6 Review and Practice
Summary
Choices are forced on us by scarcity; economists study the choices that people make. Scarce goods are those for which the choice of one alternative requires giving up another. The opportunity cost of any choice is the value of the best alternative forgone in making that choice.
Some key choices assessed by economists include what to produce, how to produce it, and for whom it should be produced. Economics is distinguished from other academic disciplines that also study choices by an emphasis on the central importance of opportunity costs in evaluating choices, the assumption of maximizing behavior that serves the interests of individual decision makers, and a focus on evaluating choices at the margin.
Economic analyses may be aimed at explaining individual choice or choices in an individual market; such investigations are largely the focus of microeconomics. The analysis of the impact of those individual choices on such aggregates as total output, the level of employment, and the price level is the concern of macroeconomics.
Working within the framework of the scientific method, economists formulate hypotheses and then test them. These tests can only refute a hypothesis; hypotheses in science cannot be proved. A hypothesis that has been widely tested often comes to be regarded as a theory; one that has won virtually universal acceptance is a law. Because of the complexity of the real world, economists rely on models that rest on a series of simplifying assumptions. The models are used to generate hypotheses about the economy that can be tested using real-world data.
Statements of fact and hypotheses are positive statements. Normative statements, unlike positive statements, cannot be tested and provide a source for potential disagreement.
Firms exist to organize the resources of society, and to help answer many of economic questions. When the self-interest of the firms outstrips their usefulness to society, we call this a “market failure”. Remedies must be undertaken to protect the consumers, and the transactional flow of goods and services.
Corporate social responsibility has had many models over the years, with economic responsibility, such as profits, playing a different role in each one.
Problems
- Why does the fact that something is scarce require that we make choices?
- Does the fact that something is abundant mean it is not scarce in the economic sense? Why or why not?
- In some countries, such as Cuba and North Korea, the government makes most of the decisions about what will be produced, how it will be produced, and for whom. Does the fact that these choices are made by the government eliminate scarcity in these countries? Why or why not?
- Explain what is meant by the opportunity cost of a choice.
- What is the approximate dollar cost of the tuition and other fees associated with the economics course you are taking? Does this dollar cost fully reflect the opportunity cost to you of taking the course?
- In the Case in Point essay “The Rising Cost of Energy,” what would be some of the things that would be included in an estimate of the opportunity cost of preserving part of northern Alberta Canada by prohibiting heavy crude oil extraction? Do you think that the increased extraction represents the best use of the land? Why or why not?
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Indicate whether each of the following is a topic of microeconomics or macroeconomics:
- The impact of higher oil prices on the production of steel
- The increased demand in the last 15 years for exotic dietary supplements
- The surge in aggregate economic activity that hit much of Asia late in the early 2000s
- The sharp increases in U.S. employment and total output that occurred between 2003 and 2007
- The impact of preservation of wilderness areas on the logging industry and on the price of lumber
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Determine whether each of the following raises a “what,” “how,” or “for whom” issue. Are the statements normative or positive?
- A requirement that aluminum used in cars be made from recycled materials will raise the price of automobiles.
- The federal government does not spend enough for children.
- An increase in police resources provided to the inner city will lower the crime rate.
- Automation destroys jobs.
- Efforts to improve the environment tend to reduce production and employment.
- Japanese firms should be more willing to hire additional workers when production rises and to lay off workers when production falls.
- Access to health care should not be limited by income.
- Your time is a scarce resource. What if the quantity of time were increased, say to 48 hours per day, and everyone still lived as many days as before. Would time still be scarce?
- Most college students are under age 25. Give two explanations for this—one based on the benefits people of different ages are likely to receive from higher education and one based on the opportunity costs of a college education to students of different ages.
- Some municipal water companies charge customers a flat fee each month, regardless of the amount of water they consume. Others meter water use and charge according to the quantity of water customers use. Compare the way the two systems affect the cost of water use at the margin.
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How might you test each of the following hypotheses? Suggest some problems that might arise in each test due to the ceteris paribus (all-other-things-unchanged) problem and the fallacy of false cause.
- Reducing the quantity of heroin available will increase total spending on heroin and increase the crime rate.
- Higher incomes make people happier.
- Higher incomes make people live longer.
- Many models in physics and in chemistry assume the existence of a perfect vacuum (that is, a space entirely empty of matter). Yet we know that a perfect vacuum cannot exist. Are such models valid? Why are models based on assumptions that are essentially incorrect?
- Suppose you were asked to test the proposition that publishing students’ teacher evaluations causes grade inflation. What evidence might you want to consider? How would the inability to carry out controlled experiments make your analysis more difficult?
- Referring to the Case in Point “Baldness and Heart Disease,” explain the possible fallacy of false cause in concluding that baldness makes a person more likely to have heart disease.
- In 2005 the Food and Drug Administration ordered that Vioxx and other popular drugs for treating the pain of arthritis be withdrawn from the market. The order resulted from a finding that people taking the drugs had an increased risk of cardiovascular problems. Some researchers criticized the government’s action, arguing that concluding that the drugs caused the cardiovascular problems represented an example of the fallacy of false cause. Can you think of any reason why this might be the case?
- In the wake of corporate scandals such as those Enron, WorldCom, Lehman Brothers, and the Bernie Madoff scandal, many argue that decision makers making decisions without risking their own fortunes, such as managers of large, publicly traded firms, or stock traders, make those decision to maximize their own welfare, rather than the company’s or the shareholders. Does such behavior create problems in using strictly profit as a basis for examining the value of a company in decision making?
- Is it reasonable to expect firms to ever act in the public interest if it is detrimental to their own?
