Econ 102 Ch. 1

nonlinear relationships

*slope is ZERO at point of maximum/ minimum* (nonlinear curve) slope varies along a nonlinear curve the slope of the line between any two points on this curve will be different from the slope of the line between any two other points. Each slope will be different as we move along the curve. Instead of using a line between two points to discuss slope, mathematicians and economists prefer to discuss the slope at a particular point. - The slope at a point on the curve, such as point B in the graph in Figure A-10, is the slope of a line tangent to that point. A tangent line is a straight line that touches a curve at only one point.

2 opposing sets of answers for the 3 fundamental questions of economic systems

1. centralized command and control 2. the price system

rules of thumb

A key behavioral implication of the bounded rationality assumption is that people should use so-called rules of thumb: Because every possible choice cannot be considered, an individual will tend to fall back on methods of making decisions that are simpler than trying to sort through every possibility. A problem confronting advocates of behavioral economics is that people who appear to use rules of thumb may in fact behave as if they are fully rational. ex. if a person faces persistently predictable ranges of choices for a while, the individual may rationally settle into repetitive behaviors that an outside observer might conclude to be consistent with a rule of thumb. According to the bounded rationality assumption, the person will continue to rely on a rule of thumb even if there is a major change in the environment that the individual faces. Time and time again, however, economists find that people respond to altered circumstances by fundamentally changing their behaviors. *The bulk of economic analysis continues to rely on the rationality assumption as the basis for constructing economic models*

understanding economics as a science

Economics is a social science that employs the same kinds of methods used in other sciences, such as biology, physics, and chemistry. Like these other sciences, economics uses models, or theories *Economic models, or theories*, are simplified representations of the real world that we use to help us understand, explain, and predict economic phenomena in the real world.

positive analysis

Economics uses positive analysis, *a value-free approach to inquiry*. No subjective or moral judgments enter into the analysis. Positive analysis relates to statements such as "If A, then B." For example, "If the price of gasoline goes up relative to all other prices, then the amount of it that people buy will fall." That is a positive economic statement. It is a statement of what is. It is not a statement of anyone's value judgment or subjective feelings. def. analysis that is strictly limited to making either purely descriptive statements or scientific predictions; for ex., "If A, then B." A statement of what is. (WITHOUT reference to feelings)

self- interest

Economists assume that individuals act as if they systematically pursue self-motivated interests and respond predictably to perceived opportunities to attain those interests. This central insight of economics was first clearly articulated by Adam Smith in 1776. (famous book - An Inquiry into the Nature and Causes of the Wealth of Nations)

Assumptions

Every model, or theory, must be based on a set of assumptions. Assumptions define the array of circumstances in which our model is most likely to be applicable ex. When some people predicted that sailing ships would fall off the edge of the earth, they used the assumption that the earth was flat. Columbus did not accept the implications of such a model because he did not accept its assumptions. He assumed that the world was round. The real-world test of his own model refuted the flat-earth model. Indirectly, then, it was a test of the assumption of the flat-earth model. Assumptions are a shorthand for reality

bounded rationality

Proponents of behavioral economics suggest that traditional economic models assume that people exhibit three "unrealistic" characteristics: 1. Unbounded selfishness. People are interested only in their own satisfaction. 2. Unbounded willpower. Their choices are always consistent with their long-term goals. 3. Unbounded rationality. They are able to consider every relevant choice. def. the hypothesis that people are nearly, but not fully, rational, so that they cannot examine every possible choice available to them but instead use *simple rules of thumb* to sort among the alternatives that happen to occur to them

defining self-interest

We assume that individuals seek many goals, not just increased wealth measured in monetary terms. Thus, the self-interest part of our economic-person assumption includes goals relating to prestige, friendship, love, power, helping others, creating works of art, and many other matters. We can also think in terms of enlightened self-interest, whereby individuals, in the pursuit of what makes them better off, also achieve the betterment of others around them In brief, individuals are assumed to want the ability to further their goals by making decisions about how items around them are used.

deciding on the usefulness of a model

We generally do not attempt to determine the usefulness, or "goodness," of a model merely by evaluating how realistic its assumptions are. Rather, we consider a model "good" if it yields usable predictions that are supported by real-world observations. In other words, can we use the model to predict what will happen in the world around us? Does the model provide useful implications about how things happen in our world? Once we have determined that the model may be useful in predicting real-world phenomena, the scientific approach to the analysis of the world around us requires that we consider evidence. (Evidence is used to test the usefulness of a model. This is why *we call economics an empirical science*)

number line

a line that can be divided into segments of equal length, each associated w/ a number 1. The points on the line divide the line into equal segments. 2. The numbers associated with the points on the line increase in value from left to right. Saying it the other way around, the numbers decrease in value from right to left. However you say it, what you're describing is formally called an ordered set of points. When we use a distance to represent a quantity, such as barrels of oil, graphically, we are scaling the number line. - In the example shown, the distance between 0 and 10 might represent 10 barrels of oil, or the distance from 0 to 40 might represent 40 barrels. we can construct both horizontal and vertical number lines This line is divided into segments such that the distance between −2 and −1 is the same as the distance between 0 and 1. By drawing the horizontal and vertical lines on the same sheet of paper, we are able to express the relationships between variables graphically. We draw them (1) so that they intersect at each other's 0 point and (2) so that they are perpendicular to each other. The result is a set of coordinate axes, where each line is called an axis. When we have two axes, they span a *plane*. With a coordinate value system, you need two numbers to specify a single point in the plane; when you see a single point on a graph, you know that it represents two numbers or two values. *the point of intersection of the two lines is referred to as the origin* (the intersection of the y axis and the x axis in a graph) Point A represents a "paired observation" of the variables x and y (10, 1) *In economics, it is conventional to put dollar values on the y axis and quantities on the horizontal axis* *Note that an inverse relationship between two variables shows up on a graph as a line or curve that slopes downward from left to right.* (You might as well get used to the idea that economists call a straight line a "curve" even though it may not curve at all. Economists' data frequently turn out to be curves, so they refer to everything represented graphically, even straight lines, as curves.)

table

a list of numerical values showing the relationship between two (or more) variables. Any table can be converted into a graph, which is a visual representation of that list

inverse relationships (way in which 2 variables can be related)

a relationship b/w 2 variables that is negative, meaning that an increase in one variable is associated with a decrease in the other and a decrease in one variable is associated with an increase in the other.

direct relationships (way in which 2 variables can be related)

a relationship b/w 2 variables that is positive, meaning that an increase in one variable is associated with an increase in the other and a decrease in one variable is associated with a decrease in the other

economic system

a society's institutional mechanism for determining the way in which scarce resources are used to satisfy human desires

dependent variable

a variable whose value changes according to changes in the value of one or more independent variables changes as a result of changes in the value of the independent variable. ex. even if nothing else is changing in your life, your weight depends on your intake of calories. The independent variable is caloric intake, and the dependent variable is weight. independent variable = cause dependent variable = effect

independent variable

a variable whose value is determined independently of, or outside, the equation under study can change in value freely

centralized command and control (economic system)

aka central planning by a centralized authority, such as a king or queen, a dictator, a central government, or some other type of authority. Such an entity assumes responsibility for addressing fundamental economic issues. Under command and control, this authority decides what items to produce and how many, determines how the scarce resources will be organized in the items' production, and identifies who will be able to obtain the items. ex. a government might decide that particular types of automobiles ought to be produced in certain numbers. The government might issue specific rules for how to manage the production of these vehicles, or it might even establish ownership over those resources so that it can make all such resource allocation decisions directly. Finally, the government will then decide who will be authorized to purchase or otherwise utilize the vehicles.

the Price System (economic system)

aka market system shorthand term describing an economic system that answers the three basic economic questions via decentralized decision making. Under a pure price system, individuals and families own all of the scarce resources used in production. Consequently, choices about what and how many items to produce are left to private parties to determine on their own initiative, as are decisions about how to go about producing those items. Furthermore, individuals and families choose how to allocate their own incomes to obtain the produced items at prices established via privately organized mechanisms. prices define the terms under which people agree to make exchanges. Prices signal to everyone within a price system which resources are relatively scarce and which are relatively abundant (This signaling aspect of the price system provides information to individual buyers and sellers about what and how many items should be produced, how production of items should be organized, and who will choose to buy the produced items) ex. individuals and families own the facilities used to produce automobiles. They decide which types of automobiles to produce, how many of them to produce, and how to bring labor and machines together within their facilities to generate the desired production. Other individuals and families decide how much of their earnings they wish to spend on automobiles.

behavioral economics

an approach to the study of consumer behavior that emphasizes psychological limitations and complications that potentially interfere with rational decision making *bounded rationality* advocates of behavioral economics have proposed replacing the rationality assumption with the assumption of bounded rationality, which assumes that people cannot examine and think through every possible choice they confront. - As a consequence, behavioral economists suggest, individuals cannot always pursue, on their own, their best long-term personal interests. They sometimes require help.

normative analysis

analysis concerned with what ought to be def. analysis involving value judgements about economic policies; relates to whether outcomes are good or bad. A statement of what ought to be. A positive economic statement is "If the price of gas rises, people will buy less." If we add to that analysis the statement "so we should not allow the price to go up," we have entered the realm of normative economics—we have expressed a value judgment. In fact, any time you see the word *should*, you will know that values are entering into the discussion *remember that positive statements are concerned with what is, whereas normative statements are concerned with what ought to be* When we express a value judgment, we are simply saying what we prefer, like, or desire. Because individual values are diverse, we expect—and indeed observe—that people express widely varying value judgments about how the world ought to be.

an alternative approach to economic analysis

behavioral economics

The three fundamental questions of economics (economic systems)

concern the problem of how to allocate society's scarce resources: 1. What and how much will be produced? Some mechanism must exist for determining which items will be produced while others remain inventors' pipe dreams or individuals' unfulfilled desires. 2. How will items be produced? - a decision must be made about the mix of resources used in production, the way in which they are organized, and how they are brought together at a particular location. (ex. machinery, human labor; It is possible to use more labor and fewer machines, or vice versa. It is possible, for instance, to produce an item with an aim to maximize the number of people employed) 3. For whom will items be produced? - Once an item is produced, who should be able to obtain it? People use scarce resources to produce any item, so typically people value access to that item. Thus, determining a mechanism for distributing produced items is a crucial issue for any society.

models of behavior NOT thought processes

economists' models do not relate to the way people think. Economic models relate to the way people act, to what they do in life with their limited resources. Rather, the task at hand is to predict how people will behave, which may be quite different from what they say they will do (much to the consternation of poll takers and market researchers).

Economics is typically divided into two types of analysis:

microeconomics & macroeconomics

incentives

play a crucial role in influencing all of the economic choices that people make def. rewards or penalties for engaging in a particular activity is the starting point for analyzing choices people make in all walks of life *self-interest and incentives are central to any decision-making process* (not sufficient for predicting the choices that people will actually make)

empirical

relying on real-world data in evaluating the usefulness of a model means that evidence (data) is looked at to see whether we are right. Economists are often engaged in empirically testing their models

"models" or "theories"

simplified representations of the real world used as the basis for predictions or explanations The social sciences—especially economics—make little use of laboratory experiments in which changes in variables are studied under controlled conditions. - Rather, social scientists, and especially economists, usually have to test their models, or theories, by examining what has already happened in the real world. *a model, by definition, is an abstraction from reality* The nature of scientific model building is that the model should capture only the essential relationships that are sufficient to analyze the particular problem or answer the particular question with which we are concerned. *An economic model cannot be faulted as unrealistic simply because it does not represent every detail of the real world* ex. A map of a city that shows only major streets is not faulty if, in fact, all you wish to know is how to pass through the city using major streets. As long as a model is able to shed light on the central issue at hand or forces at work, it may be useful. they focus on what is relevant to the problem at hand and omit what is not.

the Ceteris Paribus Assumption: All other things being equal

the assumption that nothing changes except the factor or factors being studied. Ceteris paribus means "other things constant" or "other things equal." ex. One of the most important determinants of how much of a particular product a family buys is how expensive that product is relative to other products. We know that in addition to relative prices, other factors influence decisions about making purchases. Some of them have to do with income, others with tastes, and yet others with custom and religious beliefs. Whatever these other factors are, we hold them constant when we look at the relationship between changes in prices and changes in how much of a given product people will purchase. (focus is given on 2 variables here, changes in price & how much of a given product people will purchase; everything else is held constant)

the rationality assumption

the assumption that people do not intentionally make decisions that would leave them worse off The distinction here is between what people may think—the realm of psychology and psychiatry and perhaps sociology—and what they do Economics does NOT involve itself in analyzing individual or group thought processes. *Economics looks at what people actually do in life with their limited resources* Knowing what happens on average is a good place to start. In this way, we avoid building our thinking on exceptions rather than on reality.

slope

the change in the y value divided by the corresponding change in the x value of a curve; the "incline" of the curve rise over run The slope is the amount of rise divided by the amount of run. A specific property of a straight line is that its *slope is the same between any two points*. In other words, the slope is constant at all points on a straight line in a graph.

mixed economic systems

the economic systems of the world's nations are mixed economic systems that incorporate aspects of both centralized command and control and a decentralized price system. At any given time, some nations lean toward centralized mechanisms of command and control and allow relatively little scope for decentralized decision making. At the same time, other nations limit the extent to which a central authority dictates answers to the three basic economic questions, leaving people mostly free to utilize a decentralized price system to generate their own answers. *A given country may reach different decisions at different times about how much to rely on command and control versus a price system to answer its three basic economic question*

Microeconomics

the study of decision making undertaken by individuals (or households) and by firms It is like looking through a microscope to focus on the small parts of our economy. ex.'s - the effects of changes in the price of gasoline relative to that of other energy sources. It examines the effects of new taxes on a specific product or industry. If the government establishes new health care regulations, how individual firms and consumers would react to those regulations Modern economists are increasingly using microeconomic analysis b/c - even though macroeconomic analysis focuses on aggregates, those aggregates are the result of choices made by individuals and firms.

Economics

the study of how people allocate their limited resources to satisfy their unlimited wants "resources" & "wants" are crucial to understand here helps us study how such choices are made we examine situations in which individuals choose how to do things, when to do things, and with whom to do them. Ultimately, the purpose of economics is to explain choices.

Macroeconomics

the study of the behavior of the economy as a whole, including such economywide phenomena such as changes in unemployment, the general price level, and national income ex's - rate of inflation, the amount of economywide unemployment, and the yearly growth in the output of goods and services in the nation In other words, macroeconomics deals with aggregates, or totals—such as total output in an economy.

resources

things used to produce goods and services to satisfy people's wants things that have value

aggregates

total amounts or quantities aggregate demand, for ex., is total planned expenditures throughout a nation

wants

what people would buy if their incomes were unlimited