TAILIEUCHUNG - Ten Principles of Economics - Part 5

Ten Principles of Economics - Part 5. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 2 THINKING LIKE AN ECONOMIST 43 variables constant we know that changes in the price of novels cause changes in the quantity Emma demands. Remember however that our demand curve came from a hypothetical example. When graphing data from the real world it is often more difficult to establish how one variable affects another. The first problem is that it is difficult to hold everything else constant when measuring how one variable affects another. If we are not able to hold variables constant we might decide that one variable on our graph is causing changes in the other variable when actually those changes are caused by a third omitted variable not pictured on the graph. Even if we have identified the correct two variables to look at we might run into a second problem reverse causality. In other words we might decide that A causes B when in fact B causes A. The omitted-variable and reverse-causality traps require us to proceed with caution when using graphs to draw conclusions about causes and effects. Omitted Variables To see how omitting a variable can lead to a deceptive graph let s consider an example. Imagine that the government spurred by public concern about the large number of deaths from cancer commissions an exhaustive study from Big Brother Statistical Services Inc. Big Brother examines many of the items found in people s homes to see which of them are associated with the risk of cancer. Big Brother reports a strong relationship between two variables the number of cigarette lighters that a household owns and the probability that someone in the household will develop cancer. Figure 2A-6 shows this relationship. What should we make of this result Big Brother advises a quick policy response. It recommends that the government discourage the ownership of cigarette lighters by taxing their sale. It also recommends that the government require warning labels Big Brother has determined that this lighter is dangerous to your health. In judging the validity of

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