Specialization only makes sense, though, if workers can use the pay they receive for doing their jobs to purchase the other goods and services that they need. In short, specialization requires trade. You do not have to know anything about electronics or sound systems to play music—you just buy an iPod or MP3 player, download the music and listen.
You do not have to know anything about artificial fibers or the construction of sewing machines if you need a jacket—you just buy the jacket and wear it. You do not need to know anything about internal combustion engines to operate a car—you just get in and drive. Instead of trying to acquire all the knowledge and skills involved in producing all of the goods and services that you wish to consume, the market allows you to learn a specialized set of skills and then use the pay you receive to buy the goods and services you need or want.
This is how our modern society has evolved into a strong economy. Economics is not primarily a collection of facts to be memorized, though there are plenty of important concepts to be learned. Instead, economics is better thought of as a collection of questions to be answered or puzzles to be worked out. Most important, economics provides the tools to work out those puzzles. The study of economics does not dictate the answers, but it can illuminate the different choices.
Economics seeks to solve the problem of scarcity, which is when human wants for goods and services exceed the available supply. A modern economy displays a division of labor, in which people earn income by specializing in what they produce and then use that income to purchase the products they need or want. The division of labor allows individuals and firms to specialize and to produce more for several reasons: a It allows the agents to focus on areas of advantage due to natural factors and skill levels; b It encourages the agents to learn and invent; c It allows agents to take advantage of economies of scale.
Division and specialization of labor only work when individuals can purchase what they do not produce in markets. Learning about economics helps you understand the major problems facing the world today, prepares you to be a good citizen, and helps you become a well-rounded thinker.
Bureau of Labor Statistics, U. Department of Labor. Williamson, Lisa. Accessed December 1, Skip to content Chapter 1. Welcome to Economics! Learning Objectives By the end of this section, you will be able to: Discuss the importance of studying economics Explain the relationship between production and division of labor Evaluate the significance of scarcity.
Self-Check Questions What is scarcity? Can you think of two causes of scarcity? Residents of the town of Smithfield like to consume hams, but each ham requires 10 people to produce it and takes a month.
If the town has a total of people, what is the maximum amount of ham the residents can consume in a month? She likes to eat vegetables, but is not very good at growing them. Why does it make more economic sense for her to spend her time at the consulting job and shop for her vegetables?
A computer systems engineer could paint his house, but it makes more sense for him to hire a painter to do it. For this reason, an understanding of economic thought makes you a more successful citizen.
As a citizen, the study of economics makes you more calculated in your decision making. Economic decisions require that you take many variables into consideration when coming to a conclusion. In this way, it is much more scientific and mathematical than general political philosophy or simple common sense guessing.
One of these variables is scarcity. To determine whether something is scarce, try asking a few questions: Is it limited and desirable? Is there more than one use for it? Would someone pay money for it? If the answer is yes for any of the questions, the resource is scarce. By this test, almost everything can be said to be scarce.
Is it limited? Oh, yes. Is there more than one way to use land in NYC? Of course. Do people pay for land? You bet. Land in New York City is very scarce. How about a similarly sized plot of land in rural Kansas? While it feels plentiful as one drives through on a family road trip, there is not an infinite amount of land. Is it desirable? Someone would be willing to pay money for land in Kansas.
Are there multiple uses? Perhaps the land can grow crops, support a new subdivision of houses, or be utilized as open space for nature lovers. While land in New York City is obviously much more scarce than land in rural Kansas, we find that as a general rule, land is scarce. Furthermore, relative scarcity is reflected in the price.
Land in New York City is much more expensive than a plot in Kansas. In short, opportunity cost is all around us. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else; in short, opportunity cost is the value of the next best alternative. Since people must choose, they inevitably face trade-offs in which they have to give up things they desire to get other things they desire more.
In some cases, recognizing the opportunity cost can alter personal behavior. Five dollars each day does not seem to be that much. Opportunity cost also comes into play with societal decisions. Universal health care would be nice, but the opportunity cost of such a decision would be less housing, environmental protection, or national defense. These trade-offs also arise with government policies. For example, after the terrorist plane hijackings on September 11, , many proposals, such as the following, were made to improve air travel safety:.
According to the United States Department of Transportation, more than million passengers took plane trips in the United States in Say that, on average, each air passenger spends an extra 30 minutes in the airport per trip. Economists commonly place a value on time to convert an opportunity cost in time into a monetary figure. Clearly, the opportunity costs of waiting time can be just as substantial as costs involving direct spending.
How do we get the most we can from the resources we have? Over time, markets and trade have come into existence and have become highly efficient mechanisms for optimizing our use of resources and bringing us the most and best combination of goods and services.
Think back to pioneer days, when the average person knew how to do so much more on his or her own than someone today—everything from shoeing a horse to growing, hunting, and preserving food to building a house and repairing equipment.
The formal study of economics began when Adam Smith — published his famous book, The Wealth of Nations, in Many authors had written about economics in the centuries before Smith, but he was the first to address the subject in a comprehensive way. In the first chapter of the book, Smith introduces the idea of the division of labor , which means that the way a good or service is produced is divided into a number of tasks that are performed by different workers, instead of all the tasks being performed by the same person.
To illustrate the division of labor, Smith counted how many tasks were involved in making a pin: drawing out a piece of wire, cutting it to the right length, straightening it, putting a head on one end and a point on the other, packaging pins for sale, and so on. Smith counted eighteen distinct tasks that were typically performed by different people—all for a pin!
Modern companies divide tasks, too. A complex business like a large manufacturing factory or a hospital can have hundreds of job classifications. When the tasks involved with producing a good or service are divided and subdivided, workers and businesses can produce a greater quantity of those goods or services. In his study of pin factories, Smith observed that one worker alone might make twenty pins in a day, but that a small business of ten workers some of whom would need to do two or three of the eighteen tasks involved in pin making , could make forty-eight thousand pins in a day.
How can a group of workers, each specializing in certain tasks, produce so much more than the same number of workers who try to produce the entire good or service by themselves? Smith offered three reasons. First, specialization in a particular small job allows workers to focus on the parts of the production process in which they have an advantage. People have different skills, talents, and interests, so they will be better at some jobs than at others.
The particular advantages may be based on educational choices, which are shaped, in turn, by interests and talents. Only those with medical training qualify to become doctors, for instance. Whatever the reason, if people specialize in the production of what they do best, they will be more productive than if they produce a combination of things, some of which they are good at and some of which they are not.
Second, workers who specialize in certain tasks often learn to produce more quickly and with higher quality. Unlike engineering and accounting majors, economics and other social science majors tend to be distributed over a broad range of occupations. Suppose that you are considering something other than a career in economics.
Would choosing to study economics help you? The evidence suggests it may. Suppose, for example, that you are considering law school. The study of law requires keen analytical skills; studying economics sharpens such skills. Economists have traditionally argued that undergraduate work in economics serves as excellent preparation for law school. Table 1. Economics majors tied philosophy majors for the highest average score. Here are the average LSAT scores and rankings for the 12 undergraduate majors with more than 1, students taking the test to enter law school in the — academic year.
Did the strong performance by economics and philosophy majors mean that training in those fields sharpens analytical skills tested in the LSAT, or that students with good analytical skills are more likely to major in them? Both were probably at work. Economics and philosophy clearly attract students with good analytical skills—and studying economics or philosophy helps to develop those skills. Of course, you may not be interested in going to law school.
One consideration relevant to selecting a major is potential earnings in that field. The National Association of Colleges and Employers conducts a quarterly survey of salary offers received by college graduates with various majors. The results for the summer survey for selected majors are given in Table 1. If you are going for the big bucks, the best strategy is to major in petroleum engineering.
But as the table suggests, economics majors as a group did quite well in For psychology, median salary offer is reported. You will also consider your interests and abilities in making a decision about whether to pursue further study in economics. And, of course, you will consider the expected benefits of alternative courses of study. What is your opportunity cost of pursuing study of economics? Does studying more economics serve your interests and will doing so maximize your satisfaction level?
These considerations may be on your mind as you begin to study economics at the college level and obviously students will make many different choices. But, should you decide to pursue a major in economics, you should know that a background in this field is likely to serve you well. In what way does this estimate illustrate the economic way of thinking? He wanted to spend the day with his girlfriend, Bea—it was, after all, her birthday. His alternative was to spend the day with Homer and the family, which he did not really want to do, partly because they never visited him anyway.
As for the forgone alternative, Bea dies that day, possibly because of a broken heart from not being able to spend the day with Grampa. Sources: R. Andrew Luccasen and M. The Simpsons , Episode no. The information given suggests one element of the economic way of thinking: assessing the choice at the margin. The estimate reflects the cost of one more child for a family that already has one.
It is not clear from the information given how close the estimate of cost comes to the economic concept of opportunity cost. An economist would add the value of the best alternative use of the additional time that will be required for the child. If the couple is looking far ahead, it may want to consider the opportunity cost of sending a child to college.
And, if it is looking very far ahead, it may want to consider the fact that nearly half of all parents over the age of 50 support at least one child over the age of This is a problem in microeconomic analysis, because it focuses on the choices of individual households. But certainly much of the basic methodology of economics and many of its difficulties are common to every social science—indeed, to every science.
This section explores the application of the scientific method to economics. Researchers often examine relationships between variables. A variable Something whose value can change. By contrast, a constant Something whose value does not change. The speed at which a car is traveling is an example of a variable. The number of minutes in an hour is an example of a constant.
Research is generally conducted within a framework called the scientific method A systematic set of procedures through which knowledge is created. In the scientific method, hypotheses are suggested and then tested. A hypothesis An assertion of a relationship between two or more variables that could be proven to be false.
A statement is not a hypothesis if no conceivable test could show it to be false. If solar radiation were shown to be unrelated to plant growth or to retard plant growth, then the hypothesis would be demonstrated to be false. If a test reveals that a particular hypothesis is false, then the hypothesis is rejected or modified.
In the case of the hypothesis about solar radiation and plant growth, we would probably find that more sunlight increases plant growth over some range but that too much can actually retard plant growth. Such results would lead us to modify our hypothesis about the relationship between solar radiation and plant growth.
If the tests of a hypothesis yield results consistent with it, then further tests are conducted. A hypothesis that has not been rejected after widespread testing and that wins general acceptance is commonly called a theory A hypothesis that has not been rejected after widespread testing and that wins general acceptance. A theory that has been subjected to even more testing and that has won virtually universal acceptance becomes a law A theory that has been subjected to even more testing and that has won virtually universal acceptance.
We will examine two economic laws in the next two chapters. Even a hypothesis that has achieved the status of a law cannot be proven true. There is always a possibility that someone may find a case that invalidates the hypothesis. That possibility means that nothing in economics, or in any other social science, or in any science, can ever be proven true. All scientific thought involves simplifications of reality.
The real world is far too complex for the human mind—or the most powerful computer—to consider. Scientists use models instead. A model A set of simplifying assumptions about some aspect of the real world. Models are always based on assumed conditions that are simpler than those of the real world, assumptions that are necessarily false.
A model of the real world cannot be the real world. For that model, we will assume that an economy can produce only two goods.
Then we will explore the model of demand and supply. One of the assumptions we will make there is that all the goods produced by firms in a particular market are identical. Of course, real economies and real markets are not that simple. Reality is never as simple as a model; one point of a model is to simplify the world to improve our understanding of it. Economists often use graphs to represent economic models.
The appendix to this chapter provides a quick, refresher course, if you think you need one, on understanding, building, and using graphs. Models in economics also help us to generate hypotheses about the real world.
In the next section, we will examine some of the problems we encounter in testing those hypotheses. Here is a hypothesis suggested by the model of demand and supply: an increase in the price of gasoline will reduce the quantity of gasoline consumers demand. How might we test such a hypothesis? Economists try to test hypotheses such as this one by observing actual behavior and using empirical that is, real-world data.
The number of gallons of gasoline consumed by U. The small increase in the quantity of gasoline consumed by motorists as its price rose is inconsistent with the hypothesis that an increased price will lead to a reduction in the quantity demanded. Does that mean that we should dismiss the original hypothesis?
On the contrary, we must be cautious in assessing this evidence. Several problems exist in interpreting any set of economic data. One problem is that several things may be changing at once; another is that the initial event may be unrelated to the event that follows.
The next two sections examine these problems in detail. The hypothesis that an increase in the price of gasoline produces a reduction in the quantity demanded by consumers carries with it the assumption that there are no other changes that might also affect consumer demand. A better statement of the hypothesis would be: An increase in the price of gasoline will reduce the quantity consumers demand, ceteris paribus.
But things changed between May and May Economic activity and incomes rose both in the United States and in many other countries, particularly China, and people with higher incomes are likely to buy more gasoline. Employment rose as well, and people with jobs use more gasoline as they drive to work. Population in the United States grew during the period. In short, many things happened during the period, all of which tended to increase the quantity of gasoline people purchased.
Our observation of the gasoline market between May and May did not offer a conclusive test of the hypothesis that an increase in the price of gasoline would lead to a reduction in the quantity demanded by consumers.
Other things changed and affected gasoline consumption. Such problems are likely to affect any analysis of economic events. We cannot ask the world to stand still while we conduct experiments in economic phenomena. Economists employ a variety of statistical methods to allow them to isolate the impact of single events such as price changes, but they can never be certain that they have accurately isolated the impact of a single event in a world in which virtually everything is changing all the time.
In laboratory sciences such as chemistry and biology, it is relatively easy to conduct experiments in which only selected things change and all other factors are held constant. Hypotheses in economics typically specify a relationship in which a change in one variable causes another to change.
We call the variable that responds to the change the dependent variable A variable that responds to change. Sometimes the fact that two variables move together can suggest the false conclusion that one of the variables has acted as an independent variable that has caused the change we observe in the dependent variable. Consider the following hypothesis: People wearing shorts cause warm weather.
Certainly, we observe that more people wear shorts when the weather is warm. Presumably, though, it is the warm weather that causes people to wear shorts rather than the wearing of shorts that causes warm weather; it would be incorrect to infer from this that people cause warm weather by wearing shorts.
Reaching the incorrect conclusion that one event causes another because the two events tend to occur together is called the fallacy of false cause The incorrect assumption that one event causes another because the two events tend to occur together.
The accompanying essay on baldness and heart disease suggests an example of this fallacy. Because of the danger of the fallacy of false cause, economists use special statistical tests that are designed to determine whether changes in one thing actually do cause changes observed in another.
Given the inability to perform controlled experiments, however, these tests do not always offer convincing evidence that persuades all economists that one thing does, in fact, cause changes in another.
In the case of gasoline prices and consumption between May and May , there is good theoretical reason to believe the price increase should lead to a reduction in the quantity consumers demand. And economists have tested the hypothesis about price and the quantity demanded quite extensively. They have developed elaborate statistical tests aimed at ruling out problems of the fallacy of false cause. While we cannot prove that an increase in price will, ceteris paribus, lead to a reduction in the quantity consumers demand, we can have considerable confidence in the proposition.
Two kinds of assertions in economics can be subjected to testing.
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