Chapter 1: What is Economics?

CHAPTER OBJECTIVES:
● Definition of Economics
● Two Big Economic Questions
● The Economic Way of Thinking
● Economics in The News
● Graphs In Economics
● Mathematical Note

DEFINITION OF ECONOMICS:

● ALL ECONOMIC QUESTIONS ARE BASED UPON THE THEORY OF SCARCITY

● All economic questions arise because we want more than we can get
○ Limited resources vs Unlimited Wants (The main theory of Economics)
● Scarcity:
○ The fact that there is a limited amount of resources to satisfy unlimited wants
■ Because we face scarcity we must make Choices:
● The choices we make depends on the incentives we face
● Incentives:
○ A reward that encourages an action or a penalty that discourages that action

● Economics:
○ The social science that studies the choices that individuals, businesses,
governments, and entire societies make as they cope with scarcity and the
incentives that influence and reconcile those choices

○ Microeconomics:
■ The study of the choices that individuals and businesses make, the way
those choices interact in markets and the influence of governments
■ How to allocate scarce resources
■ Example:
● Why are people buying more ebooks and fewer hard copy books?
○ Macroeconomics:
■ The study of the performance of the national and global economies
■ Example:
● Why does the unemployment rate in Canada fluctuate?

○ Examples of Economic Models:

 ■ The use of simple equations, lines and charts to break down complex
real-world problems (Simplifying Assumptions)
● Production Possibility Frontier:
○ It assumes that you are only trading off between two things
and that everything else is equal (Ceteris Paribus)
● Price Equilibrium:
○ Supply and demand

TWO BIG ECONOMIC QUESTIONS:

● There are two big questions that summarize the scope of economics:
○ 1) How do the choices end up determining what, how and or whom goods and
services are produced?
○ 2) Do choices made in the pursuit of self-interest also promote social interest?

● Question 1) What, How and For Whom?:

○ Goods and Services:
■ The objects that people value and produce to satisfy human wants

○ What?:
■ In Canada, Agriculture (2%), Manufactured Goods (28%), Services (70%)
of total production
■ In Ethiopia, Agriculture (35%), Manufactured Goods (28%), Services
(44%) of total production
● What determines these patterns of production?
● How do choices end up determining the quantity of each item
produced in Canada and around the world?
○ How?
■ Factors of Production:
● The resources used to produce goods and services
● Grouped into Four Categories:
○ 1) Land:
■ The natural resources that we use to produce goods
and services
○ 2) Labour:
■ The work times and work effort that people devote
to producing goods and services
■ Includes the physical and mental efforts of all the
people who work
■ Human Capital:
 ● The knowledge, skills, training, education
and expertise the people obtain
○ 3) Capital:
■ The tools, instruments, machines, buildings and
other constructions that businesses use to produce
goods and services
○ 4) Entreprenuership:
■ The human resource that organizes labour, land and
capital
■ Drivers of economic progress
■ Develop new ideas about what and how to produce,
make business decisions and bear the risks that arise
from these decisions
● What determines how the factors of production are used to produce
each good and service

○ For Whom?:
■ Who consumes the goods and services that are produced depends on the
incomes that people earn:
● Land earns Rent
● Labour earns Wages
● Capital earns Interest
● Entrepreneurship earns Profit
■ Labour earns the most income
● Wages are about 70% of the total income

● Question 2) Do Choices Made in the Pursuit of Self-Interest Also Promote Social

Interest?
○ Everyday, 35.4 million Canadians and 7.2 billion people in other countries make
economic choices that result in What, How and For Whom goods and services are
produced
■ Do we produce the right things in the right quantities?
■ Do we use our factors of production in the best way?
■ Do the goods and services go to those who benefit most of them?
○ Self-Interest:
■ You make a choice that is in your Self-Interest: Choices that you think are
best for you
○ Social Interest:
■ Choices that are best for society as a whole
■ Social Interest has 2 dimensions:
 ● Efficiency and Social Interest:
○ Resource use is efficient if it is not possible to make
someone better off without making someone else worse off
○ Equity is fairness, where it is possible to make someone
better off without making anyone worse off
● Fair Shares and Social Interest:
○ The idea that social interest requires “fair shares” is a
deeply held on
○ But what is fair?
○ Four topics that generate discussion and that illustrate tension between
self-interest and social interest are:
■ Globalization:
● The expansion of international trade, borrowing and lending and
investment
● Is in the self-interest of consumers who buy low-cost imported
goods and services and in the self-interest of the multinational
firms that produce in low-cost regions and sell in high-price
regions
■ Information-Age Monopolies:
● Information Revolution:
○ The technological change of the past 40 years
○ The information revolution has clearly served your
self-interest: It has provided your smartphone, laptop, loads
of handy application and the Internet
○ It has also served in the self-interest of Bill Gates of
Microsoft and Gordon Moore of Interl, both of whom have
seen their wealth soar
■ Climate Change:
● Climate change is a political issue today
● Every political leader is acutely aware of the problem and the
popularity of having proposals that might lower carbon emissions
● Burning fossil fuels to generate electricity and to power airplanes,
automobiles and trucks pours a staggering 28 billion tonnes-4
tonnes per person- of carbon dioxide into the atmosphere each year
● ⅔ of the world’s carbon emissions comes from the United States,
China, the EU, Russia and India
● The fastest growing emissions are coming from India and China
● The amount of global warming caused by economic activity and its
effects are uncertain, but the emissions continue to grow and pose
huge risks
 ● Every day when you make self-interested choices to use electricity
and gasoline, you contribute to carbon emissions
● You leave your carbon footprint
● You can lessen your carbon footprint by walking, riding a bike ,
taking a cold shower or planting a tree
●
■ Economic Instability:
● In 2008, U.S. banks were in trouble
○ They had made loans that borrowers couldn’t repay and
they were holding securities the values of which had
crashed
○ Banks’ choices to take deposits and make loans are made in
self-interest, but does this lending and borrowing serve the
social interest?
○ Do banks lend too much in the pursuit of profit?

THE ECONOMIC WAY OF THINKING:

● Six key ideas define the economic way of thinking:

○ 1) A choice is a tradeoff:
■ Because we face scarcity, we must make choices, and when we make a
choice, we select from the available alternatives
■ Think about every choice as a Tradeoff:
● An exchange- giving up one thing to get something else
■ For example:
● On Saturday night, will you study or go out?
○ You can’t study or have fun at the same time, so you must
make a choice
○ Whatever you choose, you could have chosen something
else
■ Your choice is a tradeoff

○ 2) People make rational choices by comparing benefits and costs:

■ Economists view the choices that people make as rational
■ Rational Choices:
● Compares costs and benefits and achieves the greatest benefit over
cost for the person making the choice
● Only the wants of a person making a choice are relevant to
determine its rationality
■ The idea of rational choice provides an answer to the first question:
 ● What goods and services will be produced and in what quantities?
○ The answer is: Those that people rationally choose to buy

○ 3) Benefit is what you gain from something:

■ Benefit:
● The gain or pleasure that something brings and it is determined by
preferences
■ Preferences:
● What a person likes and dislikes and the intensity of those feelings

○ 4) Cost is what you must give up to get something:

■ Opportunity Cost:
● WHAT YOU GAVE UP/WHAT YOU GAINED
● The highest-valued alternative that must be given up to get it
● For Example:
○ What is the opportunity cost of going to a concert:
■ The things you can’t afford to buy if you purchase a
concert ticket
■ The things you can’t do with your time if you go to
the concert

○ 5) Most choices are “how-much” choices made at the margin:

■ You can allocate the next hour between studying and instant messaging
your friends
■ The choice is not all or nothing, but you must decide how many minutes to
allocate to each activity
■ To make this decision, you compare the benefit of a little bit more study
time with its cost- you make your choice at the Margin
■ To make a choice at the margin, you evaluate the consequences of making
incremental changes in the use of your time
■ Marginal Benefit:
● The benefit from pursuing an incremental increase in an activity
■ Marginal Cost:
● The opportunity cost of pursuing an incremental increase in an
activity
■ If the marginal benefit from an incremental increase in an activity exceeds
its marginal cost, your rational choice is to do more of that activity

○ 6) Choices respond to incentives:

 ■ A change in marginal cost or a change in marginal benefit changes the
incentives that we face and leads us to change our choice
■ The central idea of economics is that we can predict how choices will
change by looking at changes in incentives
■ Incentives are also the key to reconciling self-interest and the social
interest

● Positive vs Normative Statements:

○ Positive Statements:
■ Not something that is necessarily true but is something that can be tested
○ Normative Statements:
■ One that is really a matter of opinion

ECONOMICS IN THE NEWS:

● The Internet For Everyone:
○ In 2013, Facebook founder Mark Zuckerburg created internet.org (bring internet
to the ⅔ of the population that don’t have it

○ The Economic Questions and Answers Of Internet.org:

■ Q1) What is the fundamental economic problem and how does this news
clip illustrate it?
● A1) The fundamental economic problem is scarcity: the fact that
wants exceed the resources available to satisfy them
○ The news clip illustrates scarcity because Mark
Zuckerberg’s want for everyone to get online exceeds the
resources available to satisfy it
■ Q2) What are some of the things that might be forgone for more people to
get online?
● A2) Some of the scarce resources that are used to produce
airplanes, war ships and Big Macs could be reallocated and used to
produce more computers and Internet service
■ Q3) Why don’t more people make the tradeoffs needed to get online?
● A3) People don’t make the tradeoffs needed to get online because
for them the marginal cost of doing so would exceed the marginal
benefit
■ Q4) Why might it be in Mark Zuckerberg’s self-interest to get everyone
online?
● A4) More people using the internet = increase in number of people
using Mark Zuckerburg’s services = More revenue and profits for
Mark Zuckerburg
■ Q5) Why might it not be in the social interest for everyone to get online?
● A5) It would not be in the social interest to get everyone online if
the marginal cost of an Internet connection exceeded its marginal
benefit