• This chapter describes the tools needed to begin forming an economic analysis • The foundation of all economic analysis is the use of economic data, graphs, and models. These topics are introduced and discussed with the issue of health care
1. Observations: What Economist Endeavor to Explain
• Virtually all the questions economists seek to answer come from observing the economy. They document and quantify their observations by collecting and examining data • A standard measure of the size and activity of an economy is gross domestic product (GDP)
Time-Series Graphs • Any series of data that is measured over time is called a time-series. A series that is plotted over time is called a time-series graph. • We use a time-series graph to describe the behavior of a series over time. Economic models are used to explain the behavior.
Correlation • Two series of data may be related. Correlation (positive and negative) measures the potential relationship. • What can you say about the correlation between good grades on economic tests and time spent partying?
Correlation and Causation • Correlation and causation are not the same. To say that two series are correlated does not mean that once causes (leads) another. Correlation between two series may be caused by a third series.
Economic Data • Data measure the interaction of households (consumers), firms, and governments. Most interaction occurs in markets. • A market is a mechanism in which exchange between buyers and sellers take place.
2. Economic Models • A model is an explanation of how the economy, or part of the economy, works. • Models are built on theories and tell economists whether variables are negatively or positively related.
• Economic models may be classified according to whether they seek to explain an economy (macroeconomics) or seek to explain aspects of individual behavior (microeconomics). • Theories and models are not stagnant. New models and theories evolve often.
3. Using Economics for Public Economic Policy • Ever since the Wealth of Nations by Adam Smith (1776), economists have been motivated by a desire to improve government policy. • Positive economics simply explains the results of policy (What it is) • Normative economics attempts to develop and recommend policy (What it should be). • Economics is independent of political parties. It has a set of tools that aid in thinking.