Chapter 1 Introducing the Economic Way of Thinking

• Scarcity (Resource scarcity): There are limited amounts of resources

o This does not mean people have small amounts of resources.
o Even for people who have abundant resources, they still face the scarcity problem.
o The condition in which human wants are forever greater than the available supply
of time, goods, and resources.
• Economics is the study of how to use the available resources efficiently in response to the
problem of scarcity.
o Efficiency is always the priority
o Equity is also important, but efficiency is usually more important.

• Resources:
o A Consumer’s Perspective:
▪ Allowance
▪ Salary
▪ Loans
▪ Credit Card
▪ Scholarship
▪ Network
o A Producer’s Perspective:
▪ Labor
• The mental and physical capacity of workers to produce goods and
services.
▪ Capital (K)
• Physical K:
o The physical plants, machinery, and equipment used to
produce other goods. Capital goods are human made goods
that do not directly satisfy human wants
▪ Factories
▪ Office Buildings
▪ Warehouses
▪ Robots + AI
▪ Trucks
• Financial K:
o Money
o Stocks
o Bonds
• Human K (not capital):
o Knowledge
▪ Land:
• Any natural resource provided by nature used to produce goods
and services
• Renewable Resources
• Nonrenewable Resources

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• Microeconomics is the branch of economics that studies decision making by a single
individual, household, firm, industry, or level of government.
• Macroeconomics is the branch of economics that studies decision making for the
economy as a whole.

• Methodology of Economics:
o Problem Identification
▪ Need to Ask the right questions.
▪ Why? As well as what?
o Develop a Model
o Gather Data and Test the Theory (or Hypothesis)
▪ If other people can get the same results, then the model is valid
• Model:
o A simplified version of reality, such as a map of interstate
highways.
▪ The right version or the right slice of reality
▪ Focuses on two or three variables and explore their
relationships
▪ All the other things remain constant, fixed or
unchanged as parameters
▪ When parameters change, it is called comparative
statics
o Formulate a Conclusion
• Ceteris Paribus:
o A Latin phrase means while certain variables change, “All other things remain
unchanged.”
o We make assumptions to simply reality.
▪ Examples:
• We simplify things all the time by making assumptions
• V= l × w × h
o Assuming it is a cube
o Assuming it has straight lines and 90 degrees at each corner
• m1 × m2
G = g × --------------
r2
o Assuming that there are only two objects
o Assuming there is no air resistance

• Different relationship between variables:

o Be careful with your assumptions
o What is the relationship between variables and parameters?
• Correlation:
o Association
▪ Sometimes, it occurs by chance and eventually disappears
▪ Sometimes, there are association (statistical) relationship that will not
disappear over time

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 ▪ The ages of two students, X and Y.
▪ X and Y increase in the same direction and at the same speed
▪ Does the aging of one student cause the aging of another student?
▪ There is no causation relationship between these variables
▪ An association relationship
• Causation:
o There is a causal or cause-and-effect relationship between variables
▪ Example:
• What is the relationship between GPA and IQ?
• Do they have a causation relationship?
• Is IQ a variable?
• GPA = f(efforts | IQ) = (IQ) x (Efforts)½
• Score is zero if efforts = 0
• Online assignments

• Efficiency vs Equity
o Efficiency – A situation where society is “doing the best it can” with existing
recourses and technology
o Equity – Fairness in the way production is distributed among members of society,
but how fair is fair?
o Efficiency is concerned with maximizing the size of the economic pie.
o Equity is concerned with how the pie is divided.
o There can be a tradeoff between efficiency and equity.
o How should two people share a pizza in a fair way?
o It is much more complicated for a market or country.

• Positive Economics Statements:

o Statement based on facts
▪ Description of what is
▪ Objective
• Can be easily tested
• Normative Economics Statement:
o Statement based on the facts and opinions (value judgment)
▪ Opinions (or prescription)
• What should be done what shouldn’t be done

▪ Subjective
▪ Cannot be easily tested
▪ Value judgment keywords
• Should or shouldn’t
• Good or bad
• Better or worse
• Fair or unfair

• Example:

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 o Trump administration distributed checks to people during the pandemic in 2020.
▪ This is a positive economic statement
▪ How do we turn this into a normative economic statement?
o It is good (or bad) that Trump administration distributed checks to people during
the pandemic in 2020.
▪ This is a normative economic statement
o How about “Trump administration did not distribute checks to people during the
pandemic in 2020”?
▪ This is a false but positive statement as there is no value judgement.
Another Example
• The US unemployment rate today is about 6.7% - A positive but wrong statement.
• The US unemployment rate today is about 2% - A positive but wrong statement.
• The US unemployment rate today is about 3.7% - A positive and correct answer.
• The US unemployment rate today should be about 2.5% - A normative statement.

• Three Fundamental Economic Questions

o What to produce?
o How to produce?
o For whom to produce?