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The Nature and Method of Economics MR. CLARKE. HOLY CROSS CATHOLIC SECONDARY FEBRUARY 2012. The Nature of Economics “Want is a growing giant whom the coat of Have was never large enough to cover.” - Ralph Waldo Emerson, circa 1860. The Economic Perspective A viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions. We have Unlimited Wants... But a limited amount of resources, how to deal with this is the Economic Problem. There is no “Free Lunch” Because there are scarce inputs (labour, land, capital etc.), we must forgo something to gain something else... Opportunity Cost is the sacrifice that we make, or what we give up in order to gain something else. Every decision we make comes with an opportunity cost. Rational Behaviour Economists must assume that human beings are rational creatures, that they make self-interested choices in their ordering of actions. People have different preferences and preferences can change. Economists often strive to predict these changes... but are humans always rational? Marginal Analysis The comparison of marginal benefits and costs. Does the extra unit of cost outweigh the extra unit of benefit in making a purchase or engaging in an activity? The status quo is difficult as marginal decisions are always being made. Why would someone who is a light eater eat more at a buffet? The Scientific Method The systematic pursuit of knowledge through the formulation of a problem, collection of data, and the formulation of hypotheses. Economic laws and principles are statements about economic behaviour that enable prediction of the probable effects of certain actions. Hypothesis Theory Law / Principle Communism versus the “Law of Demand.” Does price change how consumers behave? Generalizations What is a generalization? Economic theories and laws are imprecise because no two individuals or institutions are exactly alike. We express our theories and laws as the tendencies of “typical or average” consumers, workers, or firms. Ceteris Paribus To arrive at an economic theory, we must assume “other-things being equal.” When examining how consumers will react to buying Coca-Cola when the price of Pepsi increases, we must assume “other things remain equal.” Like in other sciences, we must isolate variables to test theories. Applied Economics / Policy Economics The application of theories and date to formulate policies that aim to resolve economic problems or further goals. Reduce poverty, increase spending, reduce unemployment, raise taxes, generate wealth. www.bankofcanada.ca What are the generally accepted aims of economic policy? Economic Growth Balance of Trade Economic Security Full Employment Economic Goals Economic Efficiency Price Stability Equitable Income Distribution Economic Freedom Tradeoffs The sacrifice of some or all of one economic goal, good, or service to achieve some other goal, good, or service. Economists must assess tradeoffs to ascertain the best outcome for society. - Ex. Taxation helps with equitable income distribution but may reduce economic efficiency and economic freedom. Macroeconomics The branch of economics concerned with the economy as a whole, or aggregates. Aggregates are a collection of specific economic units treated as if they were one unit. Macro-economists aim to obtain an overview of the structure of the economy. Ex. Total output (GDP), total employment, inflation levels (CPI). Microeconomics The branch of economics concerned with such individual units as industries, firms, and households. Measure the price of a single product (Gold Watches), or the number of employees required at a single firm (Rolex). Macro deals with the beach as a whole, Micro deals with the sand, rocks, etc. Key Question Page 17 # 7 Microeconomics or Macroeconomics? Positive and Normative Economics Positive: The analysis of facts or data to establish scientific generalizations about economic behaviour. Positive economics focuses on facts and cause and effect relationships. It does not involve value judgements. It deals with what the economy is actually like. “Factual analysis.” Normative economics is the part of economics involving value judgements about what the economy SHOULD be like. Positive economics concerns what is, while normative embodies subjective feelings about what ought to be. Ex. Substantial tuition increases reduce enrolment (positive). Tuition should be subsidized to promote education (normative). Pitfalls to Objective Economics Biases Loaded Terminology Definitions Fallacy of Composition Causation Fallacies Bias and Loaded Terminology Most people already possess inherent bias with regards to money and economic issues. This effects their economic judgements. Economic writing often contains loaded terminology because writers often represent personal interests or groups. Ex. Suncor’s profits could be labelled “obscene,” “healthy,” “fat,” “stellar.” Definitions and Fallacy of Composition Economic definitions are often particular and must be understood in context. “Investment,” for instance, refers to buying real physical capital and assets, not stocks. www.tse.com Fallacy of Composition is incorrectly reasoning that what is true for the individual or part is necessarily true for the group or whole. Ex. A farmer who has a great crop sees his personal income increase, but incomes for farmers as a whole will not. Causation Fallacies Post-Hoc Fallacy: Incorrectly reasoning that when one event precedes another the first event must have caused the second event. - Christopher Columbus and the Solar Eclipse. Correlation versus Causation: Correlation between two events only indicates that the two are associated, not necessarily that one CAUSED the other. Ex. Education and income? Chapter Questions. Page 17 # 9 Page 17# 12 Internet Application Question # 1: Simply go to www.statscan.gc.ca and search for the inflation, real GDP, and unemployment rates to answer the question.