The Nature and Scope of Economics

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CHAPTER ONE

The Nature and Scope of Economics

PURPOSE

This chapter acquaints the reader with the nature and scope of economics. To this end, it first defines economics rather elaborately and then analyzes the definition. As a result, the definition can be used as a point of departure for discussing the ramifications of the nature and scope of economics. The chapter also shows how economics is related to other sciences, such as physics, sociology, psychology, philosophy, and political science. The ensuing discussion distinguishes between economic theory and economic policy, and it analyzes the economic decision-making process.

CHAPTER LEARNING OBJECTIVES

After studying Chapter 1, your students should be able to:

1. Define the term economics and explain its scope.

2. Identify the four productive resources and name the payment each receives for its contribution.

3. Explain the relationship of economics to other sciences.

4. Distinguish between economic theory and economic policy.

5. Identify and define the new economic concepts and terms presented in the chapter.

6. Distinguish between microeconomics and macroeconomics. Explain why choices must be made regarding which goods and services to buy every day.

NEW TERMS AND DEFINITIONS

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Economics A social science that studies how people and institutions within a society make choices and how these choices determine the use of society’s scarce resources.

Production The creation or addition of utility.

UtilityThe ability of a good or service to satisfy a want.

Total product The sum of all the goods and services produced by an economy over a given time period.

DistributionThe allocation of the total product among the productive resources.

Productive resourcesInputs or resources necessary before a person or business can engage in the production of goods or services;

specifically, labor, land, capital, and enterprise.

LaborThe time and the effort expended by human beings involved in the production process.

LandAll the resources of the land, sea, and air.

CapitalGoods used to produce other goods and services.

EnterpriseThe act of organizing and assuming the risk of a business venture.

EntrepreneurA person who organizes and assumes the risk of a business venture.

ConsumptionThe use of a good or service.

Economic goodsAn object or service that has utility, is scarce, and is transferable.

Free goodA good that lacks the element of scarcity and therefore has no price.

Public goodAn economic good to the supplier but a free good to the user.

Consumer goodsEconomic goods that are directly utilized by the consuming public.

Capital goodsEconomic goods used to produce other consumer or capital goods.

Human capitalThe stock of labor talents and skills used to increase productivity.

Total incomeThe total value of the goods and services produced over a period of time (usually a year).

ScienceAn organized body of knowledge coordinated, arranged, and systematized according to general laws or principles.

Economic theoryDevelops rules and principles of economics and is a guide for action under a given set of circumstances.

Economic policyAction actually taken under a given set of circumstances.

Positive economicsThe area of economics dealing with what is.

Normative economicsThe area of economics dealing with what ought to be.

Marginal analysis Analyzing the value of one more or one less unit.

Assumption A supposition that something is true without proof.

Rational behavior Behavior that is consistent with a given goal.

Equilibrium A position of stability or rest, where the quantity supplied equals the quantity demanded.

Fallacy of composition An action that is beneficial to an individual may not be beneficial if done by a group.

Paradox of thrift Saving by individuals or families is desirable for it increases capital formation, but if a large number of people increase saving it may result in a decline in national income and an increase in unemployment.

Moral hazard When the government compensates individuals and firms for large-scale losses, it creates a climate for greater risk taking and greater losses in the future.

MicroeconomicsDeals with the economic problems of the individual, the firm, and the industry.

MacroeconomicsDeals with the aggregates of economics, including total production, total employment, and general price level.

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CHAPTER OUTLINE AND LECTURE NOTES

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1. Economics Defined

Economics studies how people and institutions within a society make choices, and how the choices determine how the resources of society are used. To keep the definition of economics clear to students during discussion of the chapter, project the definition, leaving ample space for inserting comments. You can then analyze each important word in the definition, adding to the definition as you proceed. In this way students will have a bird’s-eye view at all times.

A. Economics and Production.Define production as the creation or addition of utility. Define utility as the economist’s term for the ability of a good or service to satisfy a want. The sum of all the goods and services produced by an economy over a given time period is known as total product.

B. Economics and Distribution.Use Figure 1-1 to explain the four productive resources and to indicate the form of compensation each receives for its contribution to production.

C. Economics and Consumption.Explain why consumption is the ultimate end of all economic activity.

D. Goods and Services.Explain that economic goods and services must be useful, scarce, and transferable. Show how services have all the characteristics of material goods except that they are intangible. Explain the differences among economic goods, free goods, and public goods, as well as between consumer goods and capital goods.

E. Wealth and Income.Distinguish between the stock concept of wealth and the flow concept of income.

F. Economics in Relation to Other Sciences.A science is an organized body of knowledge coordinated, arranged, and systematized according to general laws or principles. As a social science, economics studies the behavior and interactions of human beings, individually and in groups, and is thus related to political science, sociology, psychology, and ethics. However, some of its laws are based on physical phenomena, and it also is closely related to mathematics.

G. Economic Theory and Policy.It is important to distinguish between economic theory and economic policy. Economic theory develops the rules and principles of economics and provides a guide for action. Economic policy refers to actions actually taken. In the course of implementation, economic principles may at times be modified by political, social, or military policy. Cite examples of this concept for students’ consideration. Explain the difference between positive economics and normative economics.

H. Economic Terms and Concepts. Economics has its own jargon and terminology. Understanding economics terminology is essential. In addition to defining marginal analysis, assumptions, rational behavior, and equilibrium; be sure that students understand that the concepts are fundamental building blocks for the study of economics. Also review the fallacy of composition, the paradox of thrift, and moral hazard.

2. Microeconomics and Macroeconomics

In distinguishing between microeconomics and macroeconomics, bring out the fact that this book (course) deals with macroeconomics, microeconomics, and international economics.

3. Economics Is a Science of Choices

There are many alternatives to consider in making economic decisions. Many problems have no clear-cut, definitive answer. A prudential judgment must be made as to the best means to attain a desired objective.

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ANSWERS TO DISCUSSION QUESTIONS AT END OF CHAPTER 1

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1. Will economics ever develop into an exact science? Why or why not?

Since economic acts are human acts, and since human beings have different educational, political, social, economic, and psychological backgrounds, there will always be varying reactions to economic situations. Furthermore, prudential judgment will continue to be necessary in making economic decisions, and such judgments are subject to error. Therefore, economics will never develop into an exact science. As the public in general learns more about economics, however, we might see more uniformity in economic actions. Moreover, we will continue to apply increasingly accurate scientific methods and quantitative techniques to the study of economics.

2. In what ways does production involve more than the manufacture and fabrication of goods?

Since middlepersons (shopkeepers, financiers, auto dealers, etc.) create utility, they produce in a way similar to a worker on an assembly line or a construction worker. Their services are essential in our modern, complex economy and are recognized as a part of the total production of the economy. Likewise, the services of doctors, lawyers, dentists, and teachers constitute part of our total production.

3. What are the four basic productive resources, and what form of compensation does each receive for its contribution to production?

The four basic productive resources are land, labor, capital, and enterprise. They are compensated in the form of wages, rent, interest, and profits, respectively.

4. Is it true that the more important a good or service is in our everyday lives, the higher the price we must pay to acquire it? Explain your answer and give examples.

A very useful good or service may have a very low price. If a good or service exists in such abundance that anyone can readily obtain it without much effort, it is not relatively as scarce and will have a relatively low monetary value. It is impossible to live without oxygen, yet you do not pay for each breath you take (except indirectly to the extent that clean air regulations drive up the prices of other goods). Other important goods that command relatively low prices include water, bread, and light bulbs.

5. Identify recent instances showing that distribution is a continuing problem in our economy.

Here the student might be expected to mention current or past labor strikes for higher wages, the relatively high interest rates on credit card debt despite generally declining interest rates in recent years, and important price increases in the economy (such as those of oil and energy) that illustrate attempts by the various resources to obtain a greater portion of the total economic pie.

6. Name some goods that were at one time free goods but are now economic goods.

Water, in the early days of some communities, was free. Other examples include land, clean air, lumber, and other resources.

7. How can the wealth of our nation be increased?

The portion of our nation’s total product or income that is not consumed is added to its wealth. Wealth can be increased by producing more capital goods directly, by improving the quality of capital goods, and by technological development.

8. Should an estimate of the value of human capital be included in the measurement of our wealth? If so, how might it be measured?

Since human capital (like machinery and equipment) is used to produce other goods and services, some economists argue that human capital should be included in the valuation of national wealth. However, some measures of wealth do not include human capital. The value of education and training may be estimated by capitalizing the income of each member of the labor force. Just as we calculate the capitalized value of land by determining what amount of money, if invested at the current rate of interest, will yield an income equal to the rental value of the land, we can capitalize the skill of a worker. If a skilled worker earns $40,000 a year, and the current rate of interest is 10 percent, the value of the worker’s skill is $400,000 ($40,000 × 10).

9. What is the relationship between economic theory and economic policy?

Economic theory tries to develop a set of economic principles or conclusions from analyses of abstract concepts. Assumptions, conditions, and models used in these analyses are often more ideal than real. Economic policy involves developing a certain course of action to follow in particular circumstances and designing measures to implement the policy. Economic policy is often based on principles or conclusions developed from economic theory, but it is commonly modified by political, military, and social concerns.

10. Why do differences of opinion among economists on matters of economic policy occur so frequently?

One cause of differences is that in many economic matters there is no objectively right or wrong answer. Furthermore, differences often reflect underlying discord about economic preferences. For example, some economists prefer security to higher wages, and vice versa. Since prudential judgments are centrally involved in much economic decision making, there are sure to be differences of opinion about economic policy among economists.

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