SOLUTIONS MANUAL
Microeconomics Private and Public Choice 17/E by Gwartney
Chapter 1: The Economic Approach
OUTLINE
I. What Is Economics About?
A. Scarcity means having to make choices.
1. Scarcity and choice are the two essential ingredients of an economic topic.
2. Scarcity is present whenever there is less of a good or resource freely available
than people would like.
a. Scarce goods are called economic goods.
b. Resources are the inputs that people use to produce goods and services and may
include human, physical, and natural resources.
3. Scarcity forces us to choose among available alternatives.
B. Scarcity and poverty are not the same.
1. Scarcity is a factual concept in which limited resources cause our desires for goods
and services to be lacking.
2. Poverty is more subjective in nature; different people have different ideas of what
it means to be “poor.”
3. We may someday eliminate poverty, but scarcity will always be with us.
C. Scarcity necessitates rationing.
1. Every society must have a method to ration the scarce resources among competing
uses.
a. Various factors can be used to ration (first-come, first-served).
b. In a market setting, price is used to ration goods and resources.
c. When price is used, the good or resource is allocated to those willing to give up
“other things” in order to obtain ownership rights.
D. The method of rationing influences the nature of competition.
1. Competition is a natural outgrowth of the need to ration scarce goods.
2. Changing the rationing method used will change the form of competition, but it
will not eliminate competitive tactics.
II. The Economic Way of Thinking
A. Eight guideposts to economic thinking
1. The use of scarce resources is costly, so decision-makers must make trade-offs.
a. Someone must give up something if we are to have more scarce goods.
(1) The highest-valued alternative that must be sacrificed is the opportunity cost
of the choice.
2. Individuals choose purposefully—they try to get the most from their limited
resources.
a. Economizing: gaining a specific benefit at the least possible cost.
, 3. Incentives matter—changes in incentives influence human choices in a predictable
way. Both monetary and nonmonetary incentives matter.
a. As personal benefits (costs) from choosing an option increase, other things
constant, a person will be more (less) likely to choose that option.
4. Individuals make decisions at the margin.
a. Decisions will be based on marginal costs and marginal benefits (utility).
5. Although information can help us make better choices, its acquisition is costly..
6. Beware of the secondary effects: Economic actions often generate indirect as well
as direct effects.
7. The value of a good or service is subjective.
8. The test of a theory is its ability to predict.
III. Positive and Normative Economics
A. Positive economics is the scientific study of “what is” among economic relationships.
1. Positive economic statements can be proved either true or false.
a. Ex: The inflation rate rises when the money supply is increased.
B. Normative economics are judgments about “what ought to be” in economic matters.
1. Normative statements cannot be proved true or false.
a. Ex: The inflation rate should be lower.
IV. Pitfalls to Avoid in Economic Thinking
A. Violation of the ceteris paribus condition can lead one to draw the wrong conclusion.
1. Ceteris paribus is a Latin term meaning “other things constant.”
2. Used when the effect of one change is being described, recognizing that if other
things changed, they also could affect the result.
B. Good intentions do not guarantee desirable outcomes.
1. Policies formed with good intentions may have unintended adverse secondary
effects.
C. Association is not causation.
1. Statistical association alone cannot establish causation.
D. The fallacy of composition: What’s true for one might not be true for all.
1. The fallacy of composition is the erroneous view that what is true for the individual
(or the part) will also be true for the group (or the whole).
2. Microeconomics focuses on narrowly defined units, while macroeconomics
focuses on highly aggregated units.
a. One must beware of the fallacy of composition when shifting from micro to
macro units.
FOCUS QUESTIONS
As you read this chapter, look for answers to the following questions:
• What is scarcity? Why does scarcity necessitate rationing and cause competition?
• What is the economic way of thinking? What is the basic postulate of economics, and why
is it so important?
• What is the difference between positive and normative economics?
,CONTEXT
The purpose of this chapter is to introduce the student to the economic way of thinking. Unless
students understand the concept of scarcity, the importance of personal incentives, and subject their
thinking to the scientific method, they will do poorly in economics.
Generally, teachers overestimate their students. While many of your students will easily grasp
the basics of the economic way of thinking, others will need additional examples and illustrations
before they understand the essentials. The concepts of scarcity, economizing behavior, and
incentives are so important, they are worth an entire lecture. Use several illustrations to highlight
the impact on human behavior of changes in personal benefits or costs.
Introductory students tend to associate economics with business decision making. We must
illustrate to them that the basic principles of economics and personal incentives influence all of
human decision making, including choices in the political and social spheres. You may also want
to contrast the methodology of economics with that of other social sciences and the physical
sciences. Discuss both the similarities and differences.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Be sure to distinguish clearly between scarcity and poverty (and shortages, once supply and
demand have been covered). Anything that we would like to have more of at no cost is scarce.
Thus, almost everything from clean air to leisure time to the ingenuity necessary to make other
resources useful is scarce. Poverty is defined as failure to attain some minimum level of
income. Poverty can conceivably be eliminated, whereas scarcity persists since goods are
scarce for both the rich and the poor. A shortage is present when purchasers would like to buy
more than is available at the current price.
2. Introducing the subject of incentives, one can readily emphasize the importance and generality
of this basic principle of economics. When an activity is made more costly, people will be less
likely to choose it. Similarly, when the benefits derived from an event increase, people will be
more likely to undertake it. Numerous examples can illustrate this concept. How does hot
weather influence one’s decision to do without air-conditioning (or a swimming pool)? How
does rewarding class attendance with higher grades influence one’s decision to go to class?
How does the grading policy of the instructor influence a student’s incentive to study?
3. Discuss the meaning of “the margin” with students. Use non-economic examples to help clarify
the idea. For example, ask students how an additional outstanding running back will influence
the quality of a football team. (This is a marginal change.) If the running back position was
previously a team weakness, the new player may make a substantial difference. On the other
hand, if the team was already strong at this position, the new player may exert little influence
on the overall performance of the team. Indicate clearly the difference between (a) the overall
performance of the team (a total concept) and (b) the change that results from the addition of
the new player (a marginal concept).
4. A good way of illustrating the search for information is to ask students how long they would
search for a $50 bill. If your time had an opportunity cost of $10, you would look as long as
you thought the probability of finding the bill in the next hour was at least 1/5. (The answer is
not five hours in this case, because time already spent searching is then a sunk cost. A person
could look well more or less than five hours.)
, 5. Give examples of actions that have secondary effects. What are the secondary effects of
overeating? Lack of adequate sleep? Restricting trade with Japan? Fixing the price of wheat at
$6 per bushel?
6. Emphasize both the theory and empirical parts of economics. Many professional economists
are engaged in the continual testing of various aspects of economic theory. Discuss how
economic theory is tested. Indicate real-world events that have convinced economists to modify
their theories. Two examples of the latter are:
a. the impact of the Great Depression on the theory that wage and price flexibility quickly
restores full employment.
b. the economic events of the 1970s on the theory that moderate inflation enables us to
permanently attain low levels of unemployment.
7. Discuss the distinctions between positive and normative economics. Point out that positive
economic statements are testable, whereas normative statements are not. Give several
illustrations of both positive and normative economic statements. The following are examples
of positive economic statements:
a. “If the price of wheat rose, buyers would purchase less of it.”
b. “Nations that import substantial amounts of crude oil will experience inflation when crude
oil prices rise.” (Although this may or may not be true, it is nonetheless a positive statement.)
c. “An increase in government borrowing will cause interest rates to rise.”
The following are examples of normative statements:
a. “The price of wheat is too high.”
b. “The United States should impose price controls on domestic oil producers if the price of
foreign oil rises.”
c. “It is wrong for lenders to charge higher interest rates to poor people than they charge the
low-credit-risk customers.”
8. It is important to emphasize that association is not the same thing as causation. Discuss the
following points with regard to this point.
a. Skirt lengths tend to rise during prosperous times (1920s and 1960s, for example) and fall
during bad times (1930s). Therefore, prosperity is caused by short skirts, whereas hard times
result from low hemlines.
b. High crude oil prices caused the inflation experienced by the United States during the 1970s.
c. The post-World War II baby boom caused the prosperity of the period from 1946 to 1965.
d. War causes inflation.
