Transcript CH. 2 NOTES - DUKES ECONOMICS

What Do
Chapter 2
Observing and
Economists
Do?
Explaining the
Economy
What Do Economists Do?
Economists try to answer questions such as:
• Why is college tuition so high?
• Why are there so many different types of
toothpaste?
• Why is the price of gasoline more than $3 a
gallon?
• Why has health-care spending increased
faster than the rest of the U.S. economy?
What Do Economists Do?
• Why is the average income of people in the
United States 35 times higher than that of
people in China?
• Why is unemployment higher in Europe than in
the United States?
• Why have the wages of college graduates
increased much more rapidly than the wages of
non-graduates?
What Do Economists Do?
 Understanding Gasoline Prices in the United
States
 Observation: The price of gasoline has risen sharply
in the past five years compared to the previous
decade.
Figure 1: Retail Price of Gasoline
in the United States, 1991–2006
What Do Economists Do?
Relative Price of Gasoline: the price of gasoline
compared to the average price of all other goods
and services in the economy.
Relative price
of gasoline
=
Price of Gasoline
_____________________________________
Average Price of All Other Goods and Services
Figure 2: Relative Price of Gasoline
Explaining an Economic Event
Economic Variable: any economic measure that
can vary over a range of values.
Economic Variables: Examples
a) GDP
b) Health-care spending
c) Health-care spending share of GDP
d) Relative price of health care
Explaining an Economic Event
Positive Correlation: occurs when two variables
move in the same direction; when one goes up,
the other goes up.
Negative Correlation: occurs when two variables
move in different directions; when one goes up,
the other goes down.
Figure 4: Price of Gasoline
versus Price of Crude Oil
Explaining an Economic Event
Correlation versus Causation
Correlation: means that one event is usually
observed to occur along with another.
Causation: means that one event brings about
another event.
Note: Correlation does not imply causation.
Explaining an Economic Event
Controlled Experiments: empirical tests of
theories in a controlled setting in which particular
effects can be isolated.
Experimental Economics: a branch of economics
that uses laboratory experiments to analyze
economic behavior.
Economic Models
Economic Model: an explanation of how the
economy or part of the economy works; an
abstraction or simplification of the real world.
Economic Models
Microeconomics: the branch of economics that
examines individual decision-making at firms and
households and the way they interact in specific
industries and markets.
Macroeconomics: the branch of economics that
examines the workings and problems of the
economy as a whole; focuses on variables such as
GDP growth and unemployment.
Economic Models
Positively Related: a situation in which an increase
in one variable is associated with an increase in
another variable (also called directly related).
Negatively Related: a situation in which an
increase in one variable is associated with a
decrease in another variable (also called inversely
related).
Economic Models: An Example
A Model with Two Variables:
Figure 6 illustrates four different ways to model the
economic relationship between the number of
doctors employed at an HMO and the number of
physical examinations given.
The four ways are: (1) with words; (2) with a
numerical value; (3) with a graph; and (4) with
algebra or an equation.
Figure 7:
Economic
Models in
Four Ways
The Ceteris Paribus Assumption
Ceteris Paribus: “all other things equal”; refers to
holding all other variables constant or keeping all
other things the same when one variable is
changed.
Recommending Appropriate Policies
• Capitalism: an economic system in which
capital is individually owned and production and
employment decisions are decentralized.
• Socialism: an economic system in which the
government owns and controls all the capital
and makes decisions about prices and
quantities.
• Mixed Economy: a market economy in which
the government plays a very large role.
Positive versus Normative Economics
Positive Economics: economic analysis that
explains what happens in the economy and why,
without making recommendations about economic
policy.
Examples of the scope of positive economics:
a) Explaining why health-care spending slowed
down in the mid-1990s
b) Explaining why gasoline prices went up
sharply in 2005
Positive versus Normative Economics
Normative Economics: economic analysis that
makes recommendations about economic policy;
aims to develop and recommend policies about
what the government should do.
Examples of the scope of normative economics:
a) Recommending policies that will prevent the
rise of health-care expenditures in the future
b) Recommending that the government
increase tax rates to prevent a budget deficit
Positive versus Normative Economics
Council of Economic Advisers: a three-member
group of economists appointed by the president of
the United States to analyze the economy and
make recommendations about economic policy.
Conclusion
• Three important points to remember as we
study more economic models:
1. Economics requires a mixture of verbal and
quantitative skills.
2. Economics is a wide-ranging discipline; it is more
than just about the stock market.
3. The study of economics is an intellectually
fascinating adventure.
Key Terms
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relative price
economic variable
controlled experiments
experimental
economics
economic model
microeconomics
macroeconomics
gross domestic product
(GDP)
positively related
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negatively related
ceteris paribus
capitalism
socialism
mixed economy
positive economics
normative economics
Council of Economic
Advisers