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Unformatted text preview: 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 1 PA RT ONE Introduction 1 What Is Economics? After studying this chapter, y ou will be able to: ■ Define economics and distinguish between microeconomics and macroeconomics ■ Explain the two big questions of economics ■ Explain the key ideas that define the economic way of thinking ■ Explain how economists go about their work as social scientists You are studying economics at a time of extraordinary change. The United States is the world’s most powerful nation, but China, India, Brazil, and Russia, nations with a combined population that dwarfs our own, are emerging to play ever greater roles in an expanding global economy. The techno- and seize the opportunities they present, you must under- logical change that is driving this expansion has brought us the stand the powerful forces at play. The economics that you’re laptops, wireless broadband, iPods, DVDs, cell phones, and about to learn will become your most reliable guide. This video games that have transformed the way we work and play. chapter gets you started. It describes the questions that But this expanding global economy has also brought us sky- economists try to answer and the ways in which they search rocketing food and fuel prices and is contributing to global for the answers. warming and climate change. Your life will be shaped by the challenges you face and the opportunities that you create. But to face those challenges 1 9160335_CH01_p001-030.qxd 2 6/22/09 8:55 AM Page 2 CHAPTER 1 What Is Economics? ◆ Definition of Economics All economic questions arise because we want more than we can get. We want a peaceful and secure world. We want clean air, lakes, and rivers. We want long and healthy lives. We want good schools, colleges, and universities. We want spacious and comfortable homes. We want an enormous range of sports and recreational gear from running shoes to jet skis. We want the time to enjoy sports, games, novels, movies, music, travel, and hanging out with our friends. What each one of us can get is limited by time, by the incomes we earn, and by the prices we must pay. Everyone ends up with some unsatisfied wants. What we can get as a society is limited by our productive resources. These resources include the gifts of nature, human labor and ingenuity, and tools and equipment that we have produced. Our inability to satisfy all our wants is called scarcity. The poor and the rich alike face scarcity. A child wants a $1.00 can of soda and two 50¢ packs of gum but has only $1.00 in his pocket. He faces scarcity. A millionaire wants to spend the weekend playing golf and spend the same weekend attending a business strategy meeting. She faces scarcity. A society wants to provide improved health care, install a computer in every classroom, explore space, clean polluted lakes and rivers, and so on. Society faces scarcity. Even parrots face scarcity! Faced with scarcity, we must choose among the available alternatives. The child must choose the soda or the gum. The millionaire must choose the golf game or the meeting. As a society, we must choose among health care, national defense, and education. The choices that we make depend on the incentives that we face. An incentive is a reward that encourages an action or a penalty that discourages one. If the price of soda falls, the child has an incentive to choose more soda. If a profit of $10 million is at stake, the millionaire has an incentive to skip the golf game. As computer prices tumble, school boards have an incentive to connect more classrooms to the Internet. Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. The subject divides into two main parts: Microeconomics Macroeconomics ■ ■ Microeconomics Microeconomics is the study of the choices that individ- uals and businesses make, the way these choices interact in markets, and the influence of governments. Some examples of microeconomic questions are: Why are people buying more DVDs and fewer movie tickets? How would a tax on e-commerce affect eBay? Macroeconomics Macroeconomics is the study of the performance of the national economy and the global economy. Some examples of macroeconomic questions are: Why did income growth slow in the United States in 2008? Can the Federal Reserve keep our economy expanding by cutting interest rates? Review Quiz ◆ Not only do I want a cracker—we all want a cracker! List some examples of scarcity in the United States today. Use the headlines in today’s news to provide some examples of scarcity around the world. Use today’s news to illustrate the distinction between microeconomics and macroeconomics. © The New Yorker Collection 1985 Frank Modell from cartoonbank.com. All Rights Reserved. Work Study Plan 1.1 and get instant feedback. 1 2 3 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 3 Two Big Economic Questions ◆ Two Big Economic Questions FIGURE 1.1 3 What Three Countries Produce United States Two big questions summarize the scope of economics: ■ ■ How do choices end up determining what, how, and for whom goods and services are produced? How can choices made in the pursuit of selfinterest also promote the social interest? Brazil China What, How, and For Whom? Goods and services are the objects that people value and produce to satisfy human wants. Goods are physical objects such as cell phones and automobiles. Services are tasks performed for people such as cell-phone service and auto-repair service. What? What we produce varies across countries and changes over time. In the United States today, agriculture accounts for less than 1 percent of total production, manufactured goods for 20 percent, and services (retail and wholesale trade, health care, and education are the biggest ones) for 80 percent. In contrast, in China today, agriculture accounts for more than 10 percent of total production, manufactured goods for 50 percent, and services for 40 percent. Figure 1.1 shows these numbers and also the percentages for Brazil, which fall between those for the United States and China. What determines these patterns of production? How do choices end up determining the quantities of cell phones, automobiles, cell-phone service, autorepair service, and the millions of other items that are produced in the United States and around the world? How? Goods and services are produced by using pro- ductive resources that economists call factors of proFactors of production are grouped into four categories: duction. ■ ■ ■ ■ Land Labor Capital Entrepreneurship Land The “gifts of nature” that we use to produce goods and services are called land. In economics, land is what in everyday language we call natural 0 20 40 60 Percentage of production Agriculture Manufacturing 80 100 Services The richer the country, the more of its production is services and the less is food and manufactured goods. Source of data: CIA Factbook 2008, Central Intelligence Agency. animation resources. It includes land in the everyday sense together with minerals, oil, gas, coal, water, air, forests, and fish. Our land surface and water resources are renewable and some of our mineral resources can be recycled. But the resources that we use to create energy are nonrenewable—they can be used only once. Labor The work time and work effort that people devote to producing goods and services is called labor. Labor includes the physical and mental efforts of all the people who work on farms and construction sites and in factories, shops, and offices. The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience. You are building your own human capital right now as you work on your economics course, and your human capital will continue to grow as you gain work experience. Human capital expands over time. Today, 86 percent of the population of the United States have completed high school and 28 percent have a college or university degree. Figure 1.2 shows these measures of the growth of human capital in the United States over the past century. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 4 CHAPTER 1 What Is Economics? 4 A Measure of Human Capital Percentage of adult population FIGURE 1.2 100 Less than 5 years of elementary school 75 quantities of goods and services. A small income leaves a person with few options and small quantities of goods and services. People earn their incomes by selling the services of the factors of production they own: ■ Some high school ■ ■ Completed high school 50 ■ 25 4 years or more of college 0 1907 Year 1927 1947 1967 1987 2007 Today, 28 percent of the population have 4 years or more of college, up from 2 percent in 1905. A further 58 percent have completed high school, up from 10 percent in 1905. Source of data: U.S. Census Bureau, Statistical Abstract of the United States. animation Capital The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are called capital. In everyday language, we talk about money, stocks, and bonds as being “capital.” These items are financial capital. Financial capital plays an important role in enabling businesses to borrow the funds that they use to buy physical capital. But because financial capital is not used to produce goods and services, it is not a productive resource. The human resource that organizes labor, land, and capital is called entrepreneurship. Entrepreneurs come up with new ideas about what and how to produce, make business decisions, and bear the risks that arise from these decisions. Entrepreneurship What determines the quantities of factors of production that are used to produce goods and services? For Whom? Who consumes the goods and services that are produced depends on the incomes that people earn. A large income enables a person to buy large Land earns rent. Labor earns wages. Capital earns interest. Entrepreneurship earns profit. Which factor of production earns the most income? The answer is labor. Wages and fringe benefits are around 70 percent of total income. Land, capital, and entrepreneurship share the rest. These percentages have been remarkably constant over time. Knowing how income is shared among the factors of production doesn’t tell us how it is shared among individuals. And the distribution of income among individuals is extremely unequal. You know of some people who earn very large incomes: Oprah Winfrey made $260 million in 2007; and Bill Gates’ wealth increased by $2 billion in 2008. You know of even more people who earn very small incomes. Servers at McDonald’s average around $6.35 an hour; checkout clerks, cleaners, and textile and leather workers all earn less than $10 an hour. You probably know about other persistent differences in incomes. Men, on the average, earn more than women; whites earn more than minorities; college graduates earn more than high-school graduates. We can get a good sense of who consumes the goods and services produced by looking at the percentages of total income earned by different groups of people. The 20 percent of people with the lowest incomes earn about 5 percent of total income, while the richest 20 percent earn close to 50 percent of total income. So on average, people in the richest 20 percent earn more than 10 times the incomes of those in the poorest 20 percent. Why is the distribution of income so unequal? Why do women and minorities earn less than white males? Economics provides some answers to all these questions about what, how, and for whom goods and services are produced and much of the rest of this book will help you to understand those answers. We’re now going to look at the second big question of economics: When does the pursuit of selfinterest promote the social interest? This question is a difficult one both to appreciate and to answer. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 5 Two Big Economic Questions How Can the Pursuit of Self-Interest Promote the Social Interest? Every day, you and 304 million other Americans, along with 6.7 billion people in the rest of the world, make economic choices that result in what, how, and for whom goods and services are produced. Self-Interest A choice is in your self-interest if you think that choice is the best one available for you. You make most of your choices in your self-interest. You use your time and other resources in the ways that make the most sense to you, and you don’t think too much about how your choices affect other people. You order a home delivery pizza because you’re hungry and want to eat. You don’t order it thinking that the delivery person needs an income. When you act on your self-interested economic choices, you come into contact with thousands of other people who produce and deliver the goods and services that you decide to buy or who buy the things that you sell. These people have made their own choices—what to produce and how to produce it, whom to hire or to work for, and so on—in their self-interest. When the pizza delivery person shows up at your door, he’s not doing you a favor. He’s earning his income and hoping for a good tip. Social Interest Self-interested choices promote the social interest if they lead to an outcome that is the best for society as a whole—an outcome that uses resources efficiently and distributes goods and services equitably (or fairly) among individuals. Resources are used efficiently when goods and services are produced 1. At the lowest possible cost, and 2. In the quantities that give the greatest possible benefit. The Big Question How can we organize our eco- nomic lives so that when each one of us makes choices that are in our self-interest, it turns out that these choices also promote the social interest? Does voluntary trading in free markets achieve the social interest? Do we need government action to guide our choices to achieve the social interest? Do we need international cooperation and treaties to achieve the global social interest? Let’s put flesh on these broad questions with some examples. 5 Self-Interest and the Social Interest To get started thinking about the tension between self-interest and the social interest, we’ll consider five topics that generate discussion in today’s world. Here, we will briefly introduce the topics and identify some of the economic questions that they pose. We’ll return to each one of them as you learn more of the economic ideas and tools that can be used to understand these issues. The topics are ■ Globalization ■ The information-age economy ■ Global warming ■ Natural resource depletion ■ Economic instability Globalization The term globalization means the expansion of international trade, borrowing and lending, and investment. Whose self-interest does globalization serve? Is it only in the self-interest of the multinational firms that produce in low-cost regions and sell in high-price regions? Is globalization in the interest of consumers who buy lower-cost goods? Is globalization in the interest of the worker in Malaysia who sews your new running shoes? Is globalization in your self-interest and in the social interest? Or should we limit globalization and restrict imports of cheap foreign-produced goods and services? Globalization Today Life in a Small and Ever Shrinking World Every day, 40,000 people travel by air between the United States and Asia and Europe. A phone call or a video-conference with people who live 10,000 miles apart is a common and easily affordable event. When Nike produces sports shoes, people in China, Indonesia, or Malaysia get work. When Apple designs a new generation iPod, electronics factories in China, Japan, Korea, and Taiwan produce and assemble the parts. When Nintendo creates a new game for the Wii, programmers in India write the code. And when China Airlines buys new airplanes, Americans who work at Boeing build them. While globalization brings expanded production and job opportunities for Asian workers, it destroys many American jobs. Workers across the manufacturing industries must learn new skills, or take lowerpaid service jobs, or retire earlier than planned. 9160335_CH01_p001-030.qxd 6 6/22/09 8:55 AM Page 6 CHAPTER 1 What Is Economics? The Information-Age Economy The technological change of the 1990s and 2000s has been called the Information Revolution. During the information revolution were scarce resources used in the best possible way? Who benefitted from Bill Gates’ decision to quit Harvard and create Microsoft? Did Microsoft produce operating systems for the personal computer that served the social interest? Did it sell its programs for prices that served the social interest? Did Bill Gates have to be paid what has now grown to $55 billion to produce the successive generations of Windows, Microsoft Office, and other programs? Did Intel make the right quality of chips and sell them in the right quantities for the right prices? Or was the quality too low and the price too high? Would the social interest have been better served if Microsoft and Intel had faced competition from other firms? Global Warming Global warming and its effect on The Source of the Information-Age A Hotter Planet So Much from One Tiny Chip Melting Ice and the Changing Climate The microprocessor or computer chip created the information age. Gordon Moore of Intel predicted in 1965 that the number of transistors that could be placed on one chip would double every 18 months (Moore’s law). This prediction turned out to be remarkably accurate. In 1980, an Intel chip had 60,000 transistors. In 2008, Intel’s Core 2 Duo processor that you might be using on your personal computer has 291 million transistors. The spinoffs from faster and cheaper computing were widespread. Telecommunications became clearer and faster; music and movie recording became more realistic; routine tasks that previously required human decision and action were automated. All the new products and processes, and the lowcost computing power that made them possible, were produced by people who made choices in their own self-interest. They did not result from any grand design or government economic plan. When Gordon Moore set up Intel and started making chips, no one had told him to do so, and he wasn’t thinking how much easier it would be for you to turn in your essay on time if you had a faster laptop. When Bill Gates quit Harvard to set up Microsoft, he wasn’t thinking about making it easier to use a computer. Moore, Gates, and thousands of other entrepreneurs were in hot pursuit of the big prizes that many of them succeeded in winning. Retreating polar icecaps are a vivid illustration of a warming planet. Over the past 100 years, the Earth’s surface air temperature is estimated to have risen by about three quarters of a degree Celsius. Uncertainty surrounds the causes, likely future amount, and effects of this temperature increase. The consensus is that the temperature is rising because the amount of carbon dioxide in the Earth’s atmosphere is increasing, and that human economic activity is a source of the increased carbon concentration. Forests convert carbon dioxide to oxygen and so act as carbon sinks, but they are shrinking. Two thirds of the world’s carbon emissions come from the United States, China, the European Union, Russia, and India. The fastest growing emissions are coming from India and China. Burning fossil fuels—coal and oil—to generate electricity and to power airplanes, automobiles, and trucks pours a staggering 28 billions tons—4 tons per person—of carbon dioxide into the atmosphere each year. The amount of future global warming and its effects are uncertain. If the temperature rise continues, the Earth’s climate will change, ocean levels will rise, and low-lying coastal areas will need to be protected against the rising tides by expensive barriers. climate change is a huge political issue today. Every serious political leader is acutely aware of the problem and of the popularity of having proposals that might lower carbon emissions. Every day, when you make self-interested choices to use electricity and gasoline, you contribute to carbon emissions; you leave your carbon footprint. You can lessen your carbon footprint by walking, riding a bike, taking a cold shower, or planting a tree. But can each one of us be relied upon to make decisions that affect the Earth’s carbon-dioxide concentration in the social interest? Must governments change the incentives we face so that our self-interested choices advance the social interest? How can governments change incentives? How can we encourage the use of wind and solar power to replace the burning of fossil fuels that bring climate change? 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 7 Two Big Economic Questions Natural Resource Depletion Tropical rainforests and ocean fish stocks are disappearing quickly. No one owns these resources and everyone is free to take what they want. When Japanese, Spanish, and Russian trawlers scoop up fish in international waters, no one keeps track of the quantities of fish they catch and no one makes them pay. The fish are free. Each one of us makes self-interested economic choices to buy products that destroy natural resources and kill wild fish stocks. When you buy soap or shampoo or eat fish and contribute to the depletion of natural resources, are your self-interested choices damaging the social interest? If they are, what can be done to change your choices so that they serve the social interest? Economic Instability The past 20 years have been ones of remarkable economic stability, so much so that they’ve been called the Great Moderation. Even the economic shockwaves of 9/11 brought only a small dip in the strong pace of U.S. and global eco- Running Out of Natural Resources Disappearing Forests and Fish Tropical rainforests in South America, Africa, and Asia support the lives of 30 million species of plants, animals, and insects—approaching 50 percent of all the species on the planet. These rainforests provide us with the ingredients for many goods, including soaps, mouthwashes, shampoos, food preservatives, rubber, nuts, and fruits. The Amazon rainforest alone converts about 1 trillion pounds of carbon dioxide into oxygen each year. Yet tropical rainforests cover less than 2 percent of the earth’s surface and are heading for extinction. Logging, cattle ranching, mining, oil extraction, hydroelectric dams, and subsistence farming destroy an area the size of two football fields every second, or an area larger than New York City every day. At the current rate of destruction, almost all the tropical rainforest ecosystems will be gone by 2030. What is happening to the tropical rainforests is also happening to ocean fish stocks. Overfishing has almost eliminated cod from the Atlantic Ocean and the southern bluefin tuna from the South Pacific Ocean. Many other species of fish are on the edge of extinction in the wild and are now available only from fish farms. 7 nomic expansion. But in August 2007, a period of financial stress began. Banks’ choices to lend and people’s choices to borrow were made in self-interest. But did this lending and borrowing serve the social interest? Did the Fed’s bail out of troubled banks serve the social interest? Or might the Fed’s rescue action encourage banks to repeat their dangerous lending in the future? The End of the Great Moderation A Credit Crunch Flush with funds, and offering record low interest rates, banks went on a lending spree to home buyers. Rapidly rising home prices made home owners feel well off and they were happy to borrow and spend. Home loans were bundled into securities that were sold and resold to banks around the world. In 2006, interest rates began to rise, the rate of rise in home prices slowed, and borrowers defaulted on their loans. What started as a trickle became a flood. By mid-2007, banks took losses that totaled billions of dollars as more people defaulted. Global credit markets stopped working, and people began to fear a prolonged slowdown in economic activity. Some even feared the return of the economic trauma of the Great Depression of the 1930s when more than 20 percent of the U.S. labor force was unemployed. The Federal Reserve, determined to avoid a catastrophe, started lending on a very large scale to the troubled banks. Review Quiz ◆ 1 2 Describe the broad facts about what, how, and for whom goods and services are produced. Use headlines from the recent news to illustrate the potential for conflict between self-interest and the social interest. Work Study Plan 1.2 and get instant feedback. We’ve looked at five topics that illustrate the big question: How can choices made in the pursuit of self-interest also promote the social interest? While working through this book, you will encounter the principles that help economists figure out when the social interest is being served, when it is not, and what might be done when the social interest is not being served? 9160335_CH01_p001-030.qxd 8 6/22/09 8:55 AM Page 8 CHAPTER 1 What Is Economics? ◆ The Economic Way of Thinking The questions that economics tries to answer tell us about the scope of economics. But they don’t tell us how economists think about these questions and go about seeking answers to them. You’re now going to begin to see how economists approach economic questions. We’ll look at the ideas that define the economic way of thinking. This way of thinking needs practice, but it is powerful, and as you become more familiar with it, you’ll begin to see the world around you with a new and sharper focus. Choices and Tradeoffs Because we face scarcity, we must make choices. And when we make a choice, we select from the available alternatives. For example, you can spend Saturday night studying for your next economics test and having fun with your friends, but you can’t do both of these activities at the same time. You must choose how much time to devote to each. Whatever choice you make, you could have chosen something else. You can think about your choice as a tradeoff. A tradeoff is an exchange—giving up one thing to get something else. When you choose how to spend your Saturday night, you face a tradeoff between studying and hanging out with your friends. Guns Versus Butter The classic tradeoff is between guns and butter. “Guns” and “butter” stand for any pair of goods. They might actually be guns and butter. Or they might be broader categories such as national defense and food. Or they might be any pair of specific goods or services such as cola and pizza, baseball bats and tennis rackets, colleges and hospitals, realtor services and career counseling. Regardless of the specific objects that guns and butter represent, the guns-versus-butter tradeoff captures a hard fact of life: If we want more of one thing, we must give up something else to get it. To get more “guns” we must give up some “butter.” The idea of a tradeoff is central to economics. We’ll look at some examples, beginning with the big questions: What, How, and For Whom goods and services are produced? We can view each of these questions in terms of tradeoffs. What, How, and For Whom Tradeoffs The questions what, how, and for whom goods and services are produced all involve tradeoffs that are similar to that between guns and butter. What Tradeoffs What goods and services are pro- duced depends on choices made by each one of us, by our government, and by the businesses that produce the things we buy. Each of these choices involves a tradeoff. Each one of us faces a tradeoff when we choose how to spend our income. You go to the movies this week, but you forgo a few cups of coffee to buy the ticket. You trade off coffee for a movie. The federal government faces a tradeoff when it chooses how to spend our tax dollars. Congress votes for more national defense but cuts back on educational programs. Congress trades off education for national defense. Businesses face a tradeoff when they decide what to produce. Nike hires Tiger Woods and allocates resources to designing and marketing a new golf ball but cuts back on its development of a new running shoe. Nike trades off running shoes for golf balls. How Tradeoffs How businesses produce the goods and services we buy depends on their choices. These choices involve tradeoffs. For example, when Krispy Kreme opens a new store with an automated production line and closes one with a traditional kitchen, it trades off labor for capital. When American Airlines replaces check-in agents with self check-in kiosks, it also trades off labor for capital. For Whom Tradeoffs For whom goods and services are produced depends on the distribution of buying power. Buying power can be redistributed—transferred from one person to another—in three ways: by voluntary payments, by theft, or through taxes and benefits organized by government. Redistribution brings tradeoffs. Each of us faces a tradeoff when we choose how much to contribute to the United Nations’ famine relief fund. You donate $50 and cut your spending. You trade off your own spending for a small increase in economic equality. We also face a tradeoff when we vote to increase the resources for catching thieves and enforcing the law. We trade off goods and services for an increase in the security of our property. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 9 T he Economic Way of Thinking We also face a for whom tradeoff when we vote for taxes and social programs that redistribute buying power from the rich to the poor. These redistribution programs confront society with what has been called the big tradeoff—the tradeoff between equality and efficiency. Taxing the rich and making transfers to the poor bring greater economic equality. But taxing productive activities such as running a business, working hard, and developing a more productive technology discourages these activities. So taxing productive activities means producing less. A more equal distribution means there is less to share. Think of the problem of how to share a pie that everyone contributes to baking. If each person receives a share of the pie that is proportional to her or his effort, everyone will work hard and the pie will be as large as possible. But if the pie is shared equally, regardless of contribution, some talented bakers will slack off and the pie will shrink. The big tradeoff is one between the size of the pie and how equally it is shared. We trade off some pie for increased equality. Choices Bring Change What, how, and for whom goods and services are produced changes over time. The quantity and range of goods and services available today is much greater than it was a generation ago. But the quality of economic life (and its rate of improvement) doesn’t depend purely on nature and on luck. It depends on many of the choices made by each one of us, by governments, and by businesses. These choices also involve tradeoffs. One choice is that of how much of our income to consume and how much to save. Our saving can be channeled through the financial system to finance businesses and to pay for new capital that increases production. The more we save, the more financial capital is available for businesses to use to buy physical capital, so the more goods and services we can produce in the future. When you decide to save an extra $1,000 and forgo a vacation, you trade off the vacation for a higher future income. If everyone saves an extra $1,000 and businesses buy more equipment that increases production, future consumption per person rises. As a society, we trade off current consumption for economic growth and higher future consumption. A second choice is how much effort to devote to education and training. By becoming better educated and more highly skilled, we become more productive and are able to produce more goods and services. 9 When you decide to remain in school for another two years to complete a professional degree and forgo a huge chunk of leisure time, you trade off leisure today for a higher future income. If everyone becomes better educated, production increases and income per person rises. As a society, we trade off current consumption and leisure time for economic growth and higher future consumption. A third choice is how much effort to devote to research and the development of new products and production methods. Ford Motor Company can hire people either to design a new robotic assembly line or to operate the existing plant and produce cars. The robotic plant brings greater productivity in the future but means smaller current production—a tradeoff of current production for greater future production. Seeing choices as tradeoffs emphasizes the idea that to get something, we must give up something. What we give up is the cost of what we get. Economists call this cost the opportunity cost. Opportunity Cost “There’s no such thing as a free lunch” expresses the central idea of economics: Every choice has a cost. The opportunity cost of something is the highestvalued alternative that we must give up to get it. For example, you face an opportunity cost of being in school. That opportunity cost is the highest-valued alternative that you would do if you were not in school. If you quit school and take a job at McDonald’s, you earn enough to go to ball games and movies and spend lots of free time with your friends. If you remain in school, you can’t afford these things. You will be able to buy these things when you graduate and get a job, and that is one of the payoffs from being in school. But for now, when you’ve bought your books, you have nothing left for games and movies. Working on assignments leaves even less time for hanging out with your friends. Giving up games, movies, and free time is part of the opportunity cost of being in school. All the what, how, and for whom tradeoffs involve opportunity cost. The opportunity cost of some guns is the butter forgone; the opportunity cost of a movie ticket is the number of cups of coffee forgone. And the choices that bring change also involve opportunity cost. The opportunity cost of more goods and services in the future is less consumption today. 9160335_CH01_p001-030.qxd 10 6/22/09 8:55 AM Page 10 CHAPTER 1 What Is Economics? Choosing at the Margin You can allocate the next hour between studying and instant messaging your friends. But the choice is not all or nothing. You must decide how many minutes to allocate to each activity. To make this decision, you compare the benefit of a little bit more study time with its cost—you make your choice at the margin. The benefit that arises from an increase in an activity is called marginal benefit. For example, suppose that you’re spending four nights a week studying and your grade point average (GPA) is 3.0. You decide that you want a higher GPA and decide to study an extra night each week. Your GPA rises to 3.5. The marginal benefit from studying for one extra night a week is the 0.5 increase in your GPA. It is not the 3.5. You already have a 3.0 from studying for four nights a week, so we don’t count this benefit as resulting from the decision you are now making. The cost of an increase in an activity is called marginal cost. For you, the marginal cost of increasing your study time by one night a week is the cost of the additional night not spent with your friends (if that is your best alternative use of the time). It does not include the cost of the four nights you are already studying. To make your decision, you compare the marginal benefit from an extra night of studying with its marginal cost. If the marginal benefit exceeds the marginal cost, you study the extra night. If the marginal cost exceeds the marginal benefit, you do not study the extra night. By evaluating marginal benefits and marginal costs and choosing only those actions that bring greater benefit than cost, we use our scarce resources in the way that makes us as well off as possible. The central idea of economics is that we can predict how choices will change by looking at changes in incentives. More of an activity is undertaken when its marginal cost falls or its marginal benefit rises; less of an activity is undertaken when its marginal cost rises or its marginal benefit falls. Incentives are also the key to reconciling selfinterest and social interest. When our choices are not in the social interest, it is because of the incentives we face. One of the challenges for economists is to figure out the incentive systems that result in selfinterested choices also being in the social interest. Human Nature, Incentives, and Institutions Economists take human nature as given and view people as acting in their self-interest. All people— consumers, producers, politicians, and public servants—pursue their self-interest. Self-interested actions are not necessarily selfish actions. You might decide to use your resources in ways that bring pleasure to others as well as to yourself. But a self-interested act gets the most value for you based on your view about value. If human nature is given and if people act in their self-interest, how can we take care of the social interest? Economists answer this question by emphasizing the crucial role that institutions play in influencing the incentives that people face as they pursue their self-interest. A system of laws that protect private property and markets that enable voluntary exchange are the fundamental institutions. You will learn as you progress with your study of economics that where these institutions exist, self-interest can indeed promote the social interest. Responding to Incentives When we make choices we respond to incentives. A change in marginal cost or a change in marginal benefit changes the incentives that we face and leads us to change our choice. For example, suppose your economics instructor gives you a set of problems and tells you that all the problems will be on the next test. The marginal benefit from working these problems is large, so you diligently work them all. In contrast, if your math instructor gives you a set of problems and tells you that none of the problems will be on the next test, the marginal benefit from working these problems is lower, so you skip most of them. Review Quiz ◆ 1 2 3 4 Provide three everyday examples of tradeoffs and describe the opportunity cost involved in each. Provide three everyday examples to illustrate what we mean by choosing at the margin. How do economists predict changes in choices? What do economists say about the role of institutions in promoting the social interest? Work Study Plan 1.3 and get instant feedback. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 11 E conomics as Social Science and Policy Tool ◆ Economics as Social Science and Policy Tool Economics is both a science and a set of tools that can be used to make policy decisions. Economics as Social Science As social scientists, economists seek to discover how the economic world works. In pursuit of this goal, like all scientists, they distinguish between two types of statements: positive and normative. Positive Statements Positive statements are about what is. They say what is currently believed about the way the world operates. A positive statement might be right or wrong, but we can test a positive statement by checking it against the facts. “Our planet is warming because of the amount of coal that we’re burning” is a positive statement. “A rise in the minimum wage will bring more teenage unemployment” is another positive statement. Each statement might be right or wrong, and it can be tested. A central task of economists is to test positive statements about how the economic world works and to weed out those that are wrong. Economics first got off the ground in the late 1700s, so economics is a young subject compared with, for example, math and physics, and much remains to be discovered. Normative Statements Normative statements are statements about what ought to be. These statements depend on values and cannot be tested. The statement “We ought to cut back on our use of coal” is a normative statement. “The minimum wage should not be increased” is another normative statement. You may agree or disagree with either of these statements, but you can’t test them. They express an opinion, but they don’t assert a fact that can be checked. They are not economics. Unscrambling Cause and Effect Economists are espe- cially interested in positive statements about cause and effect. Are computers getting cheaper because people are buying them in greater quantities? Or are people buying computers in greater quantities because they are getting cheaper? Or is some third factor causing both the price of a computer to fall and the quantity of computers to increase? 11 To answer questions such as these, economists create and test economic models. An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand. For example, an economic model of a cell-phone network might include features such as the prices of calls, the number of cell-phone users, and the volume of calls. But the model would ignore such details as cell-phone colors and ringtones. A model is tested by comparing its predictions with the facts. But testing an economic model is difficult because we observe the outcomes of the simultaneous operation of many factors. To cope with this problem, economists use natural experiments, statistical investigations, and economic experiments. Natural Experiment A natural experiment is a situa- tion that arises in the ordinary course of economic life in which the one factor of interest is different and other things are equal (or similar). For example, Canada has higher unemployment benefits than the United States, but the people in the two nations are similar. So to study the effect of unemployment benefits on the unemployment rate, economists might compare the United States with Canada. Statistical Investigation A statistical investigation looks for correlation—a tendency for the values of two variables to move together (either in the same direction or in opposite directions) in a predictable and related way. For example, cigarette smoking and lung cancer are correlated. Sometimes a correlation shows a causal influence of one variable on the other. For example, smoking causes lung cancer. But sometimes the direction of causation is hard to determine. Steven Levitt, the author of Freakonomics, whom you can meet on pp. 224–226, is a master in the use of a combination of the natural experiment and statistical investigation to unscramble cause and effect. He has used the tools of economics to investigate the effects of good parenting on education (not very strong), to explain why drug dealers live with their mothers (because they don’t earn enough to live independently), and (controversially) the effects of abortion law on crime. Economic Experiment An economic experiment puts people in a decision-making situation and varies the influence of one factor at a time to discover how they respond. 9160335_CH01_p001-030.qxd 12 6/22/09 8:55 AM Page 12 CHAPTER 1 What Is Economics? Economics as Policy Tool Economics is useful. It is a toolkit for making decisions. And you don’t need to be a fully-fledged economist to think like one and to use the insights of economics as a policy tool. Economics provides a way of approaching problems in all aspects of our lives. Here, we’ll focus on the three broad areas of: ■ ■ ■ Personal economic policy Business economic policy Government economic policy Personal Economic Policy Should you take out a student loan? Should you get a weekend job? Should you buy a used car or a new one? Should you rent an apartment or take out a loan and buy a condominium? Should you pay off your credit card balance or make just the minimum payment? How should you allocate your time between study, working for a wage, caring for family members, and having fun? How should you allocate your time between studying economics and your other subjects? Should you quit school after getting a bachelor’s degree or should you go for a master’s or a professional qualification? All these questions involve a marginal benefit and a marginal cost. And although some of the numbers might be hard to pin down, you will make more solid decisions if you approach these questions with the tools of economics. Business Economic Policy Should Sony make only flat panel televisions and stop making conventional ones? Should Texaco get more oil and gas from the Gulf of Mexico or from Alaska? Should Palm outsource its online customer services to India or run the operation from California? Should Marvel Studios produce Spider-Man 4, a sequel to Spider-Man 3? Can Microsoft compete with Google in the search engine business? Can eBay compete with the surge of new Internet auction services? Is Jason Giambi really worth $23,400,000 to the New York Yankees? Like personal economic questions, these business questions involve the evaluation of a marginal benefit and a marginal cost. Some of the questions require a broader investigation of the interactions of individuals and firms. But again, by approaching these questions with the tools of economics and by hiring economists as advisers, businesses can make better decisions. Government Economic Policy How can California balance its budget? Should the federal government cut taxes or raise them? How can the tax system be simplified? Should people be permitted to invest their Social Security money in stocks that they pick themselves? Should Medicaid and Medicare be extended to the entire population? Should there be a special tax to penalize corporations that send jobs overseas? Should cheap foreign imports of furniture and textiles be limited? Should the farms that grow tomatoes and sugar beets receive a subsidy? Should water be transported from Washington and Oregon to California? These government policy questions call for decisions that involve the evaluation of a marginal benefit and a marginal cost and an investigation of the interactions of individuals and businesses. Yet again, by approaching these questions with the tools of economics, governments make better decisions. Notice that all the policy questions we’ve just posed involve a blend of the positive and the normative. Economics can’t help with the normative part— the objective. But for a given objective, economics provides a method of evaluating alternative solutions. That method is to evaluate the marginal benefits and marginal costs and to find the solution that brings the greatest available gain. Review Quiz ◆ 1 2 3 4 5 What is the distinction between a positive statement and a normative statement? Provide an example (different from those in the chapter) of each type of statement. What is a model? Can you think of a model that you might use (probably without thinking of it as a model) in your everyday life? What are the three ways in which economists try to disentangle cause and effect? How is economics used as a policy tool? What is the role of marginal analysis in the use of economics as a policy tool? Work Study Plan 1.4 and get instant feedback. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 13 Summary SUMMARY ◆ Key Points ■ Definition of Economics (p. 2) ■ ■ ■ ■ All economic questions arise from scarcity—from the fact that wants exceed the resources available to satisfy them. Economics is the social science that studies the choices that people make as they cope with scarcity. The subject divides into microeconomics and macroeconomics. Two Big Economic Questions (pp. 3–7) ■ ■ ■ ■ ■ Two big questions summarize the scope of economics: 1. How do choices end up determining what, how, and for whom goods and services are produced? 2. When do choices made in the pursuit of selfinterest also promote the social interest? The classic guns-versus-butter tradeoff represents all tradeoffs. All economic questions involve tradeoffs. The big social tradeoff is that between equality and efficiency. The highest-valued alternative forgone is the opportunity cost of what is chosen. Choices are made at the margin and respond to incentives. Economics as Social Science and Policy Tool (pp. 11–12) ■ ■ ■ The Economic Way of Thinking (pp. 8–10) ■ 13 Economists distinguish between positive statements—what is—and normative statements— what ought to be. To explain the economic world, economists create and test economic models. Economics is used in personal, business, and government economic policy decisions. The main policy tool is the evaluation and comparison of marginal cost and marginal benefit. Every choice is a tradeoff—exchanging more of something for less of something else. Key Terms Big tradeoff, 9 Capital, 4 Economic model, 11 Economics, 2 Entrepreneurship, 4 Factors of production, 3 Goods and services, 3 Human capital, 3 Incentive, 2 Interest, 4 Labor, 3 Land, 3 Macroeconomics, 2 Margin, 10 Marginal benefit, 10 Marginal cost, 10 Microeconomics, 2 Opportunity cost, 9 Profit, 4 Rent, 4 Scarcity, 2 Self-interest, 5 Social interest, 5 Tradeoff, 8 Wages, 4 9160335_CH01_p001-030.qxd 14 6/22/09 8:55 AM Page 14 CHAPTER 1 What Is Economics? PROBLEMS and APPLICATIONS ◆ Work problems 1–6 in Chapter 1 Study Plan and get instant feedback. Work problems 7–12 as Homework, a Quiz, or a Test if assigned by your instructor. 1. Apple Computer Inc. decides to make iTunes freely available in unlimited quantities. a. How does Apple’s decision change the opportunity cost of a download? b. Does Apple’s decision change the incentives that people face? c. Is Apple’s decision an example of a microeconomic or a macroeconomic issue? 2. Which of the following pairs does not match: a. Labor and wages? b. Land and rent? c. Entrepreneurship and profit? d. Capital and profit? 3. Explain how the following news headlines concern self-interest and the social interest: a. Wal-Mart Expands in Europe b. McDonald’s Moves into Salads c. Food Must Be Labeled with Nutrition Information 4. The night before an economics test, you decide to go to the movies instead of staying home and working your MyEconLab Study Plan. You get 50 percent on your test compared with the 70 percent that you normally score. a. Did you face a tradeoff? b. What was the opportunity cost of your evening at the movies? 5. Which of the following statements is positive, which is normative, and which can be tested? a. The U.S. government should cut its imports. b. China is the United States’ largest trading partner. c. If the price of antiretroviral drugs increases, HIV/AIDS sufferers will decrease their consumption of the drugs. 6. As London prepares to host the 2012 Olympic Games, concern about the cost of the event increases. An example: Costs Soar for London Olympics The regeneration of East London is set to add extra £1.5 billion to taxpayers’ bill. The Times, London, July 6, 2006 Is the cost of regenerating East London an opportunity cost of hosting the 2012 Olympic Games? Explain why or why not. 7. Before starring as Tony Stark in Iron Man, Robert Downey Jr. had played in 45 movies that had average first-weekend box office revenues of a bit less than $5 million. Iron Man grossed $102 million on its opening weekend. a. How do you expect the success of Iron Man to influence the opportunity cost of hiring Robert Downey Jr.? b. How have the incentives for a movie producer to hire Robert Downey Jr. changed? 8. How would you classify a movie star as a factor of production? 9. How does the creation of a successful movie influence what, how, and for whom goods and services are produced? 10. How does the creation of a successful movie illustrate self-interested choices that are also in the social interest? 11. Look at today’s Wall Street Journal. a. What is the top economic news story? With which of the big questions does it deal? (It must deal with at least one of them and might deal with more than one.) b. What tradeoffs does the news item discuss or imply? c. Write a brief summary of the news item using the economic vocabulary that you have learned in this chapter and as many as possible of the key terms listed on p. 13. 12. Use the link in MyEconLab (Textbook Resources, Chapter 1) to visit Resources for Economists on the Internet. This Web site is a good place from which to search for economic information on the Internet. Click on “Blogs, Commentaries, and Podcasts,” and then click on the Becker-Posner Blog. a. Read the latest blog by these two outstanding economists. b. As you read this blog, think about what it is saying about the “what,” “how,” and “for whom” questions. c. As you read this blog, think about what it is saying about self-interest and the social interest. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 15 A ppendix: Graphs in Economics After studying this appendix, you will be able to: Make and interpret a time-series graph, a cross-section graph, and a scatter diagram Distinguish between linear and nonlinear relationships and between relationships that have a maximum and a minimum ■ –60 Graph relationships among more than two variables 20 B C 32ºF and 20,320 ft 15 10 32ºF and 0 ft –30 A 0 30 –5 Negative x 60 90 120 Temperature (degrees F) Positive –10 Graphs have axes that measure quantities as distances. Here, the horizontal axis (x-axis) measures temperature, and the vertical axis (y-axis) measures height. Point A represents a fishing boat at sea level (0 on the y-axis) on a day when the temperature is 32ºF. Point B represents a climber at the top of Mt. McKinley, 20,320 feet above sea level at a temperature of 0ºF. Point C represents a climber at the top of Mt. McKinley, 20,320 feet above sea level at a temperature of 32ºF. ◆ Graphing Data A graph represents a quantity as a distance on a line. In Fig. A1.1, a distance on the horizontal line represents temperature, measured in degrees Fahrenheit. A movement from left to right shows an increase in temperature. The point 0 represents zero degrees Fahrenheit. To the right of 0, the temperature is positive. To the left of 0 (as indicated by the minus sign), the temperature is negative. A distance on the vertical line represents height, measured in thousands of feet. The point 0 represents sea level. Points above 0 represent feet above sea level. Points below 0 (indicated by a minus sign) represent feet below sea level. By setting two scales perpendicular to each other, as in Fig. A1.1, we can visualize the relationship between two variables. The scale lines are called axes. The vertical line is the y-axis, and the horizontal line is the x-axis. Each axis has a zero point, which is shared by the two axes and called the origin. We need two bits of information to make a twovariable graph: the value of the x variable and the value of the y variable. For example, off the coast of Alaska, the temperature is 32 degrees—the value of x. A fishing boat is located at 0 feet above sea level—the value of y. These two bits of information appear as point A in Fig. A1.1. A climber at the top of Mount McKinley on a cold day is 20,320 feet above sea level in a zero-degree gale. These two pieces of information appear as point B. On a warmer day, a climber might 0ºF and 20,320 ft 25 5 Define and calculate the slope of a line ■ y Origin Below sea level ■ Height (thousands of feet) Above sea level Graphs in Economics ■ Making a Graph FIGURE A1.1 APPENDIX 15 animation be at the peak of Mt. McKinley when the temperature is 32 degrees, at point C. We can draw two lines, called coordinates, from point C. One, called the y-coordinate, runs from C to the horizontal axis. Its length is the same as the value marked off on the y-axis. The other, called the xcoordinate, runs from C to the vertical axis. Its length is the same as the value marked off on the x-axis. We describe a point on a graph by the values of its xcoordinate and its y-coordinate. Graphs like that in Fig. A1.1 can show any type of quantitative data on two variables. Economists use three types of graphs based on the principles in Fig. A1.1 to reveal and describe the relationships among variables. They are ■ ■ ■ Time-series graphs Cross-section graphs Scatter diagrams 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 16 CHAPTER 1 What Is Econom ics? 16 Time-Series Graphs Price of gasoline (2006 dollars per gallon) A time-series graph measures time (for example, months or years) on the x-axis and the variable or variables in which we are interested on the y-axis. Figure A1.2 is an example of a time-series graph. It provides some information about the price of gasoline. In this figure, we measure time in years starting in 1973. We measure the price of gasoline (the variable that we are interested in) on the y-axis. The point of a time-series graph is to enable us to visualize how a variable has changed over time and how its value in one period relates to its value in another period. A time-series graph conveys an enormous amount of information quickly and easily, as this example illustrates. It shows FIGURE A1.2 A Time-Series Graph 3.00 High 2.50 Rising quickly 2.00 Falling quickly Rising slowly 1.50 Falling slowly Low 1.00 1973 1978 1983 1988 1993 1998 2003 2008 Year ■ ■ ■ The level of the price of gasoline—when it is high and low. When the line is a long way from the x-axis, the price is high, as it was, for example, in 1981. When the line is close to the x-axis, the price is low, as it was, for example, in 1998. How the price changes—whether it rises or falls. When the line slopes upward, as in 1979, the price is rising. When the line slopes downward, as in 1986, the price is falling. The speed with which the price changes—whether it rises or falls quickly or slowly. If the line is very steep, then the price rises or falls quickly. If the line is not steep, the price rises or falls slowly. For example, the price rose quickly between 1978 and 1980 and slowly between 1994 and 1996. The price fell quickly between 1985 and 1986 and slowly between 1990 and 1994. A time-series graph also reveals whether there is a general tendency for a variable to move in one direction. A trend might be upward or downward. In Fig. A1.2, the price of gasoline had a general tendency to fall during the 1980s and 1990s. That is, although the price rose and fell, the general tendency was for it to fall—the price had a downward trend. During the 2000s, the trend has been upward. A time-series graph also helps us to detect fluctuations in a variable around its trend. You can see some peaks and troughs in the price of gasoline in Fig. A1.2. Finally, a time-series graph also lets us quickly compare the variable in different periods. Figure A1.2 shows that the 1970s and 1980s were different from trend—a A time-series graph plots the level of a variable on the y-axis against time (day, week, month, or year) on the xaxis. This graph shows the price of gasoline (in 2006 dollars per gallon) each year from 1973 to 2006. It shows us when the price of gasoline was high and when it was low, when the price increased and when it decreased, and when the price changed quickly and when it changed slowly. animation the 1990s. The price of gasoline fluctuated more during the 1970s and 1980s than it did in the 1990s. You can see that a time-series graph conveys a wealth of information, and it does so in much less space than we have used to describe only some of its features. But you do have to “read” the graph to obtain all this information. Cross-Section Graphs A cross-section graph shows the values of an economic variable for different groups or categories at a point in time. Figure A1.3, called a bar chart, is an example of a cross-section graph. The bar chart in Fig. A1.3 shows 10 leisure pursuits and the percentage of the U. S. population that participated in them during 2005. The length of each bar indicates the percentage of the population. This figure enables you to compare the popularity of these 10 activities. And you can do so much more quickly and clearly than by looking at a list of numbers. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 17 Appendix: Graphs in Economics A Cross-Section Graph FIGURE A1.3 Scatter Diagrams A scatter diagram plots the value of one variable against the value of another variable. Such a graph reveals whether a relationship exists between two variables and describes their relationship. Figure A1.4(a) shows the relationship between expenditure and income. Each point shows expenditure per person and income per person in a given year from 1997 to 2007. The points are “scattered” within the graph. The point labeled A tells us that in 2000, income per person was $25,472 and expenditure per person was $23,862. The dots in this graph form a pattern, which reveals that as income increases, expenditure increases. Figure A1.4(b) shows the relationship between the number of computers sold and the price of a computer. This graph shows that as the price of a computer falls, the number of computers sold increases. Figure A1.4(c) shows a scatter diagram of inflation and unemployment in the United States. Here, the dots show no clear relationship between these two variables. Dining out Surfing the Internet Playing cards Baking Doing crossword puzzles Playing video games Going to the zoo Dancing Attending rock concerts Playing a musical instrument 0 10 20 30 Percentage of population 17 40 50 A cross-section graph shows the level of a variable across categories or groups. This bar chart shows 10 popular leisure activities and the percentage of the U.S. population that engages in each of them. animation 100 07 06 30 25 05 04 $23,862 02 A 99 20 0 98 97 03 01 00 $25,472 20 25 30 35 Income (thousands of dollars per year) (a) Expenditure and income 90 93 95 80 97 60 99 40 05 20 0 50 100 150 200 Computer sales (millions) (b) Computer sales and prices A scatter diagram reveals the relationship between two variables. Part (a) shows the relationship between expenditure and income. Each point shows the values of the two variables in a specific year. For example, point A shows that in 2000, average income was $25,472 and average expenditure was $23,862. The pattern formed by the points shows that as income increases, expenditure increases. animation 00 03 Inflation rate (percent per year) Expenditure (thousands of dollars per year) 35 Average computer price (percentage of 1990 price) Scatter Diagrams FIGURE A1.4 6 00 06 4 07 05 01 08 04 03 99 2 98 0 4 02 5 6 7 Unemployment rate (percent) (c) Unemployment and inflation Part (b) shows the relationship between the price of a computer and the number of computers sold from 1990 to 2005. This graph shows that as the price of a computer falls, the number of computers sold increases. Part (c) shows a scatter diagram of the U.S. inflation rate and the unemployment rate from 1998 to 2008. This graph shows that inflation and unemployment are not closely related. 9160335_CH01_p001-030.qxd 18 6/22/09 8:55 AM Page 18 CHAPTER 1 What Is Econom ics? Breaks in the Axes Two of the graphs you’ve just looked at, Fig. A1.4(a) and Fig. A1.4(c), have breaks in their axes, as shown by the small gaps. The breaks indicate that there are jumps from the origin, 0, to the first values recorded. In Fig. A1.4(a), the breaks are used because the lowest value of expenditure exceeds $20,000 and the lowest value of income exceeds $20,000. With no breaks in the axes, there would be a lot of empty space, all the points would be crowded into the top right corner, and we would not be able to see whether a relationship exists between these two variables. By breaking the axes, we are able to bring the relationship into view. Putting a break in one or both axes is like using a zoom lens to bring the relationship into the center of the graph and magnify it so that the relationship fills the graph. Misleading Graphs Breaks can be used to highlight a relationship, but they can also be used to mislead—to make a graph that lies. The most common way of making a graph lie is to use axis breaks and to either stretch or compress a scale. For example, suppose that in Fig. A1.4(a), the y-axis that measures expenditure ran from zero to $35,000 while the x-axis was the same as the one shown. The graph would now create the impression that despite a huge increase in income, expenditure had barely changed. To avoid being misled, it is a good idea to get into the habit of always looking closely at the values and the labels on the axes of a graph before you start to interpret it. ◆ Graphs Used in Economic Models The graphs used in economics are not always designed to show real-world data. Often they are used to show general relationships among the variables in an economic model. An economic model is a stripped-down, simplified description of an economy or of a component of an economy such as a business or a household. It consists of statements about economic behavior that can be expressed as equations or as curves in a graph. Economists use models to explore the effects of different policies or other influences on the economy in ways that are similar to the use of model airplanes in wind tunnels and models of the climate. You will encounter many different kinds of graphs in economic models, but there are some repeating patterns. Once you’ve learned to recognize these patterns, you will instantly understand the meaning of a graph. Here, we’ll look at the different types of curves that are used in economic models, and we’ll see some everyday examples of each type of curve. The patterns to look for in graphs are the four cases in which ■ Variables move in the same direction. ■ Variables move in opposite directions. ■ Variables have a maximum or a minimum. ■ Variables are unrelated. Let’s look at these four cases. Correlation and Causation A scatter diagram that shows a clear relationship between two variables, such as Fig. A1.4(a) or Fig. A1.4(b), tells us that the two variables have a high correlation. When a high correlation is present, we can predict the value of one variable from the value of the other variable. But correlation does not imply causation. Sometimes a high correlation is a coincidence, but sometimes it does arise from a causal relationship. It is likely, for example, that rising income causes rising expenditure (Fig. A1.4a) and that the falling price of a computer causes more computers to be sold (Fig. A1.4b). You’ve now seen how we can use graphs in economics to show economic data and to reveal relationships. Next, we’ll learn how economists use graphs to construct and display economic models. Variables That Move in the Same Direction Figure A1.5 shows graphs of the relationships between two variables that move up and down together. A relationship between two variables that move in the same direction is called a positive relationship or a direct relationship. A line that slopes upward shows such a relationship. Figure A1.5 shows three types of relationships, one that has a straight line and two that have curved lines. But all the lines in these three graphs are called curves. Any line on a graph—no matter whether it is straight or curved—is called a curve. A relationship shown by a straight line is called a linear relationship. Figure A1.5(a) shows a linear relationship between the number of miles traveled in 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 19 Appendix: Graphs in Economics Positive linear relationship 300 A 200 100 0 40 Problems worked (number) 400 Positive (Direct) Relationships Recovery time (minutes) Distance covered in 5 hours (miles) FIGURE A1.5 Positive, becoming steeper 30 20 40 60 80 Speed (miles per hour) (a) Positive linear relationship 0 20 Positive, becoming less steep 15 10 5 10 20 19 100 200 300 400 Distance sprinted (yards) (b) Positive, becoming steeper Each part of this figure shows a positive (direct) relationship between two variables. That is, as the value of the variable measured on the x-axis increases, so does the value of the variable measured on the y-axis. Part (a) shows a linear relationship—as the two variables increase together, we 0 2 4 6 8 Study time (hours) (c) Positive, becoming less steep move along a straight line. Part (b) shows a positive relationship such that as the two variables increase together, we move along a curve that becomes steeper. Part (c) shows a positive relationship such that as the two variables increase together, we move along a curve that becomes flatter. animation 5 hours and speed. For example, point A shows that we will travel 200 miles in 5 hours if our speed is 40 miles an hour. If we double our speed to 80 miles an hour, we will travel 400 miles in 5 hours. Figure A1.5(b) shows the relationship between distance sprinted and recovery time (the time it takes the heart rate to return to its normal resting rate). This relationship is an upward-sloping one that starts out quite flat but then becomes steeper as we move along the curve away from the origin. The reason this curve slopes upward and becomes steeper is because the additional recovery time needed from sprinting an additional 100 yards increases. It takes less than 5 minutes to recover from sprinting 100 yards but more than 10 minutes to recover from sprinting 200 yards. Figure A1.5(c) shows the relationship between the number of problems worked by a student and the amount of study time. This relationship is an upward-sloping one that starts out quite steep and becomes flatter as we move along the curve away from the origin. Study time becomes less productive as the student spends more hours studying and becomes more tired. Variables That Move in Opposite Directions Figure A1.6 shows relationships between things that move in opposite directions. A relationship between variables that move in opposite directions is called a negative relationship or an inverse relationship. Figure A1.6(a) shows the relationship between the hours spent playing squash and the hours spent playing tennis when the total number of hours available is 5. One extra hour spent playing tennis means one hour less playing squash and vice versa. This relationship is negative and linear. Figure A1.6(b) shows the relationship between the cost per mile traveled and the length of a journey. The longer the journey, the lower is the cost per mile. But as the journey length increases, even though the cost per mile decreases, the fall in the cost is smaller the longer the journey. This feature of the relationship is shown by the fact that the curve slopes downward, starting out steep at a short journey length and then becoming flatter as the journey length increases. This relationship arises because some of the costs are fixed, such as auto insurance, and the fixed costs are spread over a longer journey. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 20 CHAPTER 1 What Is Econom ics? Negative (Inverse) Relationships 5 Negative linear relationship 4 3 2 1 0 50 Negative, becoming less steep 40 30 20 10 1 2 3 4 5 Time playing tennis (hours) (a) Negative linear relationship 0 Problems worked (number) Time playing squash (hours) FIGURE A1.6 Travel cost (cents per mile) 20 25 Negative, becoming steeper 20 15 10 5 100 200 300 400 500 Journey length (miles) (b) Negative, becoming less steep Each part of this figure shows a negative (inverse) relationship between two variables. That is, as the value of the variable measured on the x-axis increases, the value of the variable measured on the y-axis decreases. Part (a) shows a linear relationship. The total time spent playing tennis and squash is 5 hours. As the time spent playing tennis increases, the time spent playing squash decreases, and 0 2 4 6 10 8 Leisure time (hours) (c) Negative, becoming steeper we move along a straight line. Part (b) shows a negative relationship such that as the journey length increases, the travel cost decreases as we move along a curve that becomes less steep. Part (c) shows a negative relationship such that as leisure time increases, the number of problems worked decreases as we move along a curve that becomes steeper. animation Figure A1.6(c) shows the relationship between the amount of leisure time and the number of problems worked by a student. Increasing leisure time produces an increasingly large reduction in the number of problems worked. This relationship is a negative one that starts out with a gentle slope at a small number of leisure hours and becomes steeper as the number of leisure hours increases. This relationship is a different view of the idea shown in Fig. A1.5(c). Variables That Have a Maximum or a Minimum Many relationships in economic models have a maximum or a minimum. For example, firms try to make the maximum possible profit and to produce at the lowest possible cost. Figure A1.7 shows relationships that have a maximum or a minimum. Figure A1.7(a) shows the relationship between rainfall and wheat yield. When there is no rainfall, wheat will not grow, so the yield is zero. As the rainfall increases up to 10 days a month, the wheat yield increases. With 10 rainy days each month, the wheat yield reaches its maximum at 40 bushels an acre (point A). Rain in excess of 10 days a month starts to lower the yield of wheat. If every day is rainy, the wheat suffers from a lack of sunshine and the yield decreases to zero. This relationship is one that starts out sloping upward, reaches a maximum, and then slopes downward. Figure A1.7(b) shows the reverse case—a relationship that begins sloping downward, falls to a minimum, and then slopes upward. Most economic costs are like this relationship. An example is the relationship between the cost per mile and speed for a car trip. At low speeds, the car is creeping in a traffic snarl-up. The number of miles per gallon is low, so the cost per mile is high. At high speeds, the car is traveling faster than its efficient speed, using a large quantity of gasoline, and again the number of miles per gallon is low and the cost per mile is high. At a speed of 55 miles an hour, the cost per mile is at its minimum (point B). This relationship is one that starts out sloping downward, reaches a minimum, and then slopes upward. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 21 A ppendix: Graphs in Economics Maximum and Minimum Points Maximum yield 50 A 40 30 20 Increasing yield Gasoline cost (cents per mile) Wheat yield (bushels per acre) FIGURE A1.7 15 Decreasing cost Increasing cost 10 Decreasing yield Minimum cost B 5 10 0 5 10 21 30 15 20 25 Rainfall (days per month) (a) Relationship with a maximum 0 15 35 95 55 75 Speed (miles per hour) Part (a) shows a relationship that has a maximum point, A. The curve slopes upward as it rises to its maximum point, is flat at its maximum, and then slopes downward. Part (b) shows a relationship with a minimum point, B. The curve slopes downward as it falls to its minimum, is flat at its minimum, and then slopes upward. (b) Relationship with a minimum animation Variables That Are Unrelated There are many situations in which no matter what happens to the value of one variable, the other variable remains constant. Sometimes we want to show the independence between two variables in a graph, and Fig. A1.8 shows two ways of achieving this. Variables That Are Unrelated 100 75 Unrelated: y constant 50 25 0 20 40 60 80 Price of bananas (cents per pound) (a) Unrelated: y constant animation Rainfall in California (days per month) Grade in economics (percent) FIGURE A1.8 In describing the graphs in Fig. A1.5 through A1.7, we have talked about curves that slope upward or slope downward, and curves that become less steep or steeper. Let’s spend a little time discussing exactly what we mean by slope and how we measure the slope of a curve. 20 15 Unrelated: x constant 10 5 0 1 2 3 4 Output of French wine (billions of gallons) (b) Unrelated: x constant This figure shows how we can graph two variables that are unrelated. In part (a), a student’s grade in economics is plotted at 75 percent on the y-axis regardless of the price of bananas on the x-axis. The curve is horizontal. In part (b), the output of the vineyards of France on the x-axis does not vary with the rainfall in California on the y-axis. The curve is vertical. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 22 CHAPTER 1 What Is Econom ics? 22 ◆ The Slope of a Relationship If a large change in the variable measured on the y-axis ( y) is associated with a small change in the variable measured on the x-axis ( x), the slope is large and the curve is steep. If a small change in the variable measured on the y-axis ( y) is associated with a large change in the variable measured on the x-axis ( x), the slope is small and the curve is flat. We can make the idea of slope clearer by doing some calculations. We can measure the influence of one variable on another by the slope of the relationship. The slope of a relationship is the change in the value of the variable measured on the y-axis divided by the change in the value of the variable measured on the x-axis. We use the Greek letter (delta) to represent “change in.” Thus y means the change in the value of the variable measured on the y-axis, and x means the change in the value of the variable measured on the x-axis. Therefore the slope of the relationship is The Slope of a Straight Line The slope of a straight line is the same regardless of where on the line you calculate it. The slope of a straight line is constant. Let’s calculate the slopes of the lines in Fig. A1.9. In part (a), when x increases ¢ y/ ¢ x. FIGURE A1.9 The Slope of a Straight Line y y 8 8 3 Slope = — 4 7 3 Slope = – — 4 7 6 6 5 5 y=3 ∇ 4 4 3 3 2 2 ∇ ∇ 0 ∇ x=4 1 y = –3 x=4 1 1 2 3 4 5 6 7 8 x (a) Positive slope 0 1 2 3 4 5 6 7 8 x (b) Negative slope To calculate the slope of a straight line, we divide the change in the value of the variable measured on the y-axis ( y) by the change in the value of the variable measured on the x-axis ( x) as we move along the curve. Part (a) shows the calculation of a positive slope. When x increases from 2 to 6, x equals 4. That change in x animation brings about an increase in y from 3 to 6, so y equals 3. The slope ( y/ x) equals 3/4. Part (b) shows the calculation of a negative slope. When x increases from 2 to 6, x equals 4. That increase in x brings about a decrease in y from 6 to 3, so y equals –3. The slope ( y/ x) equals –3/4. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 23 Appendix: Graphs in Economics from 2 to 6, y increases from 3 to 6. The change in x is +4—that is, x is 4. The change in y is +3—that is, y is 3. The slope of that line is ¢y ¢x = 3 . 4 In part (b), when x increases from 2 to 6, y decreases from 6 to 3. The change in y is minus 3— that is, y is –3. The change in x is plus 4—that is, x is 4. The slope of the curve is FIGURE A1.10 Slope at a Point y 8 7 3 Slope = — 4 6 A 5 4 ∇ -3 = . ¢x 4 Notice that the two slopes have the same magnitude (3/4), but the slope of the line in part (a) is positive (+3/+4 = 3/4) while that in part (b) is negative (–3/+4 = –3/4). The slope of a positive relationship is positive; the slope of a negative relationship is negative. The Slope of a Curved Line The slope of a curved line is trickier. The slope of a curved line is not constant, so the slope depends on where on the curved line we calculate it. There are two ways to calculate the slope of a curved line: You can calculate the slope at a point, or you can calculate the slope across an arc of the curve. Let’s look at the two alternatives. y=3 3 2 1 0 ∇ ¢y 23 1 x=4 2 3 4 5 6 7 8 x To calculate the slope of the curve at point A, draw the red line that just touches the curve at A—the tangent. The slope of this straight line is calculated by dividing the change in y by the change in x along the line. When x increases from 0 to 4, x equals 4. That change in x is associated with an increase in y from 2 to 5, so y equals 3. The slope of the red line is 3/4. So the slope of the curve at point A is 3/4. animation Slope at a Point To calculate the slope at a point on a curve, you need to construct a straight line that has the same slope as the curve at the point in question. Figure A1.10 shows how this is done. Suppose you want to calculate the slope of the curve at point A. Place a ruler on the graph so that it touches point A and no other point on the curve, then draw a straight line along the edge of the ruler. The straight red line is this line, and it is the tangent to the curve at point A. If the ruler touches the curve only at point A, then the slope of the curve at point A must be the same as the slope of the edge of the ruler. If the curve and the ruler do not have the same slope, the line along the edge of the ruler will cut the curve instead of just touching it. Now that you have found a straight line with the same slope as the curve at point A, you can calculate the slope of the curve at point A by calculating the slope of the straight line. Along the straight line, as x increases from 0 to 4 ( x = 4) y increases from 2 to 5 ( y = 3). Therefore the slope of the straight line is ¢y ¢x = 3 . 4 So the slope of the curve at point A is 3/4. Slope Across an Arc An arc of a curve is a piece of a curve. In Fig. A1.11, you are looking at the same curve as in Fig. A1.10. But instead of calculating the slope at point A, we are going to calculate the slope across the arc from B to C. You can see that the slope at B is greater than at C. When we calculate the slope across an arc, we are calculating the average slope between two points. As we move along the arc from B to C, x increases from 3 to 5 and y increases from 4 to 5.5. The change in x is 2 ( x 2), and the change 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 24 CHAPTER 1 What Is Econom ics? 24 ◆ Graphing Relationships Among Slope Across an Arc FIGURE A1.11 More Than Two Variables y 8.0 7.0 1.5 3 Slope = — = — 2 4 6.0 C 5.5 A 5.0 ∇ y = 1.5 B 4.0 3.0 x=2 ∇ 2.0 1.0 0 1 2 3 4 5 6 7 8 x To calculate the average slope of the curve along the arc BC, draw a straight line from B to C. The slope of the line BC is calculated by dividing the change in y by the change in x. In moving from B to C, x equals 2 and y equals 1.5. The slope of the line BC is 1.5 divided by 2, or 3/4. So the slope of the curve across the arc BC is 3/4. Ceteris Paribus Ceteris paribus means “if all other rel- animation in y is 1.5 ( y 1.5). Therefore the slope is ¢y ¢x = We have seen that we can graph the relationship between two variables as a point formed by the xand y-coordinates in a two-dimensional graph. You might be thinking that although a two-dimensional graph is informative, most of the things in which you are likely to be interested involve relationships among many variables, not just two. For example, the amount of ice cream consumed depends on the price of ice cream and the temperature. If ice cream is expensive and the temperature is low, people eat much less ice cream than when ice cream is inexpensive and the temperature is high. For any given price of ice cream, the quantity consumed varies with the temperature; and for any given temperature, the quantity of ice cream consumed varies with its price. Figure A1.12 shows a relationship among three variables. The table shows the number of gallons of ice cream consumed each day at various temperatures and ice cream prices. How can we graph these numbers? To graph a relationship that involves more than two variables, we use the ceteris paribus assumption. 1.5 3 =. 2 4 So the slope of the curve across the arc BC is 3/4. This calculation gives us the slope of the curve between points B and C. The actual slope calculated is the slope of the straight line from B to C. This slope approximates the average slope of the curve along the arc BC. In this particular example, the slope across the arc BC is identical to the slope of the curve at point A. But the calculation of the slope of a curve does not always work out so neatly. You might have fun constructing some more examples and a few counterexamples. You now know how to make and interpret a graph. But so far, we’ve limited our attention to graphs of two variables. We’re now going to learn how to graph more than two variables. evant things remain the same.” To isolate the relationship of interest in a laboratory experiment, we hold other things constant. We use the same method to graph a relationship with more than two variables. Figure A1.12(a) shows an example. There, you can see what happens to the quantity of ice cream consumed when the price of ice cream varies and the temperature is held constant. The line labeled 70°F shows the relationship between ice cream consumption and the price of ice cream if the temperature remains at 70°F. The numbers used to plot that line are those in the third column of the table in Fig. A1.12. For example, if the temperature is 70°F, 10 gallons are consumed when the price is 60¢ a scoop, and 18 gallons are consumed when the price is 30¢ a scoop. The curve labeled 90°F shows consumption as the price varies if the temperature remains at 90°F. We can also show the relationship between ice cream consumption and temperature when the price of ice cream remains constant, as shown in Fig. A1.12(b). The curve labeled 60¢ shows how the consumption of ice cream varies with the temperature 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 25 Appendix: Graphs in Economics 100 80 60 40 0 60¢ 70 15¢ 50 30 90ºF 20 90 Temperature (degrees F) Graphing a Relationship Among Three Variables Temperature (degrees F) Price (cents per scoop) FIGURE A1.12 25 90 10 gallons 70 7 gallons 50 30 70ºF 10 20 40 60 Ice cream consumption (gallons per day) (a) Price and consumption at a given temperature 0 10 (b) Temperature and consumption at a given price Ice cream consumption Price (gallons per day) 30°F 50°F 70°F 90°F 15 12 18 25 50 30 10 12 18 37 45 7 10 13 27 60 5 7 10 20 75 3 5 7 14 90 2 3 5 10 105 1 2 3 6 (cents per scoop) 40 20 Ice cream consumption (gallons per day) 0 20 40 80 100 60 Price (cents per scoop) (c) Temperature and price at a given consumption Ice cream consumption depends on its price and the temperature. The table tell us how many gallons of ice cream are consumed each day at different prices and different temperatures. For example, if the price is 60¢ a scoop and the temperature is 70ºF, 10 gallons of ice cream are consumed. This set of values is highlighted in the table and each part of the figure. To graph a relationship among three variables, the value of one variable is held constant. Part (a) shows the relationship between price and consumption when temperature is held constant. One curve holds temperature at 90ºF and the other holds it at 70ºF. Part (b) shows the relationship between temperature and consumption when price is held constant. One curve holds the price at 60¢ a scoop and the other holds it at 15¢ a scoop. Part (c) shows the relationship between temperature and price when consumption is held constant. One curve holds consumption at 10 gallons and the other holds it at 7 gallons. animation when the price of ice cream is 60¢ a scoop, and a second curve shows the relationship when the price is 15¢ a scoop. For example, at 60¢ a scoop, 10 gallons are consumed when the temperature is 70°F and 20 gallons are consumed when the temperature is 90°F. Figure A1.12(c) shows the combinations of temperature and price that result in a constant consumption of ice cream. One curve shows the combinations that result in 10 gallons a day being consumed, and the other shows the combinations that result in 7 gallons a day being consumed. A high price and a high temperature lead to the same consumption as a lower price and a lower temperature. For example, 10 gallons of ice cream are consumed at 70°F and 60¢ a scoop, at 90°F and 90¢ a scoop, and at 50°F and 45¢ a scoop. ◆ With what you have learned about graphs, you can move forward with your study of economics. There are no graphs in this book that are more complicated than those that have been explained in this appendix. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 26 CHAPTER 1 What Is Econom ics? 26 MATHEMATICAL NOTE ◆ Equations of Straight Lines If a straight line in a graph describes the relationship between two variables, we call it a linear relationship. Figure 1 shows the linear relationship between a person’s expenditure and income. This person spends $100 a week (by borrowing or spending previous savings) when income is zero. And out of each dollar earned, this person spends 50 cents (and saves 50 cents). All linear relationships are described by the same general equation. We call the quantity that is measured on the horizontal axis (or x-axis) x, and we call the quantity that is measured on the vertical axis (or y-axis) y. In the case of Fig. 1, x is income and y is expenditure. straight line hits the y-axis at a value equal to a. Figure 1 illustrates the y-axis intercept. For positive values of x, the value of y exceeds a. The constant b tells us by how much y increases above a as x increases. The constant b is the slope of the line. Slope of Line As we explain in the chapter, the slope of a relationship is the change in the value of y divided by the change in the value of x. We use the Greek letter (delta) to represent “change in.” So y means the change in the value of the variable measured on the y-axis, and x means the change in the value of the variable measured on the x-axis. Therefore the slope of the relationship is y/ x. A Linear Equation y a bx. Expenditure (dollars per week) In this equation, a and b are fixed numbers and they are called constants. The values of x and y vary, so these numbers are called variables. Because the equation describes a straight line, the equation is called a linear equation. The equation tells us that when the value of x is zero, the value of y is a. We call the constant a the y-axis intercept. The reason is that on the graph the 400 y = a + bx Value of y Slope = b 300 200 To see why the slope is b, suppose that initially the value of x is x1, or $200 in Fig. 2. The corresponding value of y is y1, also $200 in Fig. 2. The equation of the line tells us that y1 a bx 1. (1) Now the value of x increases by x to x 1 + x (or $400 in Fig. 2). And the value of y increases by y to y 1 + y (or $300 in Fig. 2). The equation of the line now tells us that y y1 Expenditure (dollars per week) The equation that describes a straight-line relationship between x and y is a b(x 1 x) 400 y1 + Δy 300 Δy 200 y1 100 0 y-axis intercept = a 100 200 Value of x 100 Δx x1 300 400 500 Income (dollars per week) Figure 1 Linear relationship 0 100 200 x 1 + Δx 300 400 500 Income (dollars per week) Figure 2 Calculating slope (2) 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 27 M athematical Note To calculate the slope of the line, subtract equation (1) from equation (2) to obtain y bx (3) and now divide equation (3) by x to obtain y/ x relationships have a slope that is positive. In the equation of the line, the constant b is positive. In this example, the y-axis intercept, a, is 100. The slope b equals y/ x, which in Fig. 2 is 100/200 or 0.5. The equation of the line is y b. 100 Position of Line The y-axis intercept determines the position of the line on the graph. Figure 3 illustrates the relationship between the y-axis intercept and the position of the line. In this graph, the y-axis measures saving and the x-axis measures income. When the y-axis intercept, a, is positive, the line hits the y-axis at a positive value of y—as the blue line does. Its y-axis intercept is 100. When the y-axis intercept, a, is zero, the line hits the y-axis at the origin— as the purple line does. Its y-axis intercept is 0. When the y-axis intercept, a, is negative, the line hits the y-axis at a negative value of y—as the red line does. Its y-axis intercept is –100. As the equations of the three lines show, the value of the y-axis intercept does not influence the slope of the line. All three lines have a slope equal to 0.5. Figure 4 shows a negative relationship—the two variables x and y move in the opposite direction. All negative relationships have a slope that is negative. In the equation of the line, the constant b is negative. In the example in Fig. 4, the y-axis intercept, a, is 30. The slope, b, equals y/ x, which is –20/2 or –10. The equation of the line is y 30 Positive Relationships Figure 1 shows a positive relationship—the two variables x and y move in the same direction. All positive ( 10)x or y 30 10x. Example A straight line has a y-axis intercept of 50 and a slope of 2. What is the equation of this line? The equation of a straight line is y Saving (dollars per week) 0.5x. Negative Relationships So the slope of the line is b. a bx where a is the y-axis intercept and b is the slope. So the equation is y 50 2x. y 300 Positive y-axis intercept, a = 100 y = 100 + 0.5x 200 y = 0.5x 100 20 Positive y-axis intercept, a = 30 y = –100 + 0.5x 30 Slope, b = –10 20 0 –100 –200 100 200 300 400 500 600 Income (dollars per week) 10 Negative y-axis intercept, a = –100 y = 30 – 10x 0 Figure 3 The y-axis intercept 27 1 2 Figure 4 Negative relationship x 9160335_CH01_p001-030.qxd 28 6/22/09 8:55 AM Page 28 CHAPTER 1 What Is Econom ics? Review Quiz ◆ 1 2 3 4 5 What are the three types of graphs used to show economic data? Give an example of a time-series graph. List three things that a time-series graph shows quickly and easily. Give three examples, different from those in the chapter, of scatter diagrams that show a positive relationship, a negative relationship, and no relationship. Draw some graphs to show the relationships between two variables a. That move in the same direction. SUMMARY 6 7 8 Work Study Plan 1.A and get instant feedback. ◆ Key Points The Slope of a Relationship (pp. 22–24) ■ Graphing Data (pp. 15–18) ■ ■ ■ A time-series graph shows the trend and fluctuations in a variable over time. A cross-section graph shows how the value of a variable changes across the members of a population. A scatter diagram shows the relationship between two variables. It shows whether two variables are positively related, negatively related, or unrelated. Graphs Used in Economic Models (pp. 18–21) ■ ■ b. That move in opposite directions. c. That have a maximum. d. That have a minimum. Which of the relationships in question 5 is a positive relationship and which is a negative relationship? What are the two ways of calculating the slope of a curved line? How do we graph a relationship among more than two variables? Graphs are used to show relationships among variables in economic models. Relationships can be positive (an upward-sloping curve), negative (a downward-sloping curve), positive and then negative (have a maximum point), negative and then positive (have a minimum point), or unrelated (a horizontal or vertical curve). ■ ■ The slope of a relationship is calculated as the change in the value of the variable measured on the y-axis divided by the change in the value of the variable measured on the x-axis—that is, y/ x. A straight line has a constant slope. A curved line has a varying slope. To calculate the slope of a curved line, we calculate the slope at a point or across an arc. Graphing Relationships Among More Than Two Variables (pp. 24–25) ■ ■ To graph a relationship among more than two variables, we hold constant the values of all the variables except two. We then plot the value of one of the variables against the value of another. Key Figures Figure A1.1 Figure A1.5 Figure A1.6 Figure A1.7 Making a Graph, 15 Positive (Direct) Relationships, 19 Negative (Inverse) Relationships, 20 Maximum and Minimum Points, 21 Figure A1.9 The Slope of a Straight Line, 22 Figure A1.10 Slope at a Point, 23 Figure A1.11 Slope Across an Arc, 24 Key Terms Ceteris paribus, 24 Cross-section graph, 16 Direct relationship, 18 Inverse relationship, 19 Linear relationship, 18 Negative relationship, 19 Positive relationship, 18 Scatter diagram, 17 Slope, 22 Time-series graph, 16 Trend, 16 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 29 P roblems and Applications PROBLEMS and APPLICATIONS 29 ◆ Work problems 1–5 in Chapter 1A Study Plan and get instant feedback. Work problems 6–10 as Homework, a Quiz, or a Test if assigned by your instructor. 1. The spreadsheet provides data on the U.S. economy: Column A is the year, column B is the inflation rate, column C is the interest rate, column D is the growth rate, and column E is the unemployment rate. 3. Calculate the slope of the following relationship. y 10 8 A B C D E 1 1997 2.8 7.6 2.5 5.6 2 1998 2.9 7.4 3.7 5.4 3 1999 2.3 7.3 4.5 4.9 4 2000 1.6 6.5 4.2 4.5 5 2001 2.2 7.0 4.4 4.2 6 2002 3.4 7.6 3.7 4.0 7 2003 2.8 7.1 0.8 4.7 8 2004 1.6 6.5 3.6 5.8 9 2005 2.3 5.7 3.1 6.0 10 2006 2.5 5.6 2.9 4.6 11 2007 4.1 5.6 2.2 4.6 a. Draw a time-series graph of the inflation rate. b. In which year(s) (i) was inflation highest, (ii) was inflation lowest, (iii) did it increase, (iv) did it decrease, (v) did it increase most, and (vi) did it decrease most? c. What was the main trend in inflation? d. Draw a scatter diagram of the inflation rate and the interest rate. Describe the relationship. e. Draw a scatter diagram of the growth rate and the unemployment rate. Describe the relationship. 2. ‘Hulk’ Tops Box Office With Sales of $54.5 Million: Theaters Movie Hulk The Happening Zohan Crystal Skull Revenue (number) 6 4 2 0 4.0 8.0 x 4. Calculate the slope of the following relationship: a. At point A and at point B. b. Across the arc AB. y 10.0 8.0 A 6.0 4.0 B 1.5 0 2 4 6 8 10 x 5. The table gives the price of a balloon ride, the temperature, and the number of rides a day. (dollars per theater) 3,505 15,560 2,986 10,214 3,462 4,737 3,804 3,561 Bloomberg.com, June 15, 2008 a. Draw a graph to show the relationship between the revenue per theater on the y-axis and the number of theaters on the x-axis. Describe the relationship. b. Calculate the slope of the relationship between 3,462 and 3,804 theaters. 12.0 Balloon rides (number per day) Price (dollars per ride) 50ºF 70ºF 90ºF 5 32 40 50 10 27 32 40 15 18 27 32 Draw graphs to show the relationship between a. The price and the number of rides, holding the temperature constant. Describe this relationship. b. The number of rides and temperature, holding the price constant. 9160335_CH01_p001-030.qxd 6/22/09 8:55 AM Page 30 CHAPTER 1 What Is Econom ics? 30 6. The spreadsheet provides data on oil and gasoline: Column A is the year, column B is the price of oil (dollars per barrel), column C is the price of gasoline (cents per gallon), column D is U.S. oil production, and column E is the U.S. quantity of gasoline refined (both in millions of barrels per day). A B C D E 1 1997 16 117 2.35 1998 9 98 2.28 1999 24 131 2.15 8.3 4 2000 22 145 2.13 8.0 5 2001 18 111 2.12 8.3 6 2002 30 144 2.10 8.8 7 2003 28 153 2.07 8.7 8 2004 36 184 1.98 9.2 A 8.3 3 y 18 8.3 2 8. Calculate the slope of the following relationship at point A. 9 2005 52 224 1.89 8.9 10 2006 57 239 1.86 9.4 11 2007 90 303 1.86 10 0 4 x 9 9. Calculate the slope of the following relationship: a. At point A and at point B. b. Across the arc AB. 9.1 y a. Draw a time-series graph of the quantity of gasoline refined. b. In which year(s) (i) was the quantity of gasoline refined highest, (ii) was it lowest, (iii) did it increase, (iv) did it decrease, (v) did it increase most, and (vi) did it decrease most? c. What was the main trend in this quantity? d. Draw a scatter diagram of the price of oil and the quantity of oil. Describe the relationship. e. Draw a scatter diagram of the price of gasoline and the quantity of gasoline. Describe the relationship. 7. Draw a graph that shows the relationship between the two variables x and y: x y 0 25 1 24 2 22 3 18 4 12 5 0 a. Is the relationship positive or negative? b. Does the slope of the relationship increase or decrease as the value of x increases? c. Think of some economic relationships that might be similar to this one. d. Calculate the slope of the relationship between x and y when x equals 3. e. Calculate the slope of the relationship across the arc as x increases from 4 to 5. A 6 4 B 2 0 1 2 3 4 5 x 10. The table gives information about umbrellas: price, the number purchased, and rainfall. Umbrellas (number per day) Price (dollars per umbrella) 0 20 30 40 4 2 1 1 2 (inches of rainfall) 7 4 2 8 7 4 Draw graphs to show the relationship between a. Price and the number of umbrellas purchased, holding the amount of rainfall constant. Describe this relationship. b. The number of umbrellas purchased and the amount of rainfall, holding the price constant. Describe this relationship. ...
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This note was uploaded on 02/07/2010 for the course ECON 251 taught by Professor Blanchard during the Fall '08 term at Purdue University-West Lafayette.

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