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Unformatted text preview: 000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 1PART ONE IntroductionAfter studying this chapter,you will be able to:Define economics and distinguish betweenmicroeconomics and macroeconomicsExplain the two big questions of economicsExplain the key ideas that define the economic way ofthinkingExplain how economists go about their work as socialscientists and policy advisers1You are studying economics at a time of extraordinary challenge and change.The United States, Europe, and Japan, the worlds richest nations, are still notfully recovered from a deep recession in which incomes shrank and millions ofjobs were lost. Brazil, China, India, and Russia, poorer nations with acombined population that dwarfs our own, are growing rapidly and playingever-greater roles in an expanding global economy.The economic events of the past few years stand as a stark reminder that welive in a changing and sometimes turbulent world. New businesses are born andold ones die. New jobs are created and old onesdisappear. Nations, businesses, and individuals must findways of coping with economic change.Your life will be shaped by the challenges that youface and the opportunities that you create. But to face those challenges andseize the opportunities they present, you must understand the powerful forces atplay. The economics that youre about to learn will become your most reliableguide. This chapter gets you started. It describes the questions that economiststry to answer and the ways in which they think as they search for the answers.WHAT IS ECONOMICS?1000200010270728684_CH01_p001-026.qxd26/22/113:59 PMPage 2CHAPTER 1 What Is Economics?x Definition of EconomicsA fundamental fact dominates our lives: We wantmore than we can get. Our inability to get everythingwe want is called scarcity. Scarcity is universal. It confronts all living things. Even parrots face scarcity!Because we cant get everything we want, we mustmake choices. You cant afford both a laptop and aniPhone, so you must choose which one to buy. Youcant spend tonight both studying for your next testand going to the movies, so again, you must choosewhich one to do. Governments cant spend a tax dollar on both national defense and environmental protection, so they must choose how to spend that dollar.Your choices must somehow be made consistentwith the choices of others. If you choose to buy a laptop, someone else must choose to sell it. Incentives reconcile choices. An incentive is a reward that encouragesan action or a penalty that discourages one. Prices actas incentives. If the price of a laptop is too high, morewill be offered for sale than people want to buy. And ifthe price is too low, fewer will be offered for sale thanpeople want to buy. But there is a price at whichchoices to buy and sell are consistent.Economics is the social science that studies thechoices that individuals, businesses, governments,and entire societies make as they cope with scarcityand the incentives that influence and reconcile thosechoices.Not only do I want a crackerwe all want a cracker! The New Yorker Collection 1985Frank Modell from All Rights Reserved.Think about the things that you want and thescarcity that you face. You want to live a long andhealthy life. You want to go to a good school, college,or university. You want to live in a well-equipped,spacious, and comfortable home. You want the latestsmart phone and a faster Internet connection foryour laptop or iPad. You want some sports and recreational gearperhaps some new running shoes, or anew bike. And you want more time, much more thanis available, to go to class, do your homework, playsports and games, read novels, go to the movies, listento music, travel, and hang out with your friends.What you can afford to buy is limited by yourincome and by the prices you must pay. And yourtime is limited by the fact that your day has 24 hours.You want some other things that only governments provide. You want to live in a peaceful andsecure world and safe neighborhood and enjoy thebenefits of clean air, lakes, and rivers.What governments can afford is limited by thetaxes they collect. Taxes lower peoples incomes andcompete with the other things they want to buy.What everyone can getwhat society can getislimited by the productive resources available. Theseresources are the gifts of nature, human labor andingenuity, and all the previously produced tools andequipment.The subject has two parts:Microeconomicss MacroeconomicsMicroeconomics is the study of the choices that individuals and businesses make, the way these choicesinteract in markets, and the influence of governments.Some examples of microeconomic questions are: Whyare people downloading more movies? How would atax on e-commerce affect eBay?Macroeconomics is the study of the performance ofthe national economy and the global economy. Someexamples of macroeconomic questions are: Why isthe U.S. unemployment rate so high? Can theFederal Reserve make our economy expand by cutting interest rates?sREVIEW QUIZ123List some examples of the scarcity that you face.Find examples of scarcity in todays headlines.Find an illustration of the distinction betweenmicroeconomics and macroeconomics intodays headlines.You can work these questions in StudyPlan 1.1 and get instant feedback.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 3Two Big Economic Questionsx Two Big EconomicFIGURE 1.13What Three Countries ProduceQuestionsTwo big questions summarize the scope of economics:ssUnited StatesHow do choices end up determining what, how,and for whom goods and services are produced?Can the choices that people make in the pursuit oftheir own self-interest also promote the broadersocial interest?BrazilChinaWhat, How, and For Whom?are the objects that people valueand produce to satisfy human wants. Goods are physical objects such as cell phones and automobiles.Services are tasks performed for people such as cellphone service and auto-repair service.0204060Percentage of productionGoods and servicesWhat? What we produce varies across countries andchanges over time. In the United States today, agriculture accounts for 1 percent of total production,manufactured goods for 22 percent, and services(retail and wholesale trade, health care, and educationare the biggest ones) for 77 percent. In contrast, inChina today, agriculture accounts for 11 percent oftotal production, manufactured goods for 49 percent,and services for 40 percent. Figure 1.1 shows thesenumbers and also the percentages for Brazil, whichfall between those for the United States and China.What determines these patterns of production?How do choices end up determining the quantities ofcell phones, automobiles, cell-phone service, autorepair service, and the millions of other items that areproduced 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 fourcategories:duction.ssssLandLaborCapitalEntrepreneurshipLand The gifts of nature that we use to producegoods and services are called land. In economics,land is what in everyday language we call naturalresources. It includes land in the everyday senseAgricultureManufacturing80100ServicesAgriculture and manufacturing is a small percentage of production in rich countries such as the United States and alarge percentage of production in poorer countries such asChina. Most of what is produced in the United States isservices.Source of data: CIA Factbook 2010, Central Intelligence Agency.animationtogether 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 energyare nonrenewablethey can be used only once.The work time and work effort that peopledevote to producing goods and services is calledlabor. Labor includes the physical and mental effortsof 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 obtainfrom education, on-the-job training, and work experience. You are building your own human capitalright now as you work on your economics course,and your human capital will continue to grow as yougain work experience.Human capital expands over time. Today, 87 percent of the adult population of the United States havecompleted high school and 29 percent have a collegeor university degree. Figure 1.2 shows these measuresof the growth of human capital in the United Statesover the past century.Labor000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 4CHAPTER 1 What Is Economics?4Percentage of adult population100For Whom? Who consumes the goods and servicesthat are produced depends on the incomes that people earn. People with large incomes can buy a widerange of goods and services. People with smallincomes have fewer options and can afford a smallerrange of goods and services.People earn their incomes by selling the services ofthe factors of production they own:A Measure of HumanCapitalFIGURE 1.2Less than 5 years ofelementary school75Some high schoolsCompletedhigh school50sss254 years ormore of college01908Year19281948196819882008In 2008 (the most recent data), 29 percent of the population had 4 years or more of college, up from 2 percent in1908. A further 58 percent had completed high school, upfrom 10 percent in 1908.Source of data: U.S. Census Bureau, Statistical Abstract of theUnited States, 2010.animationThe 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 arefinancial capital. Financial capital plays an importantrole in enabling businesses to borrow the funds thatthey use to buy physical capital. But because financialcapital is not used to produce goods and services, it isnot a productive resource.CapitalThe human resource thatorganizes labor, land, and capital is called entrepreneurship. Entrepreneurs come up with new ideasabout what and how to produce, make businessdecisions, and bear the risks that arise from thesedecisions.EntrepreneurshipWhat determines the quantities of factors ofproduction that are used to produce goods andservices?Land earns rent.Labor earns wages.Capital earns interest.Entrepreneurship earns profit.Which factor of production earns the mostincome? The answer is labor. Wages and fringebenefits are around 70 percent of total income.Land, capital, and entrepreneurship share the rest.These percentages have been remarkably constantover time.Knowing how income is shared among the factors of production doesnt tell us how it is sharedamong individuals. And the distribution of incomeamong individuals is extremely unequal. You knowof some people who earn very large incomes:Angelina Jolie earns $10 million per movie; and theNew York Yankees pays Alex Rodriguez $27.5 million a year.You know of even more people who earn verysmall incomes. Servers at McDonalds averagearound $7.25 an hour; checkout clerks, cleaners,and textile and leather workers all earn less than $10an hour.You probably know about other persistent differences in incomes. Men, on average, earn morethan women; whites earn more than minorities;college graduates earn more than high-schoolgraduates.We can get a good sense of who consumesthe goods and services produced by looking atthe percentages of total income earned bydifferent groups of people. The 20 percent of people with the lowest incomes earn about 5 percentof total income, while the richest 20 percent earnclose to 50 percent of total income. So on average,people in the richest 20 percent earn more than10 times the incomes of those in the poorest20 percent.Why is the distribution of income so unequal?Why do women and minorities earn less than whitemales?000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 5Two Big Economic QuestionsEconomic Instability The years between 1993 and2007 were a period of remarkable economic stability,so much so that theyve been called the GreatModeration. During those years, the U.S. and globaleconomies were on a roll. Incomes in the UnitedStates increased by 30 percent and incomes in Chinatripled. Even the economic shockwaves of 9/11Economics in ActionA Credit CrunchFlush with funds and offering record low interestrates, banks went on a lending spree to home buyers.Rapidly rising home prices made home owners feelwell off and they were happy to borrow and spend.Home loans were bundled into securities that weresold and resold to banks around the world.In 2006, as interest rates began to rise and therate of rise in home prices slowed, borrowersdefaulted on their loans. What started as a tricklebecame a flood. As more people defaulted, bankstook losses that totaled billions of dollars by mid2007.Global credit markets stopped working, andpeople began to fear a prolonged slowdown in economic activity. Some even feared the return of theeconomic trauma of the Great Depression of the1930s when more than 20 percent of the U.S. laborforce was unemployed. The Federal Reserve, determined to avoid a catastrophe, started lending on avery large scale to the troubled banks.5brought only a small dip in the strong pace of U.S.and global economic growth.But in August 2007, a period of financial stressbegan. A bank in France was the first to feel the painthat soon would grip the entire global financialsystem.Banks take in peoples deposits and get more fundsby borrowing from each other and from other firms.Banks use these funds to make loans. All the bankschoices to borrow and lend and the choices of peopleand businesses to lend to and borrow from banks aremade in self-interest. But does this lending and borrowing serve the social interest? Is there too much borrowing and lending that needs to be reined in, or is theretoo little and a need to stimulate more?When the banks got into trouble, the FederalReserve (the Fed) bailed them out with big loansbacked by taxpayer dollars. Did the Feds bailout oftroubled banks serve the social interest? Or might theFeds rescue action encourage banks to repeat theirdangerous lending in the future?Banks werent the only recipients of public funds.General Motors was saved by a government bailout.GM makes its decisions in its self-interest. The government bailout of GM also served the firms self-interest.Did the bailout also serve the social interest?REVIEW QUIZ12Describe the broad facts about what, how, andfor whom goods and services are produced.Use headlines from the recent news to illustratethe potential for conflict between self-interestand the social interest.You can work these questions in StudyPlan 1.2 and get instant feedback.Weve looked at four topics and asked many questions that illustrate the big question: Can choicesmade in the pursuit of self-interest also promote thesocial interest? Weve asked questions but notanswered them because weve not yet explained theeconomic principles needed to do so.By working through this book, you will discoverthe economic principles that help economists figureout when the social interest is being served, when it isnot, and what might be done when it is not beingserved. We will return to each of the unansweredquestions in future chapters.000200010270728684_CH01_p001-026.qxd66/22/113:59 PMPage 6CHAPTER 1 What Is Economics?x The Economic Wayof ThinkingThe questions that economics tries to answer tell usabout the scope of economics, but they dont tell ushow economists think and go about seeking answersto these questions. Youre now going to see how economists go about their work.Were going to look at six key ideas that define theeconomic way of thinking. These ideas ares A choice is a tradeoff.s People make rational choices by comparing b enefits and costs.s Benefit is what you gain from something.s Cost is what you must give up to get something.s Most choices are how-much choices made at themargin.s Choices respond to incentives.A Choice Is a TradeoffBecause we face scarcity, we must make choices.And when we make a choice, we select from theavailable alternatives. For example, you can spendSaturday night studying for your next economicstest or having fun with your friends, but you cantdo both of these activities at the same time. Youmust choose how much time to devote to each.Whatever choice you make, you could have chosensomething else.You can think about your choices as tradeoffs. Atradeoff is an exchangegiving up one thing to getsomething else. When you choose how to spend yourSaturday night, you face a tradeoff between studyingand hanging out with your friends.Making a Rational ChoiceEconomists view the choices that people make asrational. A rational choice is one that compares costsand benefits and achieves the greatest benefit overcost for the person making the choice.Only the wants of the person making a choice arerelevant to determine its rationality. For example,you might like your coffee black and strong butyour friend prefers his milky and sweet. So it isrational for you to choose espresso and for yourfriend to choose cappuccino.The idea of rational choice provides an answer tothe first question: What goods and services will beproduced and in what quantities? The answer isthose that people rationally choose to buy!But how do people choose rationally? Why domore people choose an iPod rather than a Zune?Why has the U.S. government chosen to build aninterstate highway system and not an interstatehigh-speed railroad system? The answers turn oncomparing benefits and costs.Benefit: What You GainThe benefit of something is the gain or pleasure that itbrings and is determined by preferencesby what aperson likes and dislikes and the intensity of those feelings. If you get a huge kick out of Guitar Hero, thatvideo game brings you a large benefit. And if you havelittle interest in listening to Yo Yo Ma playing a Vivaldicello concerto, that activity brings you a small benefit.Some benefits are large and easy to identify, suchas the benefit that you get from being in school. Abig piece of that benefit is the goods and servicesthat you will be able to enjoy with the boost to yourearning power when you graduate. Some benefitsare small, such as the benefit you get from a slice ofpizza.Economists measure benefit as the most that aperson is willing to give up to get something. You arewilling to give up a lot to be in school. But youwould give up only an iTunes download for a sliceof pizza.Cost: What You Must Give UpThe opportunity cost of something is the highestvalued alternative that must be given up to get it.To make the idea of opportunity cost concrete,think about your opportunity cost of being in school.It has two components: the things you cant afford tobuy and the things you cant do with your time.Start with the things you cant afford to buy. Youvespent all your income on tuition, residence fees, books,and a laptop. If you werent in school, you would havespent this money on tickets to ball games and moviesand all the other things that you enjoy. But thats onlythe start of your opportunity cost. Youve also given upthe opportunity to get a job. Suppose that the best jobyou could get if you werent in school is working atCitibank as a teller earning $25,000 a year. Anotherpart of your opportunity cost of being in school is allthe things that you could buy with the extra $25,000you would have.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 7T he Economic Way of ThinkingAs you well know, being a student eats up manyhours in class time, doing homework assignments,preparing for tests, and so on. To do all these schoolactivities, you must give up many hours of what wouldotherwise be leisure time spent with your friends.So the opportunity cost of being in school is allthe good things that you cant afford and dont havethe spare time to enjoy. You might want to put adollar value on that cost or you might just list allthe items that make up the opportunity cost.The examples of opportunity cost that weve justconsidered are all-or-nothing costsyoure either inschool or not in school. Most situations are not likethis one. They involve choosing how much of anactivity to do.How Much? Choosing at the MarginYou can allocate the next hour between studying andinstant messaging your friends, but the choice is not allor nothing. You must decide how many minutes toallocate to each activity. To make this decision, youcompare the benefit of a little bit more study time withits costyou make your choice at the margin.The benefit that arises from an increase in anactivity is called marginal benefit. For example, yourmarginal benefit from one more night of study beforea test is the boost it gives to your grade. Your marginal benefit doesnt include the grade youre alreadyachieving without that extra night of work.The opportunity cost of an increase in an activity iscalled marginal cost. For you, the marginal cost ofstudying one more night is the cost of not spendingthat night on your favorite leisure activity.To make your decisions, you compare marginalbenefit and marginal cost. If the marginal benefitfrom an extra night of study exceeds its marginal cost,you study the extra night. If the marginal cost exceedsthe marginal benefit, you dont study the extra night.The central idea of economics is that we can predict the self-interested choices that people make bylooking at the incentives they face. People undertakethose activities for which marginal benefit exceedsmarginal cost; and they reject options for whichmarginal cost exceeds marginal benefit.For example, your economics instructor gives youa problem set and tells you these problems will be onthe next test. Your marginal benefit from workingthese problems is large, so you diligently work them.In contrast, your math instructor gives you a problemset on a topic that she says will never be on a test.You get little marginal benefit from working theseproblems, so you decide to skip most of them.Economists see incentives as the key to reconciling self-interest and social interest. When ourchoices are not in the social interest, it is because ofthe incentives we face. One of the challenges foreconomists is to figure out the incentives that resultin self-interested choices being in the social interest.Economists emphasize the crucial role that institutions play in influencing the incentives that peopleface as they pursue their self-interest. Laws that protect private property and markets that enable voluntary exchange are the fundamental institutions. Youwill learn as you progress with your study of economics that where these institutions exist, self-interest can indeed promote the social interest.REVIEW QUIZ123Choices Respond to IncentivesEconomists take human nature as given and viewpeople as acting in their self-interest. All peopleyou, other consumers, producers, politicians, andpublic servantspursue their self-interest.Self-interested actions are not necessarily selfishactions. You might decide to use your resources inways that bring pleasure to others as well as to yourself. But a self-interested act gets the most benefit foryou based on your view about benefit.745Explain the idea of a tradeoff and think of threetradeoffs that you have made today.Explain what economists mean by rationalchoice and think of three choices that youvemade today that are rational.Explain why opportunity cost is the best forgone alternative and provide examples of someopportunity costs that you have faced today.Explain what it means to choose at the marginand illustrate with three choices at the marginthat you have made today.Explain why choices respond to incentives andthink of three incentives to which you haveresponded today.You can work these questions in StudyPlan 1.3 and get instant feedback.000200010270728684_CH01_p001-026.qxd86/22/113:59 PMPage 8CHAPTER 1 What Is Economics?x Economics as Social Science andPolicy ToolEconomics is both a social science and a toolkit foradvising on policy decisions.Economist as Social ScientistAs social scientists, economists seek to discover howthe economic world works. In pursuit of this goal,like all scientists, economists distinguish betweenpositive and normative statements.Positive Statements A positive statement is aboutwhat is. It says what is currently believed about theway the world operates. A positive statement mightbe right or wrong, but we can test it by checking itagainst the facts. Our planet is warming because ofthe amount of coal that were burning is a positivestatement. We can test whether it is right or wrong.A central task of economists is to test positivestatements about how the economic world worksand to weed out those that are wrong. Economicsfirst got off the ground in the late 1700s, so it is ayoung science compared with, for example, physics,and much remains to be discovered.Normative Statements A normative statement isabout what ought to be. It depends on values and cannot be tested. Policy goals are normative statements.For example, We ought to cut our use of coal by 50percent is a normative policy statement. You mayagree or disagree with it, but you cant test it. Itdoesnt assert a fact that can be checked.Unscrambling Cause and Effect Economists are par-ticularly interested in positive statements aboutcause and effect. Are computers getting cheaperbecause people are buying them in greater quantities? Or are people buying computers in greaterquantities because they are getting cheaper? Or issome third factor causing both the price of a computer to fall and the quantity of computers boughtto increase?To answer such questions, economists create andtest economic models. An economic model is adescription of some aspect of the economic worldthat includes only those features that are needed forthe purpose at hand. For example, an economicmodel 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 modelwould ignore cell-phone colors and ringtones.A model is tested by comparing its predictions withthe facts. But testing an economic model is difficultbecause we observe the outcomes of the simultaneouschange of many factors. To cope with this problem,economists look for natural experiments (situationsin the ordinary course of economic life in which theone factor of interest is different and other things areequal or similar); conduct statistical investigations tofind correlations; and perform economic experimentsby putting people in decision-making situations andvarying the influence of one factor at a time to discover how they respond.Economist as Policy AdviserEconomics is useful. It is a toolkit for advising governments and businesses and for making personaldecisions. Some of the most famous economists workpartly as policy advisers.For example, Jagdish Bhagwati of ColumbiaUniversity has advised governments and internationalorganizations on trade and economic developmentissues.Christina Romer of the University of California,Berkeley, is on leave and serving as the chief economic adviser to President Barack Obama and headof the Presidents Council of Economic Advisers.All the policy questions on which economists provide advice involve a blend of the positive and thenormative. Economics cant help with the normativepartthe policy goal. But for a given goal, economics provides a method of evaluating alternative solutionscomparing marginal benefits and marginalcosts and finding the solution that makes the best useof the available resources.REVIEW QUIZ1234Distinguish between a positive statement and anormative statement and provide examples.What is a model? Can you think of a modelthat you might use in your everyday life?How do economists try to disentangle causeand effect?How is economics used as a policy tool?You can work these questions in StudyPlan 1.4 and get instant feedback.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 9S ummary9SUMMARYKey PointsThe Economic Way of Thinking (pp. 67)sDefinition of Economics (p. 2)sssAll economic questions arise from scarcityfromthe fact that wants exceed the resources availableto satisfy them.Economics is the social science that studies thechoices that people make as they cope withscarcity.The subject divides into microeconomics andmacroeconomics.ssssEvery choice is a tradeoffexchanging more ofsomething for less of something else.People make rational choices by comparing benefitand cost.Costopportunity costis what you must give upto get something.Most choices are how much choices made at themargin by comparing marginal benefit and marginal cost.Choices respond to incentives.Working Problem 1 will give you a better understandingof the definition of economics.Working Problems 4 and 5 will give you a better understanding of the economic way of thinking.Two Big Economic Questions (pp. 35)Economics as Social Science and Policy Tool (p. 8)sTwo big questions summarize the scope ofeconomics:1. How do choices end up determining what,how, and for whom goods and services areproduced?2. When do choices made in the pursuit of selfinterest also promote the social interest?Working Problems 2 and 3 will give you a better understanding of the two big questions of economics.sssEconomists distinguish between positive statementswhat isand normative statementswhat ought to be.To explain the economic world, economists createand test economic models.Economics is a toolkit used to provide advice ongovernment, business, and personal economicdecisions.Working Problem 6 will give you a better understandingof economics as social science and policy tool.Key TermsBenefit, 6Capital, 4Economic model, 8Economics, 2Entrepreneurship, 4Factors of production, 3Goods and services, 3Human capital, 3Incentive, 2Interest, 4Labor, 3Land, 3Macroeconomics, 2Margin, 7Marginal benefit, 7Marginal cost, 7Microeconomics, 2Opportunity cost, 6Preferences, 6Profit, 4Rational choice, 6Rent, 4Scarcity, 2Tradeoff, 6Wages, 4000200010270728684_CH01_p001-026.qxd106/22/113:59 PMPage 10CHAPTER 1 What Is Economics?STUDY PLAN PROBLEMS AND APPLICATIONSYou can work Problems 1 to 6 in MyEconLab Chapter 1 Study Plan and get instant feedback.Definition of Economics (Study Plan1.1)1. Apple Inc. decides to make iTunes freely availablein unlimited quantities.a. Does Apples decision change the incentivesthat people face?b. Is Apples decision an example of a microeconomic or a macroeconomic issue?Two Big Economic Questions (Study Plan1.2)2. Which of the following pairs does not match?a. Labor and wagesb. Land and rentc. Entrepreneurship and profitd. Capital and profit3. Explain how the following news headlines concern self-interest and the social interest.a. Starbucks Expands in Chinab. McDonalds Moves into Saladsc. Food Must Be Labeled with Nutrition DataThe Economic Way of Thinking (Study Plan1.3)4. The night before an economics test, you decideto go to the movies instead of staying home andworking your MyEconLab Study Plan. You get50 percent on your test compared with the 70percent that you normally score.a. Did you face a tradeoff?b. What was the opportunity cost of yourevening at the movies?5. Costs Soar for London OlympicsThe regeneration of East London, the site of the2012 Olympic Games, is set to add extra 1.5billion to taxpayers bill.Source: The Times, London, July 6, 2006Is the cost of regenerating East London anopportunity cost of hosting the 2012 OlympicGames? Explain why or why not.Economics as Social Science and Policy Tool(Study Plan1.4)6. Which of the following statements is positive,which is normative, and which can be tested?a. The United States should cut its imports.b. China is the largest trading partner of theUnited States.c. If the price of antiretroviral drugs increases,HIV/AIDS sufferers will decrease their consumption of the drugs.ADDITIONAL PROBLEMS AND APPLICATIONSYou can work these problems in MyEconLab if assigned by your instructor.Definition of Economics7. Hundreds Line up for 5 p.m. Ticket GiveawayBy noon, hundreds of Eminem fans had lined upfor a chance to score free tickets to the concert.Source: Detroit Free Press, May 18, 2009When Eminem gave away tickets, what was freeand what was scarce? Explain your answer.Two Big Economic Questions8. How does the creation of a successful movieinfluence what, how, and for whom goods andservices are produced?9. How does a successful movie illustrate self-interested choices that are also in the social interest?The Economic Way of Thinking10. Before starring in Iron Man, Robert Downey Jr.had appeared in 45 movies that grossed an average of $5 million on the opening weekend. Incontrast, Iron Man grossed $102 million.a. How do you expect the success of Iron Man toinfluence the opportunity cost of hiringRobert Downey Jr.?b. How have the incentives for a movie producerto hire Robert Downey Jr. changed?11. What might be an incentive for you to take aclass in summer school? List some of the benefitsand costs involved in your decision. Would yourchoice be rational?Economics as Social Science and Policy Tool12. Look at todays Wall Street Journal. What is theleading economic news story? With which of thebig economic questions does it deal and whattradeoffs does it discuss or imply?13. Provide two microeconomic statements and twomacroeconomic statements. Classify your statements as positive or normative. Explain why.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 11A ppendix: Graphs in EconomicsGraphs in EconomicsAbove sea levelAfter studying this appendix,you will be able to:Make and interpret a scatter diagramIdentify linear and nonlinear relationships andrelationships that have a maximum and aminimumA 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. Amovement from left to right shows an increase intemperature. The point 0 represents zero degreesFahrenheit. To the right of 0, the temperature is positive. To the left of 0 the temperature is negative (asindicated by the minus sign). A distance on the vertical line represents height, measured in thousands offeet. The point 0 represents sea level. Points above 0represent feet above sea level. Points below 0 represent feet below sea level (indicated by a minus sign).In Fig. A1.1, the two scale lines are perpendicularto each other and are called axes. The vertical line isthe y-axis, and the horizontal line is the x-axis. Eachaxis has a zero point, which is shared by the two axesand called the origin.To make a two-variable graph, we need two piecesof information: the value of the variable x and thevalue of the variable y. For example, off the coast ofAlaska, the temperature is 32 degreesthe value of x.A fishing boat is located at 0 feet above sea levelthevalue of y. These two bits of information appear aspoint A in Fig. A1.1. A climber at the top of MountMcKinley on a cold day is 20,320 feet above sea levelin a zero-degree gale. These two pieces of informationappear as point B. On a warmer day, a climber mightbe at the peak of Mt. McKinley when the temperatureis 32 degrees, at point C.We can draw two lines, called coordinates, frompoint C. One, called the x-coordinate, runs from C tothe vertical axis. This line is called the x-coordinate0F and20,320 ft2520BC32F and20,320 ft151032F and0 ft560Below sea levelx Graphing DatayOriginDefine and calculate the slope of a lineGraph relationships among more than twovariablesMaking a GraphFIGURE A1.1Height (thousands of feet)APPENDIX1130A0305Negativex6090120Temperature (degrees F)Positive10Graphs have axes that measure quantities as distances.Here, the horizontal axis (x-axis) measures temperature, andthe vertical axis (y-axis) measures height. Point A representsa fishing boat at sea level (0 on the y-axis) on a day whenthe temperature is 32F. Point B represents a climber at thetop of Mt. McKinley, 20,320 feet above sea level at atemperature of 0F. Point C represents a climber at the topof Mt. McKinley, 20,320 feet above sea level at a temperature of 32F.animationbecause its length is the same as the value marked offon the x-axis. The other, called the y-coordinate, runsfrom C to the horizontal axis. This line is called they-coordinate because its length is the same as thevalue marked off on the y-axis.We describe a point on a graph by the values ofits x-coordinate and its y-coordinate. For example, atpoint C, x is 32 degrees and y is 20,320 feet.A graph like that in Fig. A1.1 can be made usingany quantitative data on two variables. The graph canshow just a few points, like Fig. A1.1, or manypoints. Before we look at graphs with many points,lets reinforce what youve just learned by looking attwo graphs made with economic data.Economists measure variables that describe what,how, and for whom goods and services are produced.These variables are quantities produced and prices.Figure A1.2 shows two examples of economic graphs.000200010270728684_CH01_p001-026.qxd3:59 PMPage 12CHAPTER 1 What Is Economics?FIGURE A1.2150Two Graphs of Economic Data8.3 millionsongs at 99cents per song99A50058.3 1015Quantity (millions of songs per day)(a) iTunes downloads: quantity and priceQuantity (millions of albums per day)12Price (cents per song)6/22/ million songsand 0.4 millionalbums weredownloaded0.60.4B0.2058.3 1015Quantity (millions of songs per day)The graph in part (a) tells us thatin January 2010, 8.3 millionsongs per day were downloadedfrom the iTunes store at a price of99 cents a song.The graph in part (b) tells usthat in January 2010, 8.3 millionsongs per day and 0.4 millionalbums per day were downloadedfrom the iTunes store.(b) iTunes downloads: songs and albumsanimationFigure A1.2(a) is a graph about iTunes song downloadsin January 2010. The x-axis measures the quantity ofsongs downloaded per day and the y-axis measures theprice of a song. Point A tells us what the quantity andprice were. You can read this graph as telling youthat in January 2010, 8.3 million songs a day weredownloaded at a price of 99 per song.Figure A1.2(b) is a graph about iTunes song andalbum downloads in January 2010. The x-axis measures the quantity of songs downloaded per day andthe y-axis measures the quantity of albums downloaded per day. Point B tells us what these quantitieswere. You can read this graph as telling you that inJanuary 2010, 8.3 million songs a day and 0.4 million albums were downloaded.The three graphs that youve just seen tell youhow to make a graph and how to read a data pointon a graph, but they dont improve on the raw data.Graphs become interesting and revealing when theycontain a number of data points because then youcan visualize the data.Economists create graphs based on the principlesin Figs. A1.1 and A1.2 to reveal, describe, and visualize the relationships among variables. Were nowgoing to look at some examples. These graphs arecalled scatter diagrams.Scatter DiagramsA scatter diagram is a graph that plots the value of onevariable against the value of another variable for anumber of different values of each variable. Such agraph reveals whether a relationship exists betweentwo variables and describes their relationship.The table in Fig. A1.3 shows some data on twovariables: the number of tickets sold at the box officeand the number of DVDs sold for eight of the mostpopular movies in 2009.What is the relationship between these two variables? Does a big box office success generate a largevolume of DVD sales? Or does a box office successmean that fewer DVDs are sold?We can answer these questions by making a scatterdiagram. We do so by graphing the data in the table.In the graph in Fig. A1.3, each point shows the number of box office tickets sold (the x variable) and thenumber of DVDs sold (the y variable) of one of themovies. There are eight movies, so there are eightpoints scattered within the graph.The point labeled A tells us that Star Trek sold 34million tickets at the box office and 6 million DVDs.The points in the graph form a pattern, which revealsthat larger box office sales are associated with largerDVD sales. But the points also tell us that this association is weak. You cant predict DVD sales with anyconfidence by knowing only the number of ticketssold at the box office.Figure A1.4 shows two scatter diagrams of economic variables. Part (a) shows the relationshipbetween income and expenditure, on average, duringa ten-year period. Each point represents income andexpenditure in a given year. For example, point Ashows that in 2006, income was $31 thousand andexpenditure was $30 thousand. This graph shows thatas income increases, so does expenditure, and the relationship is a close one.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 13A ppendix: Graphs in Economics13A Scatter DiagramTicketsMovieDVDs(millions)Twilight3810Transformers:Revenge of the Fallen549Up39DVDs sold (millions)FIGURE A1.31110898Harry Potter andthe Half-Blood Prince407Star Trek3467A6The Hangover3765Ice Age:Dawn of the Dinosaurs265The Proposal22502030 34405060Box office tickets sold (millions)The table lists the number oftickets sold at the box officeand the number of DVDssold for eight popularmovies. The scatter diagramreveals the relationshipbetween these two variables.Each point shows the valuesof the two variables for aspecific movie. For example,point A shows the point forStar Trek, which sold 34 million tickets at the box officeand 6 million DVDs. The pattern formed by the pointsshows that there is a tendency for large box officesales to bring greater DVDsales. But you couldnt predict how many DVDs amovie would sell just byknowing its box office sales.animationYou can see that a scatter diagram conveys awealth of information, and it does so in much lessspace than we have used to describe only some of itsfeatures. But you do have to read the graph toobtain all this information.Figure A1.4(b) shows a scatter diagram of U.S.inflation and unemployment during the 2000s. Here,the points for 2000 to 2008 show no relationshipbetween the two variables, but the high unemploymentrate of 2009 brought a low inflation rate that year.Expenditure(thousands of dollars per year)3509080630022500007A0504030131253540Income (thousands of dollars per year)(a) Income and expenditureanimationInflation rate (percent per year)Two Economic Scatter DiagramsFIGURE A1.45080605000701 04034320210109246810Unemployment rate (percent)(b) Unemployment and inflationThe scatter diagram in part (a) showsthe relationship between income andexpenditure from 2000 to 2009. PointA shows that in 2006, income was$31 (thousand) on the x-axis andexpenditure was $30 (thousand) onthe y-axis. This graph shows that asincome rises, so does expenditure andthe relationship is a close one.The scatter diagram in part (b)shows a weak relationship betweenunemployment and inflation in theUnited States during most of the 2000s.000200010270728684_CH01_p001-026.qxd146/22/113:59 PMPage 14CHAPTER 1 What Is Economics?x Graphs Used inBreaks in the Axes The graph in Fig. A1.4(a) hasbreaks in its axes, as shown by the small gaps. Thebreaks indicate that there are jumps from the origin,0, to the first values recorded.The breaks are used because the lowest values ofincome and expenditure exceed $20,000. If we madethis graph with no breaks in its axes, there would be alot of empty space, all the points would be crowdedinto the top right corner, and it would be difficult tosee whether a relationship exists between these twovariables. By breaking the axes, we are able to bringthe relationship into view.Putting a break in one or both axes is like usinga zoom lens to bring the relationship into the centerof the graph and magnify it so that the relationshipfills the graph.Misleading Graphs Breaks can be used to highlighta relationship, but they can also be used to misleadto make a graph that lies. The most commonway of making a graph lie is to put a break in theaxis and either to stretch or compress the scale. Forexample, suppose that in Fig. A1.4(a), the y-axisthat measures expenditure ran from zero to $35,000while the x-axis was the same as the one shown. Thegraph would now create the impression that despitea huge increase in income, expenditure had barelychanged.To avoid being misled, it is a good idea to getinto the habit of always looking closely at the valuesand the labels on the axes of a graph before you startto interpret it.Correlation and Causation A scatter diagram thatshows a clear relationship between two variables, suchas Fig. A1.4(a), tells us that the two variables have ahigh correlation. When a high correlation is present,we can predict the value of one variable from thevalue of the other variable. But correlation does notimply causation.Sometimes a high correlation is a coincidence,but sometimes it does arise from a causal relationship. It is likely, for example, that rising incomecauses rising expenditure (Fig. A1.4a) and that highunemployment makes for a slack economy in whichprices dont rise quickly, so the inflation rate is low(Fig. A1.4b).Youve now seen how we can use graphs in economics to show economic data and to reveal relationships. Next, well learn how economists usegraphs to construct and display economic models.Economic ModelsThe graphs used in economics are not always designedto show real-world data. Often they are used to showgeneral relationships among the variables in an economic model.An economic model is a stripped-down, simplified description of an economy or of a componentof an economy such as a business or a household. Itconsists of statements about economic behaviorthat can be expressed as equations or as curves in agraph. Economists use models to explore the effectsof different policies or other influences on theeconomy in ways that are similar to the use ofmodel airplanes in wind tunnels and models of theclimate.You will encounter many different kinds ofgraphs in economic models, but there are somerepeating patterns. Once youve learned to recognizethese patterns, you will instantly understand themeaning of a graph. Here, well look at the differenttypes of curves that are used in economic models,and well see some everyday examples of each type ofcurve. The patterns to look for in graphs are the fourcases in whichsVariables move in the same direction.sVariables move in opposite directions.sVariables have a maximum or a minimum.sVariables are unrelated.Lets look at these four cases.Variables That Move in the Same DirectionFigure A1.5 shows graphs of the relationshipsbetween two variables that move up and downtogether. A relationship between two variables thatmove in the same direction is called a positive relationship or a direct relationship. A line that slopesupward shows such a relationship.Figure A1.5 shows three types of relationships:one that has a straight line and two that have curvedlines. All the lines in these three graphs are calledcurves. Any line on a graphno matter whether it isstraight or curvedis called a curve.A relationship shown by a straight line is calleda linear relationship. Figure A1.5(a) shows a linear relationship between the number of miles traveled in000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 15A ppendix: Graphs in EconomicsPositivelinearrelationship300A200100040Problems worked (number)400Positive (Direct) RelationshipsRecovery time (minutes)Distance covered in 5 hours (miles)FIGURE A1.5Positive,becomingsteeper3020102015406080Speed (miles per hour)(a) Positive linear relationship020Positive,becomingless steep15105100200300400Distance sprinted (yards)(b) Positive, becoming steeperEach part shows a positive (direct) relationship between twovariables. That is, as the value of the variable measured onthe x-axis increases, so does the value of the variable measured on the y-axis. Part (a) shows a linear positiverelationshipas the two variables increase together, wemove along a straight line.02468Study time (hours)(c) Positive, becoming less steepPart (b) shows a positive relationship such that as thetwo variables increase together, we move along a curve thatbecomes steeper.Part (c) shows a positive relationship such that as thetwo variables increase together, we move along a curve thatbecomes flatter.animation5 hours and speed. For example, point A shows thatwe will travel 200 miles in 5 hours if our speed is 40miles an hour. If we double our speed to 80 miles anhour, we will travel 400 miles in 5 hours.Figure A1.5(b) shows the relationship betweendistance sprinted and recovery time (the time it takesthe heart rate to return to its normal resting rate).This relationship is an upward-sloping one thatstarts out quite flat but then becomes steeper as wemove along the curve away from the origin. The reason this curve becomes steeper is that the additionalrecovery time needed from sprinting an additional100 yards increases. It takes less than 5 minutes torecover from sprinting 100 yards but more than 10minutes to recover from 200 yards.Figure A1.5(c) shows the relationship betweenthe number of problems worked by a student andthe amount of study time. This relationship is anupward-sloping one that starts out quite steep andbecomes flatter as we move along the curve awayfrom the origin. Study time becomes less productiveas the student spends more hours studying andbecomes more tired.Variables That Move in Opposite DirectionsFigure A1.6 shows relationships between things thatmove in opposite directions. A relationship betweenvariables that move in opposite directions is called anegative relationship or an inverse relationship.Figure A1.6(a) shows the relationship betweenthe hours spent playing squash and the hours spentplaying tennis when the total time available is 5hours. One extra hour spent playing tennis meansone hour less spent playing squash and vice versa.This relationship is negative and linear.Figure A1.6(b) shows the relationship betweenthe 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 thecost per mile decreases, the fall in the cost is smallerthe longer the journey. This feature of the relationshipis shown by the fact that the curve slopes downward,starting out steep at a short journey length and thenbecoming flatter as the journey length increases. Thisrelationship arises because some of the costs are fixed,such as auto insurance, and the fixed costs are spreadover a longer journey.000200010270728684_CH01_p001-026.qxd3:59 PMPage 16CHAPTER 1 What Is Economics?Negative (Inverse) Relationships5Negativelinearrelationship4321050Negative,becomingless steep4030201012345Time playing tennis (hours)(a) Negative linear relationship0Problems worked (number)FIGURE A1.6Travel cost (cents per mile)16Time playing squash (hours)6/22/1125Negative,becomingsteeper2015105100200300 400500Journey length (miles)(b) Negative, becoming less steepEach part shows a negative (inverse) relationship betweentwo variables. Part (a) shows a linear negative relationship. The total time spent playing tennis and squash is 5hours. As the time spent playing tennis increases, the timespent playing squash decreases, and we move along astraight line.0248610Leisure time (hours)(c) Negative, becoming steeperPart (b) shows a negative relationship such that as thejourney length increases, the travel cost decreases as wemove along a curve that becomes less steep.Part (c) shows a negative relationship such that asleisure time increases, the number of problems workeddecreases as we move along a curve that becomes steeper.animationFigure A1.6(c) shows the relationship betweenthe amount of leisure time and the number of problems worked by a student. Increasing leisure timeproduces 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 smallnumber of leisure hours and becomes steeper as thenumber of leisure hours increases. This relationship isa different view of the idea shown in Fig. A1.5(c).Variables That Have a Maximumor a MinimumMany relationships in economic models have a maximum or a minimum. For example, firms try to makethe maximum possible profit and to produce at thelowest possible cost. Figure A1.7 shows relationshipsthat have a maximum or a minimum.Figure A1.7(a) shows the relationship betweenrainfall and wheat yield. When there is no rainfall,wheat will not grow, so the yield is zero. As the rainfallincreases up to 10 days a month, the wheat yieldincreases. With 10 rainy days each month, the wheatyield reaches its maximum at 40 bushels an acre (pointA). Rain in excess of 10 days a month starts to lowerthe yield of wheat. If every day is rainy, the wheat suffers from a lack of sunshine and the yield decreases tozero. This relationship is one that starts out slopingupward, reaches a maximum, and then slopes downward.Figure A1.7(b) shows the reverse casea relationship that begins sloping downward, falls to a minimum, and then slopes upward. Most economic costsare like this relationship. An example is the relationshipbetween the cost per mile and speed for a car trip. Atlow speeds, the car is creeping in a traffic snarl-up. Thenumber of miles per gallon is low, so the cost per mileis high. At high speeds, the car is traveling faster thanits efficient speed, using a large quantity of gasoline,and again the number of miles per gallon is low and thecost 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.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 17A ppendix: Graphs in EconomicsMaximum and Minimum PointsMaximumyield50A403020IncreasingyieldGasoline cost (cents per mile)Wheat yield (bushels per acre)FIGURE A1.715DecreasingcostIncreasingcost10DecreasingyieldMinimumcostB51005101730152025Rainfall (days per month)(a) Relationship with a maximum01535557595Speed (miles per hour)(b) Relationship with a minimumPart (a) shows a relationship that has a maximumpoint, A. The curve slopesupward as it rises to itsmaximum point, is flat atits maximum, and thenslopes downward.Part (b) shows a relationship with a minimumpoint, B. The curve slopesdownward as it falls to itsminimum, is flat at its minimum, and then slopesupward.animationVariables That Are UnrelatedThere are many situations in which no matter whathappens to the value of one variable, the other variable remains constant. Sometimes we want to showthe independence between two variables in a graph,and Fig. A1.8 shows two ways of achieving this.Variables That Are Unrelated10075Unrelated:y constant5025020406080Price of bananas (cents per pound)(a) Unrelated: y constantanimationRainfall in California (days per month)Grade in economics (percent)FIGURE A1.8In describing the graphs in Fig. A1.5 through Fig.A1.7, we have talked about curves that slope upwardor slope downward, and curves that become less steepor steeper. Lets spend a little time discussing exactlywhat we mean by slope and how we measure the slopeof a curve.2015Unrelated:x constant10501234Output of French wine (billions of gallons)(b) Unrelated: x constantThis figure shows howwe can graph two variablesthat are unrelated. In part(a), a students grade ineconomics is plotted at75 percent on the y-axisregardless of the price ofbananas on the x-axis. Thecurve is horizontal.In part (b), the outputof the vineyards of Franceon the x-axis does not varywith the rainfall inCalifornia on the y-axis.The curve is vertical.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 18CHAPTER 1 What Is Economics?18x The Slope of a RelationshipIf a large change in the variable measured onthe y-axis ( y) is associated with a small change inthe variable measured on the x-axis ( x), the slopeis large and the curve is steep. If a small change inthe variable measured on the y-axis ( y) is associated with a large change in the variable measuredon the x-axis ( x), the slope is small and the curveis flat.We can make the idea of slope clearer by doingsome calculations.We can measure the influence of one variable onanother by the slope of the relationship. The slopeof a relationship is the change in the value of thevariable measured on the y-axis divided by thechange in the value of the variable measured on thex-axis. We use the Greek letter (delta) to representchange in. Thus y means the change in the valueof the variable measured on the y-axis, and xmeans the change in the value of the variable measured on the x-axis. Therefore the slope of the relationship isSlope =yxThe Slope of a Straight LineThe slope of a straight line is the same regardless ofwhere on the line you calculate it. The slope of astraight line is constant. Lets calculate the slope ofthe positive relationship in Fig. A1.9. In part (a),.The Slope of a Straight LineFIGURE A1.9yy883Slope = 473Slope = 47665544332211012345678x(a) Positive slope012345678x(b) Negative slopeTo calculate the slope of a straight line, we divide the changein the value of the variable measured on the y-axis ( y ) bythe change in the value of the variable measured on the xaxis ( x) as we move along the line.Part (a) shows the calculation of a positive slope. Whenx increases from 2 to 6, x equals 4. That change in xanimationbrings 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. Whenx increases from 2 to 6, x equals 4. That increase in xbrings about a decrease in y from 6 to 3, so y equals 3.The slope ( y/ x) equals 3/4.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 19A ppendix: Graphs in Economicswhen x increases from 2 to 6, y increases from 3 to6. The change in x is +4that is, x is 4. Thechange in y is +3that is, y is 3. The slope of thatline isyx=3.4In part (b), when x increases from 2 to 6, ydecreases from 6 to 3. The change in y is minus 3that is, y is 3. The change in x is plus 4that is,x is 4. The slope of the curve isyx=-3.4Notice 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 ispositive; the slope of a negative relationship is negative.The Slope of a Curved LineThe slope of a curved line is trickier. The slope of acurved line is not constant, so the slope depends onwhere on the curved line we calculate it. There aretwo ways to calculate the slope of a curved line: Youcan calculate the slope at a point, or you can calculatethe slope across an arc of the curve. Lets look at thetwo alternatives.Slope at a Point To calculate the slope at a point ona curve, you need to construct a straight line that hasthe same slope as the curve at the point in question.Figure A1.10 shows how this is done. Suppose youwant to calculate the slope of the curve at point A.Place a ruler on the graph so that the ruler touchespoint A and no other point on the curve, then draw astraight line along the edge of the ruler. The straightred line is this line, and it is the tangent to the curveat point A. If the ruler touches the curve only atpoint A, then the slope of the curve at point A mustbe the same as the slope of the edge of the ruler. Ifthe curve and the ruler do not have the same slope,the line along the edge of the ruler will cut the curveinstead of just touching it.Now that you have found a straight line with thesame slope as the curve at point A, you can calculatethe slope of the curve at point A by calculating theslope of the straight line. Along the straight line, as x19Slope at a PointFIGURE A1.10y873Slope = 46A54321012345678xTo calculate the slope of the curve at point A, draw the redline that just touches the curve at Athe tangent. The slopeof this straight line is calculated by dividing the change in yby the change in x along the red line. When x increases from0 to 4, x equals 4. That change in x is associated with anincrease in y from 2 to 5, so y equals 3. The slope of thered line is 3/4, so the slope of the curve at point A is 3/4.animationincreases from 0 to 4 ( x is 4) y increases from 2 to 5( y is 3). Therefore the slope of the straight line isyx=3.4So the slope of the curve at point A is 3/4.Slope Across an Arc An arc of a curve is a piece of acurve. Fig. A1.11shows the same curve as in Fig.A1.10, but instead of calculating the slope at point A,we are now going to calculate the slope across the arcfrom point B to point C. You can see that the slope ofthe curve at point B is greater than at point C. Whenwe calculate the slope across an arc, we are calculatingthe average slope between two points. As we movealong the arc from B to C, x increases from 3 to 5and y increases from 4.0 to 5.5. The change in x is 2( x is 2), and the change in y is 1.5 ( y is 1.5).000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 20CHAPTER 1 What Is Economics?20x Graphing Relationships AmongSlope Across an ArcFIGURE A1.11More Than Two Variablesy8.07.03Slope = 1.5 = 26.04C5.5A5.0= 1.5B4. calculate the average slope of the curve along the arcBC, draw a straight line from point B to point C. The slopeof the line BC is calculated by dividing the change in y bythe change in x. In moving from B to C, the increase in x is2 ( x equals 2) and the change in y is 1.5 ( y equals 1.5).The slope of the line BC is 1.5 divided by 2, or 3/4. So theslope of the curve across the arc BC is 3/4.We have seen that we can graph the relationshipbetween two variables as a point formed by the xand y-coordinates in a two-dimensional graph. Youmight be thinking that although a two-dimensionalgraph is informative, most of the things in whichyou are likely to be interested involve relationshipsamong many variables, not just two. For example,the amount of ice cream consumed depends on theprice of ice cream and the temperature. If ice creamis expensive and the temperature is low, people eatmuch less ice cream than when ice cream is inexpensive and the temperature is high. For any givenprice of ice cream, the quantity consumed varieswith the temperature; and for any given temperature, the quantity of ice cream consumed varies withits price.Figure A1.12 shows a relationship among threevariables. The table shows the number of gallons ofice cream consumed each day at two different temperatures and at a number of different prices of icecream. How can we graph these numbers?To graph a relationship that involves more thantwo variables, we use the ceteris paribus assumption.Ceteris Paribusanimation(often shortened to cet par) means ifall other relevant things remain the same. To isolatethe relationship of interest in a laboratory experiment, a scientist holds everything constant except forthe variable whose effect is being studied. Economistsuse the same method to graph a relationship that hasmore than two variables.Figure A1.12 shows an example. There, you cansee what happens to the quantity of ice cream consumed when the price of ice cream varies but thetemperature is held constant.The curve labeled 70F shows the relationshipbetween ice cream consumption and the price of icecream if the temperature remains at 70F. The numbers used to plot that curve are those in the first twocolumns of the table. For example, if the temperature is 70F, 10 gallons are consumed when theprice is $2.75 a scoop and 18 gallons are consumedwhen the price is $2.25 a scoop.The curve labeled 90F shows the relationshipbetween ice cream consumption and the price ofice cream if the temperature remains at 90F. TheCeteris paribusTherefore the slope isyx=1.53=.24So the slope of the curve across the arc BC is 3/4.This calculation gives us the slope of the curvebetween points B and C. The actual slope calculatedis the slope of the straight line from B to C. Thisslope approximates the average slope of the curvealong the arc BC. In this particular example, theslope across the arc BC is identical to the slope of thecurve at point A, but the calculation of the slope of acurve does not always work out so neatly. You mighthave fun constructing some more examples and a fewcounter examples.You now know how to make and interpret agraph. So far, weve limited our attention to graphs oftwo variables. Were now going to learn how to graphmore than two variables.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 21A ppendix: Graphs in EconomicsGraphing a Relationship Among Three VariablesIce cream consumption(gallons per day)PricePrice (dollars per scoop)FIGURE A1.12213.75(dollars per scoop)70F90F2.0025502.2518362.5013262.7510202.753.007142.503.255103.50363.50When temperaturerises, curve shiftsrightward3.253.002.2590F70F2.000Ice cream consumption depends on its price and the temperature. The table tells us how many gallons of ice cream areconsumed each day at different prices and two differenttemperatures. For example, if the price is $2.75 a scoopand the temperature is 70F, 10 gallons of ice cream areconsumed.To graph a relationship among three variables, thevalue of one variable is held constant. The graph shows therelationship between price and consumption when tempera-10204060Ice cream consumption (gallons per day)ture is held constant. One curve holds temperature at 70Fand the other holds it at 90F.A change in the price of ice cream brings a movementalong one of the curvesalong the blue curve at 70F andalong the red curve at 90F.When the temperature rises from 70F to 90F, thecurve that shows the relationship between consumptionand price shifts rightward from the blue curve to the redcurve.animationnumbers used to plot that curve are those in thefirst and third columns of the table. For example, ifthe temperature is 90F, 20 gallons are consumedwhen the price is $2.75 a scoop and 36 gallons areconsumed when the price is $2.25 a scoop.When the price of ice cream changes but the temperature is constant, you can think of what happens inthe graph as a movement along one of the curves. At70F there is a movement along the blue curve and at90F there is a movement along the red curve.When Other Things ChangeThe temperature is held constant along each of thecurves in Fig. A1.12, but in reality the temperaturechanges. When that event occurs, you can think ofwhat happens in the graph as a shift of the curve.When the temperature rises from 70F to 90F, thecurve that shows the relationship between ice creamconsumption and the price of ice cream shifts rightward from the blue curve to the red curve.You will encounter these ideas of movementsalong and shifts of curves at many points in yourstudy of economics. Think carefully about whatyouve just learned and make up some examples (withassumed numbers) about other relationships.With what you have learned about graphs, you canmove forward with your study of economics. There areno graphs in this book that are more complicated thanthose that have been explained in this appendix.000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 22CHAPTER 1 What Is Economics?22MATHEMATICAL NOTEEquations of Straight LinesIf a straight line in a graph describes the relationshipbetween two variables, we call it a linear relationship.Figure 1 shows the linear relationship between a personsexpenditure and income. This person spends $100 aweek (by borrowing or spending previous savings)when income is zero. Out of each dollar earned, thisperson spends 50 cents (and saves 50 cents).All linear relationships are described by the samegeneral equation. We call the quantity that is measuredon the horizontal axis (or x-axis) x, and we call thequantity 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 increasesabove a as x increases. The constant b is the slope ofthe line.Slope of LineAs we explain in the chapter, the slope of a relationship is the change in the value of y divided by thechange in the value of x. We use the Greek letter(delta) to represent change in. So y means thechange in the value of the variable measured on they-axis, and x means the change in the value of thevariable measured on the x-axis. Therefore the slopeof the relationship isSlope =A Linear Equationyabx.Expenditure (dollars per week)In this equation, a and b are fixed numbers andthey are called constants. The values of x and y vary, sothese numbers are called variables. Because the equation describes a straight line, the equation is called alinear equation.The equation tells us that when the value of x iszero, the value of y is a. We call the constant a they-axis intercept. The reason is that on the graph the400y = a + bxValue of ySlope = b300200xTo see why the slope is b, suppose that initiallythe 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 thaty1abx 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 byy to y 1 + y (or $300 in Fig. 2).The equation of the line now tells us thaty1Expenditure (dollars per week)The equation that describes a straight-line relationship between x and y isyyab(x 1x).400300200y11000y-axisintercept = a100200Value of x100x1300400500Income (dollars per week)Figure 1 Linear relationship0100200300400500Income (dollars per week)Figure 2 Calculating slope(2)000200010270728684_CH01_p001-026.qxd6/22/113:59 PMPage 23M athematical NoteTo calculate the slope of the line, subtract equation(1) from equation (2) to obtainybx(3)and now divide equation (3) by x to obtainy/ xrelationships have a slope that is positive. In theequation of the line, the constant b is positive. In thisexample, the y-axis intercept, a, is 100. The slope bequals y/ x, which in Fig. 2 is 100/200 or 0.5. Theequation of the line isyb.100Position of LineThe y-axis intercept determines the position of theline on the graph. Figure 3 illustrates the relationshipbetween the y-axis intercept and the position of theline. In this graph, the y-axis measures saving and thex-axis measures income.When the y-axis intercept, a, is positive, the linehits the y-axis at a positive value of yas the blue linedoes. Its y-axis intercept is 100. When the y-axis intercept, a, is zero, the line hits the y-axis at the originas the purple line does. Its y-axis intercept is 0. Whenthe y-axis intercept, a, is negative, the line hits they-axis at a negative value of yas the red line does. Itsy-axis intercept is 100.As the equations of the three lines show, the valueof the y-axis intercept does not influence the slope ofthe line. All three lines have a slope equal to 0.5.Figure 4 shows a negative relationshipthe two variables x and y move in the opposite direction. All negative relationships have a slope that is negative. In theequation of the line, the constant b is negative. In theexample in Fig. 4, the y-axis intercept, a, is 30. Theslope, b, equals y/ x, which is 20/2 or 10. Theequation of the line isy30Positive RelationshipsFigure 1 shows a positive relationshipthe two variables x and y move in the same direction. All positive( 10)xory3010x.ExampleA straight line has a y-axis intercept of 50 and a slopeof 2. What is the equation of this line?The equation of a straight line isySaving (dollars per week)0.5x.Negative RelationshipsSo the slope of the line is b.abxwhere a is the y-axis intercept and b is the slope.So the equation isy 50 2x.y300Positive y-axisintercept, a = 100y = 100 + 0.5x200y = 0.5x10040Positive y-axisintercept, a = 30y = 100 + 0.5x30Slope, b = 10200100200100200300 400 500 600Income (dollars per week)10Negative y-axisintercept, a = 100y = 30 10x0Figure 3 The y-axis intercept2312Figure 4 Negative relationshipx000200010270728684_CH01_p001-026.qxd246/22/114:00 PMPage 24CHAPTER 1 What Is Economics?REVIEW QUIZ123456Explain how we read the three graphs in FigsA1.1 and A1.2.Explain what scatter diagrams show and whywe use them.Explain how we read the three scatter diagrams in Figs A1.3 and A1.4.Draw a graph to show the relationship betweentwo variables that move in the same direction.Draw a graph to show the relationship betweentwo variables that move in opposite directions.Draw a graph to show the relationship betweentwo variables that have a maximum and a minimum.7891011Which of the relationships in Questions 4 and5 is a positive relationship and which is a negative relationship?What are the two ways of calculating the slopeof a curved line?How do we graph a relationship among morethan two variables?Explain what change will bring a movementalong a curve.Explain what change will bring a shift of acurve.You can work these questions in StudyPlan 1.A and get instant feedback.SUMMARYKey PointsThe Slope of a Relationship (pp. 1820)sGraphing Data (pp. 1114)sssA graph is made by plotting the values of two variables x and y at a point that corresponds to theirvalues measured along the x-axis and the y-axis.A scatter diagram is a graph that plots the values oftwo variables for a number of different values ofeach.A scatter diagram shows the relationship betweenthe two variables. It shows whether they are positively related, negatively related, or unrelated.Graphs Used in Economic Models (pp. 1417)ssGraphs are used to show relationships among variables in economic models.Relationships can be positive (an upward-slopingcurve), 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).ssThe slope of a relationship is calculated as thechange in the value of the variable measured onthe y-axis divided by the change in the value of thevariable measured on the x-axisthat is, y/ x.A straight line has a constant slope.A curved line has a varying slope. To calculate theslope of a curved line, we calculate the slope at apoint or across an arc.Graphing Relationships Among More Than TwoVariables (pp. 2021)ssssTo graph a relationship among more than twovariables, we hold constant the values of all thevariables except two.We then plot the value of one of the variablesagainst the value of another.A cet par change in the value of a variable on anaxis of a graph brings a movement along the curve.A change in the value of a variable held constantalong the curve brings a shift of the curve.Key TermsCeteris paribus, 20Direct relationship, 14Inverse relationship, 15Linear relationship, 14Negative relationship, 15Positive relationship, 14Scatter diagram, 12Slope, 18000200010270728684_CH01_p001-026.qxd6/22/114:00 PMPage 25S tudy Plan Problems and Applications25STUDY PLAN PROBLEMS AND APPLICATIONSYou can work Problems 1 to 11 in MyEconLab Chapter 1A Study Plan and get instant feedback.Use the following spreadsheet to work Problems 1 to3. The spreadsheet provides data on the U.S. economy: Column A is the year, column B is the inflationrate, column C is the interest rate, column D is thegrowth rate, and column E is the unemployment rate.7. Calculate the slope of the following relationship.y108ABCDE119992. Draw a scatter diagram of the inflation rate andthe interest rate. Describe the relationship.2. Draw a scatter diagram of the growth rate andthe unemployment rate. Describe the relationship.3. Draw a scatter diagram of the interest rate andthe unemployment rate. Describe the relationship.Use the following news clip to work Problems 4 to 6.Clash of the Titans Tops Box Office With Sales of$61.2 Million:TheatersMovieRevenue( dollars(number)per theater)Clash of the Titans3,77716,213Tyler Perrys Why Did I2,15513,591Get MarriedHow To Train Your Dragon 4,0607,145The Last Song2,6735,989Source:, April 5, 20104. Draw a graph of the relationship between the revenue per theater on the y-axis and the number oftheaters on the x-axis. Describe the relationship.5. Calculate the slope of the relationship between4,060 and 2,673 theaters.6. Calculate the slope of the relationship between2,155 and 4,060 theaters.8.012.0xUse the following relationship to work Problems8 and 9.5.8116y10.08.0A6.04.0B1.52046810x8. Calculate the slope of the relationship at point Aand at point B.9. Calculate the slope across the arc AB.Use the following table to work Problems 10 and 11.The table gives the price of a balloon ride, the temperature, and the number of rides a day.Balloon rides(number per day)Price(dollars per ride)50F70F90F5324050102732401518273210. Draw a graph to show the relationship betweenthe price and the number of rides, when the temperature is 70F. Describe this relationship.11. What happens in the graph in Problem 10 if thetemperature rises to 90F?000200010270728684_CH01_p001-026.qxd6/22/114:00 PMPage 26...
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