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Introduction

We can begin by defining the meaning of economics:

Economics - The study of how scarce productive resources (land, labor and capital) are allocated among alternative uses and how the resulting commodities are distributed.

Economics is divided into:

• Microeconomics - examines the individual parts of the economy (such as the consumer, firm, or market structure)
• Macroeconomics - considers the overall economy. It examines economic aggregates (GDP, Investment, Inflation, etc.) and shows how they are related.

Methodology

Because the real world is so complex, it is necessary to abstract from reality. This is accomplished with the use of models (theories, hypotheses). A model identifies the most important variables and shows how they are related. It leaves out all unnecessary detail. ( ceteris paribus )

A model can be set up in one of three ways:

• Verbal description
• Geometric representation
  
• Mathematical equation

Example: We can set up a simple model examining the relationship between consumption and disposable income in three different forms.

Case 1: A verbal description

Consumption depends on disposable income, ceteris paribus.

Limitation: there is no way to test a model set up as a verbal description with empirical data

Case 2: As a graph

Limitation: Because a graph is drawn in two dimensions we are limited in the number of variables that can be represented. A graph cannot be tested empirically.

Case 3: As a mathematical equation

C = f (Yd)

where:

C = the dependent variable or endogenous variable (it is explained by the model )
f = function of
Yd = the independent variable or exogenous variable (it is given)