Economics Today The - Revised by Nicole Ball Copyright © 2021 Pearso...

Economics Today The Micro View Twentieth Edition Roger LeRoy Miller

Instructor’s Resource Manual

Revised by Nicole Ball

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Copyright © 2021 Pearson Education, Inc.Chapter 1 The Nature of Economics ◼ Overview This chapter introduces economics as a science. Economics is defined, and its subareas, macroeconomics and microeconomics, are introduced. The chapter also discusses the three fundamental questions faced by every nation of what to produce, how to produce, and for whom to produce. The chapter then presents the two types of economic systems, command and control and the price system, that are used to answer the three fundamental questions. Economic rationality and self-interest are discussed along with their implications for decision making and economic model building. The concept of behavioral economics is introduced. Economics as a science is closely associated with the development of models. To aid understanding, a significant section on the methodology of economics discusses model construction, the role of assumptions, and determining the usefulness of a model. Finally, the difference between positive and normative economics is presented. There is a discussion of why it is important to separate these two areas of analysis clearly.◼ Learning Objectives

After studying this chapter, students should be able to:

1.1 Define economics and discuss the difference between microeconomics and macroeconomics 1.2 Identify the three basic economic questions and the two opposing sets of answers 1.3 Evaluate the role that rational self-interest plays in economic analysis 1.4 Explain why economics is a science 1.5 Distinguish between positive and normative economics ◼ Outline

• The Power of Economic Analysis: The analytical framework of the course is the

economic way of thinking. The economic way of thinking permits the student to reach informed conclusions about what is happening in the world. 2 / 4

• Miller • Economics Today, Twentieth Edition

Copyright © 2021 Pearson Education, Inc.

A. Defining Economics: The study of how people allocate their limited resources

to satisfy their unlimited wants. The ultimate purpose of economics is to explain how people make choices.

B. Microeconomics versus Macroeconomics: Economics is divided into two

types of analysis: microeconomics and macroeconomics.

1. Microeconomics: The part of economic analysis that studies decision

making undertaken by individuals (or households) and by firms.

2. Macroeconomics: The part of economic analysis that studies the behavior

of the economy as a whole. It deals with economywide phenomena, such as changes in unemployment, the general price level, and national income.

II. The Three Basic Economic Questions and Two Opposing Sets of Answers: Every

nation must address three fundamental questions that concern the problem of how an economic system allocates a society’s scarce resources.

A. The Three Basic Questions: (1) What and how much will be produced? (2)

How will items be produced? (3) For whom will items be produced?

• Two Opposing Sets of Answers

1. Centralized Command and Control: A centralized command and control

system, also called central planning, has a centralized authority that decides what items to produce and how many of each, determines how the scarce resources will be organized in the items’ production, and identifies who will be able to obtain the items.

2. The Price System: A price system, also called a market system, answers

the three basic questions using decentralized decision making. In a pure price system, individuals own all the scarce resources used in production.This means those choices about what and how many of each item to produce are made by private parties on their own initiative, as are the decisions about how to produce those items. Individuals and families choose how to allocate their incomes to obtain those items at prices established by privately organized mechanisms. Those prices signal the relative scarcity of different resources, which provides information about what and how many items to produce, how to each item should be produced, and who will choose to buy the items.

3. Mixed Economic Systems: Most economic systems of the world

incorporate aspects of both centralized command and control and the decentralized price systems.III. The Economic Approach: Systematic Decisions: Economists assume that individuals act as if they pursue self-motivated interests and respond predictably to perceived opportunities to obtain those interests.

A. The Rationality Assumption: The assumption that individuals will not

intentionally make decisions that would leave them worse off.

B. Responding to Incentives: An incentive is the reward for engaging in a given

activity. Much of human behavior can be explained in terms of how individuals respond to changing incentives over time. In general, before making decisions, 3 / 4

Chapter 1 The Nature of Economics 3 Copyright © 2021 Pearson Education, Inc.individuals compare costs and benefits of their actions and choose those actions which result in higher benefits than costs.

• Defining Self-Interest: The pursuit of goals that make the individual better off.

In economic analysis, these goals are often those which can be measured in monetary terms, although the pursuit of other goals such as prestige, love, power, or others can be analyzed using this concept.IV. Economics as a Science: Economics is a social science that utilizes the same types of methods used in biology, physics, and chemistry. Economic models, or theories, are simplified representations of the real world that are developed and used as aids in understanding, explaining, and predicting economic phenomena in the real world.

A. Models and Realism: A model should capture the essential relationships that

are sufficient to analyze the specific problem or answer the specific question being asked. No economic model is complete in the sense of capturing every detail and relationship that exists in the real world.A model is, by definition, an abstraction from reality. This does not mean that models are deficient simply because they are not perfectly realistic and use simplified assumptions. Every model in every science requires simplification compared to the real world but can still be useful if it explains the issue at hand.

B. Assumptions: Assumptions define the set of circumstances in which a model is

most likely to be applicable. Every model, therefore, must be based on a set of assumptions.

• The Ceteris Paribus Assumption: All Other Things Being Equal: The

assumption that nothing changes except the factors being studied. It is used to isolate the effect of a change in one variable on another one by assuming that all other variables do not change.

C. Deciding on the Usefulness of a Model: A model is useful if it yields usable

predictions supported by real-world observations. If a model makes a prediction and factual evidence supports the prediction, then the model is useful.Economics is an empirical science; that is, it relies on real-world data in evaluating the usefulness of a model.

D. Models of Behavior, Not Thought Processes: Economic models predict how

people act and what they will do in life with their limited resources, not to the way they think. Economic models normally generalize people’s behavior.Economists are interested in what people actually do (revealed preferences) rather than what they think they will do (declared preferences).

E. Behavioral Economics and Bounded Rationality: An approach to consumer

behavior that emphasizes psychological limitations and complications that potentially interfere with rational decision making.

• Bounded Rationality: The idea that people are nearly, but not fully, rational

so that they cannot examine every choice available to them. Instead, they use simple rules of thumb to sort among the available alternatives.

2. Rules of Thumb: A behavioral implication of bounded rationality is that

people will use rules of thumb; that is, simplified methods for making

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