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Chapter 1

ECONOMICS: THE WORLD AROUND YOU

1.What is economics?

Economics is the study of how people choose to allocate scarce resources to satisfy their unlimited wants. There are several words in this definition that should be emphasized. First, people allocate scarce resources. If there was enough of a resource to go around so that everyone could have as much as he or she wanted, there would be no need to allocate.

The definition states that people have unlimited wants. Notice that it says wants, not needs. People act on the basis of their wants, not necessarily on the basis of their needs. (Otherwise they would not buy strawberry sundaes.) If each of us made a list right now of the top ten things we would like to have and our fairy godmother popped out of the air and gave us what we wanted, most of us immediately would find that there are ten more things we'd like to have. Because resources are scarce and wants are unlimited, economics studies the best way to allocate resources so that none are wasted.

2.What is the economic way of thinking?

The economic way of thinking focuses on positive, as opposed to normative, analysis, and applies the five-step scientific method: (1) recognize the problem, (2) cut away unnecessary detail by making assumptions, (3) develop a model or story, (4) make predictions, and (5) test the model.

Key Terms

Scarcity
economic good
free good
economic bad
resources
factors of production
inputs
land
labor
capital
rational self-interest
positive analysis
normative analysis
scientific method
theory
model
assumptions
ceteris paribus
test
fallacy of composition
association as causation
microeconomics
macroeconomics

Quick-Check Quiz

Section 1: The Definition of Economics

1. Which of the following is not an economic good?

  1. wine
  2. bicycles
  3. refrigerators
  4. air pollution
  5. education

2. Which of the following is not one of the three categories of resources?

  1. land
  2. automobiles
  3. capital
  4. labor
  5. None of the above are categories for resources.

3. The payment for capital is called

  1. rent.
  2. wages.
  3. salaries.
  4. interest.
  5. profit.

4. If an item is scarce,

  1. it is not an economic good.
  2. at a zero price the amount of the item that people want is less than the amount that is available.
  3. there is not enough of the item to satisfy everyone who wants it.
  4. there is enough to satisfy wants even at a zero price.
  5. it must be a resource as opposed to an input.

5. Which of the following is a free good?

  1. clean air
  2. water from a river
  3. education
  4. golf lessons
  5. None of the above is a free good.

6. The payment for land is called

  1. wages and salaries.
  2. rent.
  3. interest.
  4. profit.
  5. financial capital.

7. Rational self-interest

  1. dictates that individuals with the same information will make identical choices.
  2. means that people are completely selfish.
  3. explains why people give money to charitable organizations.
  4. explains why all drivers wear seat belts.
  5. means that people choose options that they think will give them the smallest amount of satisfaction.

Section 2: The Economic Approach

1. Analysis that does not impose the value judgments of one individual on the decision of others is called __________ analysis.

  1. positive
  2. normative
  3. economic
  4. noneconomic
  5. the scientific method of

2. Which of the following is not one of the five steps in the scientific method?

  1. Recognize the problem.
  2. Make assumptions in order to cut away unnecessary detail.
  3. Develop a model of the problem.
  4. Test the hypothesis.
  5. Make a value judgment based on the results of the hypothesis test.

3. If an individual decides to save more, he or she can save more. Therefore, if society as a whole decides to save more, it will be able to save more. This reasoning is faulty and as such is an example of

  1. ceteris paribus.
  2. the fallacy of composition.
  3. the interpretation of association as causation.
  4. the scientific method.
  5. none of the above this reasoning is not faulty.

4. Tim has noticed that every time he washes his car in the morning, it rains that afternoon. Because he believes he can cause it to rain by washing his car, he has decided to sell his services to farmers in drought-stricken areas. This reasoning is mistaken and as such is an example of

  1. ceteris paribus.
  2. the fallacy of composition.
  3. the mistaken interpretation of association as causation.
  4. the scientific method.
  5. none of the above Tim's reasoning is not faulty.

5. Which of the following is a normative statement?

  1. Lower interest rates encourage people to borrow.
  2. Higher prices for cigarettes discourage people from buying cigarettes.
  3. If the price of eggs fell, people probably would buy more eggs.
  4. There should be a higher tax on cigarettes, alcohol, and other sin items to discourage people from buying them.
  5. A higher interest rate encourages people to save more.

6. Microeconomics includes the study of

  1. how an individual firm decides the price of its product.
  2. inflation in the United States.
  3. how much output will be produced in the U.S. economy.
  4. how many workers will be unemployed in the U.S. economy.
  5. how the U.S. banking system works.

Practice Questions and Problems

Section 1: The Definition of Economics

1. _____________ exists when less of something is available than people want at a zero price.

2. Any good that is scarce is a(n) _____________ good.

3. If there is enough of a good available at a zero price to satisfy wants, the good is called a(n) _____________ good.

4. A good that people will pay to have less of is called an economic _____________ .

5. People use scarce resources to satisfy their _____________ wants.

6. _____________ means that people make the choices that they think will give them the greatest amount of satisfaction.

7. List the three categories of resources and the payments associated with each.

8. _____________ includes all natural resources, such as minerals, timber, and water, as well as the land itself.

9. _____________ refers to the physical and intellectual services of people.

10. _____________ is a manufactured or created product used solely to produce goods and services.

11. _____________ capital refers to the money value of capital as represented by stocks and bonds.

12. Resources also are called _____________ or _____________ .

13. _____________ are nonphysical products.

14. Economists believe human beings are _____________ , not selfish.

15. What is economics?

Section 2: The Economic Approach

1. Analysis that does not impose the value judgments of one individual on the decisions of others is called _____________ analysis.

2. _____________ analysis involves imposing value judgments on the decisions of others.

3. Economists generally agree on the _____________ aspects of economics.

4. List the five steps in the scientific method.

5. The role of models and _____________ is to reduce the complexity of a problem.

6. _____________ means other things being equal.

7. A theory, or _____________ , is a simplification that is used to explain an event.

8. _____________ is the study of economics at the level of the individual economic entity.

9. The _____________ is the error of attributing what applies to one to the case of many.

10. The mistaken interpretation of _____________ occurs when unrelated or coincidental events that occur at about the same time are believed to have a cause-and-effect relationship.

11. The outcome of positive analysis _____________ as society's norms change.

12. The study of the economy as a whole is called _____________ .

Thinking About and Applying Economics: The World Around You

I. The Relationship Between Speed Limits and Highway Deaths

In twenty-two of the thirty-eight states that chose to raise the speed limit on rural highways, highway deaths jumped 46 percent between May and July 1986. Transportation Committee Chairman James Howard attributed the increase in deaths to the higher speed limit. Can you think of any other reasons that highway deaths might have increased? If states that did not increase rural speed limits experienced a similar increase in highway deaths, what common mistake might Chairman Howard have made?

II. Scarce Parking in Wichita?

The following is an excerpt from the May 1, 1993, edition of The Wichita Eagle (p. A12):

It's become part of Wichita lore. Folks in these parts are nutty about parking.

They want it free. They want it at the front door of wherever they're going. They refuse to look for a parking space anywhere for more than eight or 10 seconds. And they think the downtown Wichita parking situation is horrible.

The fact is, there's plenty of parking in the city's core. About 20,000 people work downtown. There are almost 19,000 parking spaces. That nearly 1-to-1 ratio is better than other cities in the region such as Oklahoma City, and it's just as good as Topeka. And the average distance a person has to walk is about a block. That's better than similar-sized cities.

The editorial laments that people don't go downtown for activities because they think they'll have trouble parking and comments on a new report by the Metropolitan Area Planning Commission.

Relying on the information in the editorial, discuss whether parking spaces can be considered a scarce resource in downtown Wichita.

III. Resource and Income Flows

Complete the figure below.
resource and income flow chart

Chapter 1 Homework Problem

Name ________________________________________

A recent edition of the Wall Street Journal reported that some states were subsidizing Amtrak passenger trains so that state residents would have railroad transportation available.

The state of Oregon, however, had just decided to stop subsidizing a train between Eugene and Portland, Oregon, even though that meant the train would stop running. State Senator Greg Walden explained the decision this way: Subsidizing rail passengers isn't as high a priority as kids' education and keeping criminals behind bars.

Using the concepts you learned in Chapter 1, explain the economic logic underlying Senator Walden's comments.

If your instructor assigns this problem, write your answer above, then tear out this page and hand it in.

Answers

Quick-Check Quiz

Section 1: The Definition of Economics

1. d; 2. b; 3. d; 4. c; 5. e; 6. b; 7. c

If you missed any of these questions, you should go back and review Section 1 in Chapter 1.

Section 2: The Economic Approach

1. a; 2. e; 3. b; 4. c; 5. d; 6. a

If you missed any of these questions, you should go back and review Section 2 in Chapter 1.

Practice Questions and Problems

Section 1: The Definition of Economics

1. Scarcity

2. economic

3. free

4. bad

5. unlimited

6. Rational self-interest

7. land; rent labor; wages and salaries capital; interest

8. Land

9. Labor

10. Capital

11. Financial

12. factors of production; inputs

13. Services

14. self-interested

15. Economics is the study of how people choose to use their scarce resources to attempt to satisfy their unlimited wants.

Section 2: The Economic Approach

1. positive

2. Normative

3. positive

4. Recognize the problem. Make assumptions in order to cut away unnecessary detail. Develop a model of the problem. Make predictions. Test the model.

5. assumptions.

6. Ceteris paribus

7. model

8. Microeconomics

9. fallacy of composition

10. association as causation

11. does not vary

12. macroeconomics

Thinking About and Applying Economics: The World Around You

I. The Relationship Between Speed Limits and Highway Deaths

Other factors that might have increased highway deaths include the following:

1. Has there been an increase in population? It seems reasonable to expect more accidents as congestion increases.

2. Are Americans buying more smaller cars? If so, auto deaths would be expected to increase because smaller cars provide less protection in a crash.

3. Has there been an increase in the number of people drinking (or otherwise impaired) and driving? If so, we would expect an increase in the number of traffic fatalities no matter what the speed limit was.

Perhaps you can think of other factors that might account for the increase in traffic fatalities that Howard attributed to the higher speed limit. If Howard had wrongly attributed the higher death toll to the higher speed limit, he would have been mistaking association for causation.

II.Scarce Parking in Wichita?

If there is not enough of an item to satisfy everyone that wants it at a zero price, then an item is scarce. If people want parking at the front door of wherever they are going and have to walk, on average, about a block, parking is scarce.

III. Resource and Income Flows


resource and income flow chart

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