-
intercept.
Interpreting Graphs in Economics
 It is rare for real-world data points to arrange themselves as a perfectly straight line.
 It often turns out that a straight line can offer a reasonable approximation of actual data.

Interpreting Slope

1-positive Slope

What the Slope Means: the change in the

vertical axis divided by the change in the
horizontal axis.
 Positive slope indicates that two variables
are positively related; when one variable
increases, so does the other, and when one
variable decreases, the other also decreases.

2- Negative Slope:
What the Slope Means: the change in the vertical
axis divided by the change in the horizontal axis.
 negative slope indicates that two variables
are negatively related; when one variable increases,
the other decreases, and when one variable
decreases, the other increases.

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 3- Slope of Zero:

What the Slope Means: the change in the vertical axis

divided by the change in the horizontal axis.

 Slope of zero indicates that there is a constant

relationship between two variables: when one variable
changes, the other does not change.

Interpreting Slope: Calculating Slope:

Calculating Slope 1
 The slope of a straight line between two points
can be calculated in numerical terms.
 To calculate slope, begin by designating one
point as the “starting point” and the other point as the
“end point” and then calculating the rise over run
between these two points.

Calculating Slope 2
 Graphs of economic relationships are not
always straight lines but often nonlinear (curved) lines.
 Can interpret nonlinear relationships similarly
to the way we interpret linear relationships.
 Their slopes can be positive or negative. We
can calculate the slopes similarly also, looking at the
rise over the run of a segment of a curve.

Interpreting Slope: Nonlinear Relationships

Nonlinear relationships can be interpreted similar to

linear relationships.
 Their slopes can be positive (as in Figure 5) or
negative.
 We can calculate the slopes similarly also, looking at
the rise over the run of a segment of a curve.
 A higher positive slope means a steeper upward tilt to the curve, which you can see at higher
output levels.
 A negative slope that is larger in absolute value (that is, more negative) means a steeper
downward tilt to the line.
 Interpreting Slope: Nonlinear Relationships (cont.)

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Nonlinear relationships can be interpreted similar to
linear relationships.
 A slope of zero is a horizontal line.
 A vertical line has an infinite slope.
 If a line has a larger intercept, graphically, it would
shift out (or up) from the old origin, parallel to the
old line.
 If a line has a smaller intercept, it would shift in (or
down), parallel to the old line.

Types of Graphs

1-Line

Line Graphs: show a relationship between

two variables: one measured on the
horizontal axis and the other measured on
the vertical axis.
 Sometimes it’s useful to show more
than one set of data on the same axes.
 The data in the table, below, is
displayed in Figure 1, which shows
the relationship between two
variables: length and median weight
for American baby boys and girls
during the first three years of life.

Line Graphs:
 The line graph measures length in
inches on the horizontal axis and weight in
pounds on the vertical axis. For example,
point A on the figure shows that a boy who is
28 inches long will have a median weight of
about 19 pounds.
 One line on the graph shows the
length-weight relationship for boys, and the
other line shows the relationship for girls.
 This kind of graph is widely used by
health-care providers to check whether a
child’s physical development is roughly on
track.

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 2- Pie

Pie Graphs: (sometimes called

a pie chart) is used to show how
an overall total is divided into
parts. A circle represents a group
as a whole. The slices of this
circular “pie” show the relative
sizes of subgroups.
 These pie graphs show how
the U.S. population was
divided among children,
working-age adults, and the
elderly in 1970, 2000, and
what is projected for 2030.
 In a pie graph, each slice of
the pie represents a share of
the total, or a percentage.
For example, 50% would be
half of the pie and 20%
would be one-fifth of the
pie.
 Types of Graphs: Pie (cont.)

Pie Graphs:
 The three pie graphs show that the share of
the U.S. population 65 and over is growing.
 The pie graphs allow you to get a feel for the
relative size of the different age groups from 1970 to
2000 to 2030, without requiring you to slog through
the specific numbers and percentages in the table.
 Some common examples of how pie graphs
are used include dividing the population into groups
by age, income level, ethnicity, religion, occupation;
dividing different firms into categories by size,
industry, number of employees; and dividing up
government spending or taxes into its main
categories.

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 3- Bar

Bar Graphs: uses the height of

different bars to compare
quantities.
 Bar graphs can be
subdivided in a way that
reveals information
similar to that we can get
from pie charts.
 It is sometimes easier for
a reader to run his or her
eyes across several bar
graphs, comparing the
shaded areas, rather than
trying to compare several
pie graphs.
 Types of Graphs: Bar
(cont.)

Bar Graphs: uses the height of

different bars to compare quantities.
 The three bar graphs are
based on the information from the
chart about the U.S. age distribution
in 1970, 2000, and 2030.
 Graph (a) shows three bars
for each year, representing the total
number of persons in each age
bracket for each year.
 Graph (b) shows just one bar
for each year, but the different age
groups are now shaded inside the
bar.
 Graph(c), still based on the
same data, the vertical axis measures
percentages rather than the number
of persons.

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 Types of Graphs: Comparison

How do you know which graph to use for your data?

 Bar graphs are especially useful when comparing quantities.

 For example, if you are studying the populations of different countries, bar graphs can
show the relationships between the population sizes of multiple countries.
 Not only can it show these relationships, but it can also show breakdowns of different
groups within the population
 Pie graphs are often better than line graphs at showing how an overall group is divided.
 However, if a pie graph has too many slices, it can become difficult to interpret.
 Line graphs are often
the most effective
format for illustrating
a relationship
between two
variables that are both
changing.
 For example,
time-series
graphs can
show patterns
as time
changes, like
the

unemployment rate over time.

 Line graphs are widely used in economics to present continuous data about prices,
wages, quantities bought and sold, the size of the economy.

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 Quick Review

 What if scarcity? Explain its economic impact.

 What are productive resources?
 What is opportunity cost and its importance in decision-making?
 Why do trade and markets exist?
 What is the difference between macroeconomics and microeconomics?
 Why are economics models useful to economists?
 What are common economic models?
 How are equations and functions used to describe relationships? What are the cause and effects?
 What proper order of operations is used while solving simple equations with variables?
 How does a graph shows the relationship between two variables?
 How do you differentiate between a positive relationship and a negative relationship?
 How do you interpret economic information on a graph?

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