,SOLUTION MANUAL FOR Economics Today, 21st
edition Roger LeRoy Miller
Notes
1- The file is chapter after chapter.
2- We have shown you few pages sample.
3- The file contains all Appendix and Excel sheet
if it exists.
4- We have all what you need, we make update
at every time. There are many new editions
waiting you.
5- If you think you purchased the wrong file You
can contact us at every time, we can replace it
with true one.
Our email:
,Chapter 1
The Nature of Economics
◼ Overview
This chapter introduces economics as a science. Economics is defined, and its subareas,
macroeconomics and microeconomics, are introduced. The chapter also discusses the
three fundamental questions faced by every nation of what to produce, how to produce,
and for whom to produce. The chapter then presents the two types of economic
systems—the command-and-control system and the price system—that are used to
answer the three fundamental questions. Economic rationality and self-interest are
discussed along with their implications for decision-making and economic model
building. The concept of behavioral economics is introduced. Economics as a science is
closely associated with the development of models. To aid understanding, a significant
section on the methodology of economics discusses model construction, the role of
assumptions, and determining the usefulness of a model. Finally, the difference between
positive and normative economics is presented. There is a discussion of why it is
important to separate these two areas of analysis clearly.
◼ Learning Objectives
After studying this chapter, students should be able to:
1.1 Define economics and discuss the difference between microeconomics and
macroeconomics
1.2 Identify the three basic economic questions and the two opposing sets of answers
1.3 Evaluate the role that rational self-interest plays in economic analysis
1.4 Explain why economics is a science
1.5 Distinguish between positive and normative economics
◼ Outline
I. The Power of Economic Analysis: The analytical framework of the course is the
economic way of thinking. The economic way of thinking permits the student to
reach informed conclusions about what is happening in the world.
Copyright © 2026 Pearson Education, Inc.
,2 Miller • Economics Today, Twenty First Edition
A. Defining Economics: The study of how people allocate their limited resources
to satisfy their unlimited wants. The ultimate purpose of economics is to explain
how people make choices.
B. Microeconomics versus Macroeconomics: Economics is divided into two
types of analysis: microeconomics and macroeconomics.
1. Microeconomics: The part of economic analysis that studies decision-
making undertaken by individuals (or households) and by firms.
2. Macroeconomics: The part of economic analysis that studies the behavior
of the economy as a whole. It deals with economywide phenomena such as
changes in unemployment, the general price level, and national income.
II. The Three Basic Economic Questions and Two Opposing Sets of Answers: Every
nation must address three fundamental questions that concern the problem of how
an economic system allocates a society’s scarce resources.
A. The Three Basic Questions: (1) What and how much will be produced? (2)
How will items be produced? (3) For whom will items be produced?
B. Two Opposing Sets of Answers
1. Centralized Command and Control: A centralized command and control
system, also called central planning, has a centralized authority that decides
what items to produce and how many of each, determines how the scarce
resources will be organized in the items’ production, and identifies who will
be able to obtain the items.
2. The Price System: A price system, also called a market system, answers
the three basic questions using decentralized decision-making. In a pure
price system, individuals own all the scarce resources used in production.
This means those choices about what and how many of each item to
produce are made by private parties on their own initiative, as are the
decisions about how to produce those items. Individuals and families
choose how to allocate their incomes to obtain those items at prices
established by privately organized mechanisms. Those prices signal the
relative scarcity of different resources, which provides information about
what and how many items to produce, how each item should be produced,
and who will choose to buy the items.
3. Mixed Economic Systems: Most economic systems of the world
incorporate aspects of both centralized command and control and a
decentralized price system.
III. The Economic Approach: Systematic Decisions: Economists assume that
individuals act as if they pursue self-motivated interests and respond predictably to
perceived opportunities to obtain those interests.
A. The Rationality Assumption: The assumption that individuals will not
intentionally make decisions that would leave them worse off.
B. Responding to Incentives: An incentive is the reward for engaging in a given
activity. Much of human behavior can be explained in terms of how individuals
respond to changing incentives over time. In general, before making decisions,
Copyright © 2026 Pearson Education, Inc.
, Chapter 1 The Nature of Economics 3
individuals compare costs and benefits of their actions and choose those actions
which result in higher benefits than costs.
C. Defining Self-Interest: The pursuit of goals that make the individual better off.
In economic analysis, these goals are often those which can be measured in
monetary terms, although the pursuit of other goals such as prestige, love,
power, or others can be analyzed using this concept.
IV. Economics as a Science: Economics is a social science that utilizes the same types
of methods used in biology, physics, and chemistry. Economic models, or theories,
are simplified representations of the real world that are developed and used as aids
in understanding, explaining, and predicting economic phenomena in the real world.
A. Models and Realism: A model should capture the essential relationships that
are sufficient to analyze the specific problem or answer the specific question
being asked. No economic model is complete in the sense of capturing every
detail and relationship that exists in the real world.
A model is, by definition, an abstraction from reality. This does not mean that
models are deficient simply because they are not perfectly realistic and use
simplified assumptions. Every model in every science requires simplification
compared to the real world but can still be useful if it explains the issue at hand.
B. Assumptions: Assumptions define the set of circumstances in which a model is
most likely to be applicable. Every model, therefore, must be based on a set of
assumptions.
1. The Ceteris Paribus Assumption: All Other Things Being Equal: The
assumption that nothing changes except the factors being studied. It is used
to isolate the effect of a change in one variable on another one by assuming
that all other variables do not change.
C. Deciding on the Usefulness of a Model: A model is useful if it yields usable
predictions supported by real-world observations. If a model makes a prediction
and factual evidence supports the prediction, then the model is useful.
Economics is an empirical science; that is, it relies on real-world data in
evaluating the usefulness of a model.
D. Models of Behavior, Not Thought Processes: Economic models predict how
people act and what they will do in life with their limited resources, not the way
they think. Economic models normally generalize people’s behavior.
Economists are interested in what people actually do (revealed preferences)
rather than what they think they will do (declared preferences).
E. Behavioral Economics and Bounded Rationality: An approach to consumer
behavior that emphasizes psychological limitations and complications that
potentially interfere with rational decision-making.
1. Bounded Rationality: The idea that people are nearly, but not fully, rational
so that they cannot examine every choice available to them. Proponents of
behavioral economics suggest that economic models assume people exhibit
three “unrealistic” characteristics: (1) unbounded selfishness, (2) unbounded
willpower, and (3) unbounded rationality.
Copyright © 2026 Pearson Education, Inc.
,4 Miller • Economics Today, Twenty First Edition
2. Rules of Thumb: A behavioral implication of bounded rationality is that
people will use rules of thumb; that is, simplified methods for making
decisions. An important issue is that people who appear to use rules of
thumb may behave as if they are fully rational.
3. Behavioral Economics Goes Mainstream: A number of economists are
exploring ways in which psychological elements might improve analysis of
decision-making by individual consumers, firm owners and managers, and
government officials.
V. Positive versus Normative Economics: Positive economics deals with what is.
Positive economic statements are “if-then” statements and no subjective or moral
judgments enter into the analysis. Normative economics deals with what ought to
be. Normative economic statements involve value judgments and normally have the
words “ought” or “should” in them. Because positive economics predicts
consequences of actions, it can be used to predict the effects of various policies to
determine if those policies aid in achieving some desired goal. Positive economics
cannot provide criteria for choosing which outcomes or goals are preferable.
A. Distinguishing between Positive and Normative Economics: Positive
economics is an analysis that is strictly limited to making either purely
descriptive statements or scientific predictions. Normative economics is
analysis involving value judgments about economic policies as it relates to
whether outcomes are good or bad.
B. A Warning: Recognize Normative Analysis: Although it is easy to define
positive economics, it is often difficult to identify unlabeled normative
statements, even in a textbook.
◼ Points to Emphasize
THE DISCIPLINE OF ECONOMICS
Economics is the study of how people make choices to satisfy their wants. Wants have a
special meaning in economics. Wants represent those things that people would buy if
they had unlimited income. In economics, we note that income is in fact limited, and
thus, people must make choices. These choices are made based on rational self-interest.
This means that people make choices that, in their view, make them better off. People do
not voluntarily make choices that they believe will make them worse off. This
assumption of rational behavior underlies all economic decision-making.
ECONOMIC SYSTEMS AND THE ALLOCATION OF SCARCE RESOURCES
Because resources are scarce, every nation must answer the three fundamental questions
of what and how much of each item to produce, how each item will be produced, and for
whom items will be produced. Emphasize that there are not enough resources to produce
as much of everything that the citizens of any nation would want. Because resources are
scarce, decisions about which resources and how much of each resource will be used
need to be made. Again, compared to wants, resources are limited. Scarcity also means in
practice that everyone cannot have as much of everything that they would like to have.
Copyright © 2026 Pearson Education, Inc.
, Chapter 1 The Nature of Economics 5
Thus, some mechanism must exist to determine which items get produced, how much of
those items get produced, and which members of each nation will receive those items.
ECONOMIC MODELS
Economic models are simplified representations of the real world. Economic models
frequently present problems for students because they are so abstract. The goal is for
students to realize that only essential relationships are needed to deal with the problem at
hand. A classic example of using an abstract theory is the decision of whether to take an
umbrella when going outside. If a person misses the weather report, the person can look
outside at the sky. If the sky is overcast or if dark clouds can be seen in the distance, then
a prudent person will carry an umbrella. A person reasons that clouds are often associated
with rain. If there are clouds of a certain type, then rain is likely but not certain. To
actually know if rain will fall in a given place requires a complete knowledge of
atmospheric conditions in a rather large area. Even the weather service does not have this
kind of information. The simplest theory that can be used to accurately predict an
outcome is the one that should be used.
PREDICTION—THE TEST OF A THEORY
A model is useful only if it accurately predicts how things happen in the real world. It is
not correct to fault a model because its assumptions are not realistic or because it is too
abstract. Because economists cannot do controlled experiments the way chemists can,
they must look at evidence to see if the model can accurately predict actions in the real
world. Normally models are tested using statistical evidence and techniques; however, a
great deal of economic research consists of empirical testing of theories.
THE INDIVIDUAL IN ECONOMIC ANALYSIS
The unit of analysis is the individual. It is often difficult for students to distinguish
between the individual as an abstraction and a given individual in the real world. The
difference between the two can be explained in the following way. The individual as an
abstraction is a hypothetical typical individual or, as psychologists would say, a normal
individual. This is a “person” whose behavior is that which is expected most of the time
from most persons. Obviously, it is possible to find actual persons who are “abnormal”
or who do not behave in the typical way. When we say that the individual is motivated
by rational self-interest, this does not exclude the possibility that some persons may
choose to not act in their own self-interest (e.g., someone sacrificing his or her life to
save a child). It only says that in most of our affairs, we choose to do those things that
we believe will benefit us in some way and we choose not to do those things that we
believe will make us worse off. Economists have found that economic models work best
when the individual is the unit of analysis because individuals making choices are at the
basis of every decision.
POSITIVE VERSUS NORMATIVE ECONOMICS
The text points out that normative economics can be identified by statements that use the
word “should.” Other words that provide an indicator of a normative statement instead of
a positive statement are good, bad, best, desirable, undesirable, better, and worse.
Examples of these are as follows:
1. An increase in extended unemployment benefits is good because the benefits reduce
the hardship faced by the unemployed.
Copyright © 2026 Pearson Education, Inc.
,6 Miller • Economics Today, Twenty First Edition
2. Increases in interest rates by the Federal Reserve are bad because higher interest rates
hurt low-income borrowers.
3. The best policy to get the economy out of a recession is to cut taxes.
4. High gasoline prices are undesirable.
5. It would be desirable to lower the prices of drugs to combat AIDS in poor countries.
6. The increase in prescription drug prices is undesirable because many senior citizens
must choose between their drugs and food.
7. It is better to increase the progressive income tax than to increase a regressive sales
tax.
8. Of the two methods of financing a war, it is better to raise taxes on the American
people rather than to borrow the money.
◼ For Those Who Wish to Stress Theory
UNREALISTIC ASSUMPTIONS OF ECONOMIC MODELS?
One of the more frustrating aspects of economic analysis is what appears to be the
unrealistic assumptions of many economic models. For example, in the realm of
macroeconomics, the rational expectations hypothesis in its pure form talks about
workers not being fooled by expected changes in the money supply by the Federal
Reserve. It is true that most workers cannot tell you what the latest money supply growth
rate figures are. They do not subscribe to the Federal Reserve Bulletin or read the Federal
Open Market Committee report. However, workers do respond to what they perceive to be
the expected state of the economy as it affects them. If the Fed is increasing the money
supply at a faster rate and the inflation rate rises, workers will react as if they had a
model of expected inflation. It is their behavior that we measure and predict, not what
they are thinking. If the assumption of economic rationality is correct, then they will not
be systematically fooled. One way of explaining the same approach outside economics is
to point out that it is highly unlikely that a champion pool player knows the laws of physics
with regard to the exact force needed to hit the cue ball and the mathematical formulas
needed to compute the exact angle to hit the pool table bank, but his behavior is the same
as if he did.
◼ Further Questions for Class Discussion
1. Political disturbances such as wars and threats of wars in the Middle East often lead
to increases in the price of oil. You will often hear people say that the U.S.
government should not let the price rise. Ask your students the difference between
these statements. Obviously, the first is a positive statement. Generally, a political
disturbance leads to reduced supplies or to fears of reduced supplies, or both. Price
then rises. Whether or not oil prices should rise is a normative statement. Nothing
scientific can be said about it because it is based on a value judgment.
2. It is worth examining the idea that changes in incentives cause people to change their
behavior.
For example, any decrease in costs tends to encourage an activity, ceteris paribus. In
recent years, streaming services have entered the entertainment market at a lower
price point than cable or satellite subscriptions. What has happened with cable
Copyright © 2026 Pearson Education, Inc.
, Chapter 1 The Nature of Economics 7
subscriptions with the introduction of Netflix, Hulu, and Amazon Prime? Many
households have “cut the cord” and use streaming services for all their entertainment
needs.
3. An important issue raised after the financial meltdown in 2008 and the resulting
recession was how to deal with the recession. The economic stimulus policies of
cutting taxes and increasing government spending contributed to a very large increase
in the federal government’s deficit. As a result, the recession moderated, the economy
began to grow, and gross domestic product (GDP) began to rise. During this period, a
debate began in the United States that the size of government had gotten too large;
therefore, spending should be cut. Discuss the positive and normative economic
issues presented.
Positive: Increases in government spending have contributed to a large increase in the
federal deficit, which resulted in economic growth. These are positive statements
because they are testable statements about the economic effect of increases in federal
spending and reduced taxes on the size of the federal deficit, as well as the effect of
increased spending and tax cuts on the level of economic activity.
Normative: The statements that “the size of government had gotten too large” and
that “spending should be cut” are not testable—they are based on value judgments
about what “ought to be.”
4. Some widely reported and watched polls are viewed as economic indicators of future
levels of economic activity and as various measures of “consumer confidence.” The
Conference Board, the University of Michigan, and ABC News/Money Magazine all
use polls of consumers to measure their confidence in the economy. These polls ask
people about their thoughts on the economy and about their spending plans. Why are
these polls not likely to provide a reliable model for predictions? These polls measure
people’s plans, rather than what they actually do; their plans may be different from
their actions.
5. Scarcity forces society to come up with a mechanism to determine how output is to be
distributed. Typically, prices of items are used to determine this distribution. If price
is not used as an allocative mechanism, what other mechanisms can be used to
allocate output? Universities can allocate seats in classes using price (where students
bid for classes) instead of using a first-come, first-served system based on some sort
of administrative procedure. An objection to this allocation method is almost certainly
that the wealthier students would get the most desirable courses with the best
professors, and poorer students would get the less desirable courses with less talented
professors. Suppose that the university responds by providing more sections of the
high-demand courses by paying the best professors more to teach an overload? The
availability of seats will increase, and more students can take the course. Under
administrative methods, there is little or no incentive to make more sections available
(e.g., by paying qualified professors more to teach an overload in the short run and in
the long run by hiring more faculty in those areas).
◼ Answers to Questions for Critical Analysis
Copyright © 2026 Pearson Education, Inc.
, 8 Miller • Economics Today, Twenty First Edition
POLICY EXAMPLE: BUSINESSES MIGRATE BETWEEN STATES IN RESPONSE TO TAXING
INCENTIVES (P. 6)
For Critical Thinking
Why do you suppose that economists have found that other forms of state tax burdens on
small businesspeople, such as property and gross-receipts taxes, also influence small-
business migration decisions?
Any state tax burdens (income, property, or gross-receipts taxes) will create higher costs
for small businesses and give them an incentive to migrate to a state with lower taxes,
and therefore, lower costs.
Real Application
If you decide to move your small business to a lower-tax state, you’ll obviously benefit
from paying lower state taxes. What costs might you incur that you should consider in
making your calculations?
The costs of moving your business to another state would be the costs of moving
(searching for a new house and new storefront, the costs of hiring movers and packing
belongings), as well as the costs of starting your business in a new location (advertising,
establishing a new clientele base, finding new suppliers).
DIVERSITY TRENDS: ECONOMIC MODELS CONFRONT THE ISSUE OF DIFFERENCES IN
OUTCOMES RELATIVE TO UNDERLYING OPPORTUNITIES OF DIVERSE GROUPS (P. 7)
For Critical Thinking
Why do you suppose that more economists are developing empirical measures of different
groups’ opportunities?
With the increasing role that data plays in every sector of the economy today, the amount
of data available and the quality of that data have also increased. This allows for
economists to more accurately test current models and develop new ones that are more
consistent with real world data. By developing empirical measures of different groups’
opportunities, economists will be able to test models’ predictions to explain divergences
in economic outcomes that different groups experience.
AI: THE FUTURE IS NOW: PEOPLE’S CLAIMS AND ACTIONS DIFFER REGARDING
LETTING AI MANAGE THEIR PERSONAL FINANCES (P. 9)
For Critical Thinking
How might the fact that people typically have to pay a price to utilize AI-based personal-
finance services help to explain why fewer people actually have opted to use them?
How people think can be different from how they actually act. While one out of every
three individuals is willing to utilize AI applications to assist in personal finance, when it
comes to actually choosing and costs have to be considered, fewer individuals are willing
to take action. The higher the price people have to pay for AI-based personal-finance
services, the fewer services they will be willing and able to purchase. Therefore, the fact
that people have to pay to use these services will result in a lower the number of people
who actually use them.
Real Application
Copyright © 2026 Pearson Education, Inc.
edition Roger LeRoy Miller
Notes
1- The file is chapter after chapter.
2- We have shown you few pages sample.
3- The file contains all Appendix and Excel sheet
if it exists.
4- We have all what you need, we make update
at every time. There are many new editions
waiting you.
5- If you think you purchased the wrong file You
can contact us at every time, we can replace it
with true one.
Our email:
,Chapter 1
The Nature of Economics
◼ Overview
This chapter introduces economics as a science. Economics is defined, and its subareas,
macroeconomics and microeconomics, are introduced. The chapter also discusses the
three fundamental questions faced by every nation of what to produce, how to produce,
and for whom to produce. The chapter then presents the two types of economic
systems—the command-and-control system and the price system—that are used to
answer the three fundamental questions. Economic rationality and self-interest are
discussed along with their implications for decision-making and economic model
building. The concept of behavioral economics is introduced. Economics as a science is
closely associated with the development of models. To aid understanding, a significant
section on the methodology of economics discusses model construction, the role of
assumptions, and determining the usefulness of a model. Finally, the difference between
positive and normative economics is presented. There is a discussion of why it is
important to separate these two areas of analysis clearly.
◼ Learning Objectives
After studying this chapter, students should be able to:
1.1 Define economics and discuss the difference between microeconomics and
macroeconomics
1.2 Identify the three basic economic questions and the two opposing sets of answers
1.3 Evaluate the role that rational self-interest plays in economic analysis
1.4 Explain why economics is a science
1.5 Distinguish between positive and normative economics
◼ Outline
I. The Power of Economic Analysis: The analytical framework of the course is the
economic way of thinking. The economic way of thinking permits the student to
reach informed conclusions about what is happening in the world.
Copyright © 2026 Pearson Education, Inc.
,2 Miller • Economics Today, Twenty First Edition
A. Defining Economics: The study of how people allocate their limited resources
to satisfy their unlimited wants. The ultimate purpose of economics is to explain
how people make choices.
B. Microeconomics versus Macroeconomics: Economics is divided into two
types of analysis: microeconomics and macroeconomics.
1. Microeconomics: The part of economic analysis that studies decision-
making undertaken by individuals (or households) and by firms.
2. Macroeconomics: The part of economic analysis that studies the behavior
of the economy as a whole. It deals with economywide phenomena such as
changes in unemployment, the general price level, and national income.
II. The Three Basic Economic Questions and Two Opposing Sets of Answers: Every
nation must address three fundamental questions that concern the problem of how
an economic system allocates a society’s scarce resources.
A. The Three Basic Questions: (1) What and how much will be produced? (2)
How will items be produced? (3) For whom will items be produced?
B. Two Opposing Sets of Answers
1. Centralized Command and Control: A centralized command and control
system, also called central planning, has a centralized authority that decides
what items to produce and how many of each, determines how the scarce
resources will be organized in the items’ production, and identifies who will
be able to obtain the items.
2. The Price System: A price system, also called a market system, answers
the three basic questions using decentralized decision-making. In a pure
price system, individuals own all the scarce resources used in production.
This means those choices about what and how many of each item to
produce are made by private parties on their own initiative, as are the
decisions about how to produce those items. Individuals and families
choose how to allocate their incomes to obtain those items at prices
established by privately organized mechanisms. Those prices signal the
relative scarcity of different resources, which provides information about
what and how many items to produce, how each item should be produced,
and who will choose to buy the items.
3. Mixed Economic Systems: Most economic systems of the world
incorporate aspects of both centralized command and control and a
decentralized price system.
III. The Economic Approach: Systematic Decisions: Economists assume that
individuals act as if they pursue self-motivated interests and respond predictably to
perceived opportunities to obtain those interests.
A. The Rationality Assumption: The assumption that individuals will not
intentionally make decisions that would leave them worse off.
B. Responding to Incentives: An incentive is the reward for engaging in a given
activity. Much of human behavior can be explained in terms of how individuals
respond to changing incentives over time. In general, before making decisions,
Copyright © 2026 Pearson Education, Inc.
, Chapter 1 The Nature of Economics 3
individuals compare costs and benefits of their actions and choose those actions
which result in higher benefits than costs.
C. Defining Self-Interest: The pursuit of goals that make the individual better off.
In economic analysis, these goals are often those which can be measured in
monetary terms, although the pursuit of other goals such as prestige, love,
power, or others can be analyzed using this concept.
IV. Economics as a Science: Economics is a social science that utilizes the same types
of methods used in biology, physics, and chemistry. Economic models, or theories,
are simplified representations of the real world that are developed and used as aids
in understanding, explaining, and predicting economic phenomena in the real world.
A. Models and Realism: A model should capture the essential relationships that
are sufficient to analyze the specific problem or answer the specific question
being asked. No economic model is complete in the sense of capturing every
detail and relationship that exists in the real world.
A model is, by definition, an abstraction from reality. This does not mean that
models are deficient simply because they are not perfectly realistic and use
simplified assumptions. Every model in every science requires simplification
compared to the real world but can still be useful if it explains the issue at hand.
B. Assumptions: Assumptions define the set of circumstances in which a model is
most likely to be applicable. Every model, therefore, must be based on a set of
assumptions.
1. The Ceteris Paribus Assumption: All Other Things Being Equal: The
assumption that nothing changes except the factors being studied. It is used
to isolate the effect of a change in one variable on another one by assuming
that all other variables do not change.
C. Deciding on the Usefulness of a Model: A model is useful if it yields usable
predictions supported by real-world observations. If a model makes a prediction
and factual evidence supports the prediction, then the model is useful.
Economics is an empirical science; that is, it relies on real-world data in
evaluating the usefulness of a model.
D. Models of Behavior, Not Thought Processes: Economic models predict how
people act and what they will do in life with their limited resources, not the way
they think. Economic models normally generalize people’s behavior.
Economists are interested in what people actually do (revealed preferences)
rather than what they think they will do (declared preferences).
E. Behavioral Economics and Bounded Rationality: An approach to consumer
behavior that emphasizes psychological limitations and complications that
potentially interfere with rational decision-making.
1. Bounded Rationality: The idea that people are nearly, but not fully, rational
so that they cannot examine every choice available to them. Proponents of
behavioral economics suggest that economic models assume people exhibit
three “unrealistic” characteristics: (1) unbounded selfishness, (2) unbounded
willpower, and (3) unbounded rationality.
Copyright © 2026 Pearson Education, Inc.
,4 Miller • Economics Today, Twenty First Edition
2. Rules of Thumb: A behavioral implication of bounded rationality is that
people will use rules of thumb; that is, simplified methods for making
decisions. An important issue is that people who appear to use rules of
thumb may behave as if they are fully rational.
3. Behavioral Economics Goes Mainstream: A number of economists are
exploring ways in which psychological elements might improve analysis of
decision-making by individual consumers, firm owners and managers, and
government officials.
V. Positive versus Normative Economics: Positive economics deals with what is.
Positive economic statements are “if-then” statements and no subjective or moral
judgments enter into the analysis. Normative economics deals with what ought to
be. Normative economic statements involve value judgments and normally have the
words “ought” or “should” in them. Because positive economics predicts
consequences of actions, it can be used to predict the effects of various policies to
determine if those policies aid in achieving some desired goal. Positive economics
cannot provide criteria for choosing which outcomes or goals are preferable.
A. Distinguishing between Positive and Normative Economics: Positive
economics is an analysis that is strictly limited to making either purely
descriptive statements or scientific predictions. Normative economics is
analysis involving value judgments about economic policies as it relates to
whether outcomes are good or bad.
B. A Warning: Recognize Normative Analysis: Although it is easy to define
positive economics, it is often difficult to identify unlabeled normative
statements, even in a textbook.
◼ Points to Emphasize
THE DISCIPLINE OF ECONOMICS
Economics is the study of how people make choices to satisfy their wants. Wants have a
special meaning in economics. Wants represent those things that people would buy if
they had unlimited income. In economics, we note that income is in fact limited, and
thus, people must make choices. These choices are made based on rational self-interest.
This means that people make choices that, in their view, make them better off. People do
not voluntarily make choices that they believe will make them worse off. This
assumption of rational behavior underlies all economic decision-making.
ECONOMIC SYSTEMS AND THE ALLOCATION OF SCARCE RESOURCES
Because resources are scarce, every nation must answer the three fundamental questions
of what and how much of each item to produce, how each item will be produced, and for
whom items will be produced. Emphasize that there are not enough resources to produce
as much of everything that the citizens of any nation would want. Because resources are
scarce, decisions about which resources and how much of each resource will be used
need to be made. Again, compared to wants, resources are limited. Scarcity also means in
practice that everyone cannot have as much of everything that they would like to have.
Copyright © 2026 Pearson Education, Inc.
, Chapter 1 The Nature of Economics 5
Thus, some mechanism must exist to determine which items get produced, how much of
those items get produced, and which members of each nation will receive those items.
ECONOMIC MODELS
Economic models are simplified representations of the real world. Economic models
frequently present problems for students because they are so abstract. The goal is for
students to realize that only essential relationships are needed to deal with the problem at
hand. A classic example of using an abstract theory is the decision of whether to take an
umbrella when going outside. If a person misses the weather report, the person can look
outside at the sky. If the sky is overcast or if dark clouds can be seen in the distance, then
a prudent person will carry an umbrella. A person reasons that clouds are often associated
with rain. If there are clouds of a certain type, then rain is likely but not certain. To
actually know if rain will fall in a given place requires a complete knowledge of
atmospheric conditions in a rather large area. Even the weather service does not have this
kind of information. The simplest theory that can be used to accurately predict an
outcome is the one that should be used.
PREDICTION—THE TEST OF A THEORY
A model is useful only if it accurately predicts how things happen in the real world. It is
not correct to fault a model because its assumptions are not realistic or because it is too
abstract. Because economists cannot do controlled experiments the way chemists can,
they must look at evidence to see if the model can accurately predict actions in the real
world. Normally models are tested using statistical evidence and techniques; however, a
great deal of economic research consists of empirical testing of theories.
THE INDIVIDUAL IN ECONOMIC ANALYSIS
The unit of analysis is the individual. It is often difficult for students to distinguish
between the individual as an abstraction and a given individual in the real world. The
difference between the two can be explained in the following way. The individual as an
abstraction is a hypothetical typical individual or, as psychologists would say, a normal
individual. This is a “person” whose behavior is that which is expected most of the time
from most persons. Obviously, it is possible to find actual persons who are “abnormal”
or who do not behave in the typical way. When we say that the individual is motivated
by rational self-interest, this does not exclude the possibility that some persons may
choose to not act in their own self-interest (e.g., someone sacrificing his or her life to
save a child). It only says that in most of our affairs, we choose to do those things that
we believe will benefit us in some way and we choose not to do those things that we
believe will make us worse off. Economists have found that economic models work best
when the individual is the unit of analysis because individuals making choices are at the
basis of every decision.
POSITIVE VERSUS NORMATIVE ECONOMICS
The text points out that normative economics can be identified by statements that use the
word “should.” Other words that provide an indicator of a normative statement instead of
a positive statement are good, bad, best, desirable, undesirable, better, and worse.
Examples of these are as follows:
1. An increase in extended unemployment benefits is good because the benefits reduce
the hardship faced by the unemployed.
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,6 Miller • Economics Today, Twenty First Edition
2. Increases in interest rates by the Federal Reserve are bad because higher interest rates
hurt low-income borrowers.
3. The best policy to get the economy out of a recession is to cut taxes.
4. High gasoline prices are undesirable.
5. It would be desirable to lower the prices of drugs to combat AIDS in poor countries.
6. The increase in prescription drug prices is undesirable because many senior citizens
must choose between their drugs and food.
7. It is better to increase the progressive income tax than to increase a regressive sales
tax.
8. Of the two methods of financing a war, it is better to raise taxes on the American
people rather than to borrow the money.
◼ For Those Who Wish to Stress Theory
UNREALISTIC ASSUMPTIONS OF ECONOMIC MODELS?
One of the more frustrating aspects of economic analysis is what appears to be the
unrealistic assumptions of many economic models. For example, in the realm of
macroeconomics, the rational expectations hypothesis in its pure form talks about
workers not being fooled by expected changes in the money supply by the Federal
Reserve. It is true that most workers cannot tell you what the latest money supply growth
rate figures are. They do not subscribe to the Federal Reserve Bulletin or read the Federal
Open Market Committee report. However, workers do respond to what they perceive to be
the expected state of the economy as it affects them. If the Fed is increasing the money
supply at a faster rate and the inflation rate rises, workers will react as if they had a
model of expected inflation. It is their behavior that we measure and predict, not what
they are thinking. If the assumption of economic rationality is correct, then they will not
be systematically fooled. One way of explaining the same approach outside economics is
to point out that it is highly unlikely that a champion pool player knows the laws of physics
with regard to the exact force needed to hit the cue ball and the mathematical formulas
needed to compute the exact angle to hit the pool table bank, but his behavior is the same
as if he did.
◼ Further Questions for Class Discussion
1. Political disturbances such as wars and threats of wars in the Middle East often lead
to increases in the price of oil. You will often hear people say that the U.S.
government should not let the price rise. Ask your students the difference between
these statements. Obviously, the first is a positive statement. Generally, a political
disturbance leads to reduced supplies or to fears of reduced supplies, or both. Price
then rises. Whether or not oil prices should rise is a normative statement. Nothing
scientific can be said about it because it is based on a value judgment.
2. It is worth examining the idea that changes in incentives cause people to change their
behavior.
For example, any decrease in costs tends to encourage an activity, ceteris paribus. In
recent years, streaming services have entered the entertainment market at a lower
price point than cable or satellite subscriptions. What has happened with cable
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, Chapter 1 The Nature of Economics 7
subscriptions with the introduction of Netflix, Hulu, and Amazon Prime? Many
households have “cut the cord” and use streaming services for all their entertainment
needs.
3. An important issue raised after the financial meltdown in 2008 and the resulting
recession was how to deal with the recession. The economic stimulus policies of
cutting taxes and increasing government spending contributed to a very large increase
in the federal government’s deficit. As a result, the recession moderated, the economy
began to grow, and gross domestic product (GDP) began to rise. During this period, a
debate began in the United States that the size of government had gotten too large;
therefore, spending should be cut. Discuss the positive and normative economic
issues presented.
Positive: Increases in government spending have contributed to a large increase in the
federal deficit, which resulted in economic growth. These are positive statements
because they are testable statements about the economic effect of increases in federal
spending and reduced taxes on the size of the federal deficit, as well as the effect of
increased spending and tax cuts on the level of economic activity.
Normative: The statements that “the size of government had gotten too large” and
that “spending should be cut” are not testable—they are based on value judgments
about what “ought to be.”
4. Some widely reported and watched polls are viewed as economic indicators of future
levels of economic activity and as various measures of “consumer confidence.” The
Conference Board, the University of Michigan, and ABC News/Money Magazine all
use polls of consumers to measure their confidence in the economy. These polls ask
people about their thoughts on the economy and about their spending plans. Why are
these polls not likely to provide a reliable model for predictions? These polls measure
people’s plans, rather than what they actually do; their plans may be different from
their actions.
5. Scarcity forces society to come up with a mechanism to determine how output is to be
distributed. Typically, prices of items are used to determine this distribution. If price
is not used as an allocative mechanism, what other mechanisms can be used to
allocate output? Universities can allocate seats in classes using price (where students
bid for classes) instead of using a first-come, first-served system based on some sort
of administrative procedure. An objection to this allocation method is almost certainly
that the wealthier students would get the most desirable courses with the best
professors, and poorer students would get the less desirable courses with less talented
professors. Suppose that the university responds by providing more sections of the
high-demand courses by paying the best professors more to teach an overload? The
availability of seats will increase, and more students can take the course. Under
administrative methods, there is little or no incentive to make more sections available
(e.g., by paying qualified professors more to teach an overload in the short run and in
the long run by hiring more faculty in those areas).
◼ Answers to Questions for Critical Analysis
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, 8 Miller • Economics Today, Twenty First Edition
POLICY EXAMPLE: BUSINESSES MIGRATE BETWEEN STATES IN RESPONSE TO TAXING
INCENTIVES (P. 6)
For Critical Thinking
Why do you suppose that economists have found that other forms of state tax burdens on
small businesspeople, such as property and gross-receipts taxes, also influence small-
business migration decisions?
Any state tax burdens (income, property, or gross-receipts taxes) will create higher costs
for small businesses and give them an incentive to migrate to a state with lower taxes,
and therefore, lower costs.
Real Application
If you decide to move your small business to a lower-tax state, you’ll obviously benefit
from paying lower state taxes. What costs might you incur that you should consider in
making your calculations?
The costs of moving your business to another state would be the costs of moving
(searching for a new house and new storefront, the costs of hiring movers and packing
belongings), as well as the costs of starting your business in a new location (advertising,
establishing a new clientele base, finding new suppliers).
DIVERSITY TRENDS: ECONOMIC MODELS CONFRONT THE ISSUE OF DIFFERENCES IN
OUTCOMES RELATIVE TO UNDERLYING OPPORTUNITIES OF DIVERSE GROUPS (P. 7)
For Critical Thinking
Why do you suppose that more economists are developing empirical measures of different
groups’ opportunities?
With the increasing role that data plays in every sector of the economy today, the amount
of data available and the quality of that data have also increased. This allows for
economists to more accurately test current models and develop new ones that are more
consistent with real world data. By developing empirical measures of different groups’
opportunities, economists will be able to test models’ predictions to explain divergences
in economic outcomes that different groups experience.
AI: THE FUTURE IS NOW: PEOPLE’S CLAIMS AND ACTIONS DIFFER REGARDING
LETTING AI MANAGE THEIR PERSONAL FINANCES (P. 9)
For Critical Thinking
How might the fact that people typically have to pay a price to utilize AI-based personal-
finance services help to explain why fewer people actually have opted to use them?
How people think can be different from how they actually act. While one out of every
three individuals is willing to utilize AI applications to assist in personal finance, when it
comes to actually choosing and costs have to be considered, fewer individuals are willing
to take action. The higher the price people have to pay for AI-based personal-finance
services, the fewer services they will be willing and able to purchase. Therefore, the fact
that people have to pay to use these services will result in a lower the number of people
who actually use them.
Real Application
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