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PART I INTRODUCTION TO ECONOMICS Method of Economics The study of economics should begin with a sense of wonder. Pause for a moment and consider a typi cal day in your life. It might start with a bagel made in a local bakery with flour produced in Minnesota from wheat grown in Kansas and bacon from pigs raised in Ohio packaged in plastic made in New Jersey. You spill coffee from Colombia on your shirt made in Texas from textiles shipped from South Carolina. After class you drive with a friend on an interstate highway that is part of a system that took 20 years and billions of dollars to build. You stop for gasoline refined in Louisiana from Saudi Arabian crude oil brought to the United States on a supertanker that took 3 years to build at a shipyard in Maine. Later you log onto the Web with a laptop computer assembled in Indonesia from parts made in China and send an e-mail to your brother in Mexico City, and you call a buddy on a cell phone made by a company in Finland. Your call is picked up by a microwave dish hidden in a church steeple rented from the church by a cellular company that was just bought by a European conglomerate. You use or consume tens of thousands of things, both tangible and intangible, every day: buildings, rock music, iPods, telephone services, staples, paper, toothpaste, tweezers, pizza, soap, digital watches, fire protection, banks, electricity, eggs, insurance, football fields, computers, buses, rugs, subways, health services, sidewalks, and so forth. Somebody made all these things. Somebody organized men and women and materials to produce and distribute them. Thousands of decisions went into their completion. Somehow they got to you. In the United States, over 146 million people—almost half the total population—work at hundreds of thousands of different jobs producing over $14 trillion worth of goods and services every year. Some cannot find work; some choose not to work. Some are rich; others are poor. The United States imports over $257 billion worth of automobiles and parts and about $229 billion worth of petroleum and petroleum products each year; it exports around $62 billion worth of agricultural products, including food. High-rise office buildings go up in central cities. Condominiums and homes are built in the suburbs. In other places, homes are abandoned and boarded up. Some countries are wealthy. Others are impoverished. Some are growing. Some are not. Some businesses are doing well. Others are going bankrupt. At any moment in time, every society faces constraints imposed by nature and by previous generations. Some societies are handsomely endowed by nature with fertile land, water, sunshine, and natural resources. Others have deserts and few mineral resources. Some societies receive much from previous generations—art, music, technical knowledge, beautiful buildings, and pro ductive factories. Others are left with overgrazed, eroded land, cities leveled by war, or polluted natural environments. All societies face limits. CHAPTER OUTLINE Why Study Economics? p. 2 To Learn a Way of Thinking To Understand Society To Understand Global Affairs To Be an Informed Citizen The Scope of Economics p. 7 Microeconomics and Macroeconomics The Diverse Fields of Economics The Method of Economics p. 10 Descriptive Economics and Economic Theory Theories and Models Economic Policy An Invitation p. 15 Appendix: How to Read and Understand Graphs p. 18 1 2 PART I Introduction to Economics economics The study of Economics is the study of how individuals and societies choose to use the scarce resources how individuals and societies choose to use the scarce resources that nature and previous generations have provided. that nature and previous generations have provided. The key word in this definition is choose. Economics is a behavioral, or social, science. In large measure, it is the study of how people make choices. The choices that people make, when added up, translate into societal choices. The purpose of this chapter and the next is to elaborate on this definition and to introduce the subject matter of economics. What is produced? How is it produced? Who gets it? Why? Is the result good or bad? Can it be improved? Why Study Economics? There are four main reasons to study economics: to learn a way of thinking, to understand soci ety, to understand global affairs, and to be an informed citizen. To Learn a Way of Thinking Probably the most important reason for studying economics is to learn a way of thinking. Economics has three fundamental concepts that, once absorbed, can change the way you look at everyday choices: opportunity cost, marginalism, and the working of efficient markets. opportunity cost The best alternative that we forgo, or give up, when we make a choice or a decision. Opportunity Cost What happens in an economy is the outcome of thousands of individ ual decisions. People must decide how to divide their incomes among all the goods and services available in the marketplace. They must decide whether to work, whether to go to school, and how much to save. Businesses must decide what to produce, how much to produce, how much to charge, and where to locate. It is not surprising that economic analysis focuses on the process of decision making. Nearly all decisions involve trade-offs. A key concept that recurs in analyzing the decision making process is the notion of opportunity cost. The full "cost" of making a specific choice includes what we give up by not making the alternative choice. The best alternative that we forgo, or give up, when we make a choice or a decision is called the opportunity cost of that decision. When asked how much a movie costs, most people cite the ticket price. For an economist, this is only part of the answer: to see a movie takes not only a ticket but also time. The opportu nity cost of going to a movie is the value of the other things you could have done with the same money and time. If you decide to take time off from work, the opportunity cost of your leisure is the pay that you would have earned had you worked. Part of the cost of a college education is the income you could have earned by working full-time instead of going to school. If a firm pur chases a new piece of equipment for $3,000, it does so because it expects that equipment to gen erate more profit. There is an opportunity cost, however, because that $3,000 could have been deposited in an interest-earning account. To a society, the opportunity cost of using resources to launch astronauts on a space shuttle is the value of the private/civilian or other government goods that could have been produced with the same resources. scarce Limited. Opportunity costs arise because resources are scarce. Scarce simply means limited. Consider one of our most important resources—time. There are only 24 hours in a day, and we must live our lives under this constraint. A farmer in rural Brazil must decide whether it is better to con tinue to farm or to go to the city and look for a job. A hockey player at the University of Vermont must decide whether to play on the varsity team or spend more time studying. Marginalism A second key concept used in analyzing choices is the notion of marginalism The process marginalism. In weighing the costs and benefits of a decision, it is important to weigh only the of analyzing the additional or incremental costs or benefits arising from a choice or decision. costs and benefits that arise from the decision. Suppose, for example, that you live in New Orleans and that you are weighing the costs and benefits of visiting your mother in Iowa. If business required that you travel to Kansas City, the cost of visiting Mom would be only the additional, or marginal, time and money cost of getting to Iowa from Kansas City. CHAPTER 1 The Scope and Method of Economics 3 Consider the music business. To produce a typical CD, music labels spend approximately $300,000 on recording the music and music video, developing marketing materials, and distrib uting the album. Once the label has made this investment, physically producing another copy of the CD for sale typically costs about $2. When the music label is deciding whether to sign a new artist and produce a CD, the $300,000 investment is important. Companies such as EMI and Columbia Records spend a great deal of time thinking about whether a new CD by a newly dis covered artist will sell enough copies to make a profit. But once an artist is signed and the invest ment is made and the music label is trying to decide whether to manufacture the 100,001st copy of a new CD, the key cost number is $2. Every new copy costs only $2, and as long as EMI can sell that copy for more than $2, it is better off making the copy. The original investment made to cre ate the music is irrelevant—a sunk cost. Sunk costs are costs that cannot be avoided because they have already been incurred. Technically, we call the incremental cost of producing one more unit of a good or service the marginal cost. One of the interesting changes in the music business is what has happened to the marginal cost of producing another copy of a CD given the introduction of iTunes as an alterna tive to the physical CD. While it is not always easy to figure out what the marginal cost is (and we will spend some time in this text honing your skills in this area), understanding the idea of mar ginalism when thinking about choices is critical. There are numerous examples in which the concept of marginal cost is useful. For an air plane that is about to take off with empty seats, the marginal cost of an extra passenger is essen tially zero; the total cost of the trip is roughly unchanged by the addition of an extra passenger. Thus, setting aside a few seats to be sold at big discounts through www.priceline.com or other Web sites can be profitable even if the fare for those seats is far below the average cost per seat of making the trip. As long as the airline succeeds in filling seats that would otherwise have been empty, doing so is profitable. sunk costs Costs that cannot be avoided because they have already been incurred. Efficient Markets—No Free Lunch Suppose you are ready to check out of a busy grocery store on the day before a storm and seven checkout registers are open with several people in each line. Which line should you choose? Usually, the waiting time is approximately the same no matter which register you choose (assuming you have more than 12 items). If one line is much shorter than the others, people will quickly move into it until the lines are equal ized again. As you will see later, the term profit in economics has a very precise meaning. Economists, however, often loosely refer to "good deals" or risk-free ventures as profit opportunities. Using the term loosely, a profit opportunity exists at the checkout lines when one line is shorter than the others. In general, such profit opportunities are rare. At any time, many people are search ing for them; as a consequence, few exist. Markets like this, where any profit opportunities are eliminated almost instantaneously, are said to be efficient markets. (We discuss markets, the institutions through which buyers and sellers interact and engage in exchange, in detail in Chapter 2.) The common way of expressing the efficient markets concept is "there`s no such thing as a free lunch." How should you react when a stockbroker calls with a hot tip on the stock market? With skepticism. Thousands of individuals each day are looking for hot tips in the market. If a particular tip about a stock is valid, there will be an immediate rush to buy the stock, which will quickly drive up its price. This view that very few profit opportunities exist can, of course, be carried too far. There is a story about two people walking along, one an economist and one not. The noneconomist sees a $20 bill on the sidewalk and says, "There`s a $20 bill on the sidewalk." The economist replies, "That is not possible. If there were, somebody would already have picked it up." There are clearly times when profit opportunities exist. Someone has to be first to get the news, and some people have quicker insights than others. Nevertheless, news travels fast and there are thousands of people with quick insights. The general view that large profit opportuni ties are rare is close to the mark. efficient market A market in which profit opportunities are eliminated almost instantaneously. The study of economics teaches us a way of thinking and helps us make decisions. 4 PART I Introduction to Economics Industrial Revolution The period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities. To Understand Society Another reason for studying economics is to understand society better. Past and present eco nomic decisions have an enormous influence on the character of life in a society. The current state of the physical environment, the level of material well-being, and the nature and number of jobs are all products of the economic system. To get a sense of the ways in which economic decisions have shaped our environment, imag ine looking out a top-floor window of an office tower in any large city. The workday is about to begin. All around you are other tall glass and steel buildings full of workers. In the distance, you see the smoke of factories. Looking down, you see thousands of commuters pouring off trains and buses and cars backed up on freeway exit ramps. You see trucks carrying goods from one place to another. You also see the face of urban poverty: Just beyond the freeway is a large public housing project and, beyond that, burned-out and boarded-up buildings. What you see before you is the product of millions of economic decisions made over hundreds of years. People at some point decided to spend time and money building those buildings and fac tories. Somebody cleared the land, laid the tracks, built the roads, and produced the cars and buses. Economic decisions not only have shaped the physical environment but also have deter mined the character of society. At no time has the impact of economic change on a society been more evident than in England during the late eighteenth and early nineteenth centuries, a period that we now call the Industrial Revolution. Increases in the productivity of agricul ture, new manufacturing technologies, and development of more efficient forms of transporta tion led to a massive movement of the British population from the countryside to the city. At the beginning of the eighteenth century, approximately 2 out of 3 people in Great Britain worked in agriculture. By 1812, only 1 in 3 remained in agriculture; by 1900, the figure was fewer than 1 in 10. People jammed into overcrowded cities and worked long hours in factories. England had changed completely in two centuries—a period that in the run of history was nothing more than the blink of an eye. It is not surprising that the discipline of economics began to take shape during this period. Social critics and philosophers looked around and knew that their philosophies must expand to accommodate the changes. Adam Smith`s Wealth of Nations appeared in 1776. It was followed by the writings of David Ricardo, Karl Marx, Thomas Malthus, and others. Each tried to make sense out of what was happening. Who was building the factories? Why? What determined the level of wages paid to workers or the price of food? What would happen in the future, and what should happen? The people who asked these questions were the first economists. Similar changes continue to affect the character of life in more recent times. In fact, many argue that the late 1990s marked the beginning of a new Industrial Revolution. As we turned the corner into the new millennium, the "e" revolution was clearly having an impact on virtually every aspect of our lives: the way we buy and sell products, the way we get news, the way we plan vacations, the way we communicate with each other, the way we teach and take classes, and on and on. These changes have had and will clearly continue to have profound impacts on societies across the globe, from Beijing to Calcutta to New York. These changes have been driven by economics. Although the government was involved in the early years of the World Wide Web, private firms that exist to make a profit (such as Facebook, YouTube, Yahoo!, Microsoft, Google, Monster.com, Amazon.com, and E-Trade) created almost all the new innovations and products. How does one make sense of all this? What will the effects of these innovations be on the number of jobs, the character of those jobs, the family incomes, the structure of our cities, and the political process both in the United States and in other countries? During the last days of August 2005, Hurricane Katrina slammed into the coasts of Louisiana and Mississippi, causing widespread devastation, killing thousands, and leaving hundreds of thousands homeless. The economic impact of this catastrophic storm was huge. Thinking about various markets involved helps frame the problem. For example, the labor market was massively affected. By some estimates, over 400,000 jobs were lost as the storm hit. Hotels, restaurants, small businesses, and oil refineries, to name just a few, were destroyed. All the people who worked in those establishments instantaneously lost their jobs and their incomes. The cleanup and rebuilding process took time to organize, and it eventu ally created a great deal of employment. The storm created a major disruption in world oil markets. Loss of refinery capacity sent gasoline prices up immediately, nearly 40 percent to over $4 per gallon in some locations. The CHAPTER 1 The Scope and Method of Economics 5 price per gallon of crude oil rose to over $70 per barrel. Local governments found their tax bases destroyed, with no resources to pay teachers and local officials. Hundreds of hospitals were destroyed, and colleges and universities were forced to close their doors, causing tens of thou sands of students to change their plans. While the horror of the storm hit all kinds of people, the worst hit were the very poor, who could not get out of the way because they had no cars or other means of escape. The storm raised fundamental issues of fairness, which we will be discussing for years to come. The study of economics is an essential part of the study of society. To Understand Global Affairs A third reason for studying economics is to understand global affairs. News headlines are filled with economic stories. International events often have enormous economic consequences. The destruction of the World Trade Center towers in New York City in 2001 and the subsequent war on terror in Afghanistan and elsewhere led to a huge decline in both tourism and business travel. Several major airlines, including U.S. Airways and Swissair, went bankrupt. Hotel operators worldwide suffered huge losses. The war in Iraq and a strike in Venezuela, a major oil exporter, in 2003 sent oil markets gyrating dramatically, initially increasing the cost of energy across the globe. The rapid spread of HIV and AIDS across Africa will continue to have terrible economic consequences for the continent and ultimately for the world. Some claim that economic considerations dominate international relations. Certainly, politi cians place the economic well-being of their citizens near the top of their priority lists. It would be surprising if that were not so. Thus, the economic consequences of things such as environmental policy, free trade, and immigration play a huge role in international negotiations and policies. Great Britain and the other countries of the European Union have struggled with the agreement among most members to adopt a common currency, the euro. In 2005, France and the Netherlands rejected a proposed European constitution that would have gone a long way toward a completely open economy in Europe. The nations of the former Soviet Union are wrestling with a growing phe nomenon that clouds their efforts to "privatize" formerly state-owned industries: organized crime. Another important issue in today`s world is the widening gap between rich and poor nations. In 2007, world population was over 6.5 billion. Of that number, over 2.4 billion lived in low-income (less than $900 annually per capita) countries and just over 1 billion lived in high-income (over $11,000 per capita per year) countries. The 37 percent of the world`s population that lives in the low-income countries receives less than 3.3 percent of the world`s income. In dozens of countries, per capita income is only a few hundred dollars a year. The 15 percent of the popula tion in high-income countries earn 75 percent of the world`s income. An understanding of economics is essential to an understanding of global affairs. To Be an Informed Citizen A knowledge of economics is essential to being an informed citizen. During the last 35 years, the U.S. economy has been on a roller coaster. In 1973-1974, the Organization of Petroleum Exporting Countries (OPEC) succeeded in raising the price of crude oil by 400 percent. Simultaneously, a sequence of events in the world food market drove food prices up by 25 per cent. By mid-1974, prices in the United States were rising across the board at a very rapid rate. Partially as a result of government policy to fight runaway inflation, the economy went into a recession in 1975. (An inflation is an increase in the overall price level in the economy; a recession is a period of decreasing output and rising unemployment.) The recession succeeded in slowing price increases, but in the process, millions found themselves unemployed. From 1979 through 1983, it happened all over again. Prices rose rapidly, the government reacted with more policies designed to stop prices from rising, and the United States ended up with an even worse recession in 1982. By the end of that year, 10.8 percent of the work force was unemployed. Then, in mid-1990—after almost 8 years of strong economic performance—the ... - tailieumienphi.vn
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