But if you eat a second burger, you may feel a lesser amount of satisfaction than with the first burger.
Two other important economic principles are supply and demand. Market supply refers to the total amount of a certain good or service available on the market to consumers, while market demand refers to the total demand for the good or service. The interplay of supply and demand helps determine prices for a product or service, with higher demand and limited supply typically making for higher prices. In a city like New York, there is a limited supply of housing and high demand.
To rent an apartment, first, you must determine a budget.
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For this, you will have to take into account your income and how much money you are looking to spend on housing, in such a way as to maximize your utility or satisfaction. If you allocate too much of your income to rent, you will not have a lot of money left for other expenses. Thus, you will have to decide what is the most amount of money you are willing to part with, what amenities you must have in your apartment and acceptable neighborhoods. Based on all the above factors, you set a budget to get the most satisfaction for the least possible rent. You will not pay more than you have to in order to get what you want.
Considering that in this supply-constrained market there are others also interested in renting the apartments that are more in demand, you might find that you will have to increase your budget. To do this, you will have to cut down on spending in another area, like entertainment, travel, or eating out. That is the opportunity cost of finding the right apartment. Similarly, a landlord will seek to rent an apartment at the highest price possible, since her motivation generally is to get the best return by renting out the apartment.
In setting the rent, she would have to take into account the demand for the apartment and the neighborhood. If there are enough potential renters interested in the apartment, she would set a higher rent. If she were to set the rent too high, compared to what other landlords in the neighborhood are charging for comparable apartments, she would find that renters are not interested. The business owner, in this case, the landlord, also makes decisions based on supply and demand. And while she would attract a larger pool of prospective renters by setting a rent that is lower than what other neighborhood landlords are charging for comparable apartments, she would be missing out on some rental income which will not maximize her utility.
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Thus, both you and the landlord will make decisions to get the best outcome for yourselves given the constraints you face. 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.
Microeconomics vs. Macroeconomics: What's the Difference?
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.
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- Microeconomics vs. Macroeconomics: What's the Difference??
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.