Principles of Economics

Appendix

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Graphing: A Brief Review

Graphs serve two purposes. First, when developing

theories, graphs offer a visual way to express ideas that
might be less clear if described with equations or words.
Second, when analyzing data, graphs provide a powerful
way of finding and interpreting patterns.
Graphs of a Single Variable

 The pie chart in panel

(a) shows how total
income in the United
States is divided
among the sources of
income, including
compensation of
employees, corporate
profits, and so on. A
slice of the pie
represents each
source’s share of the
total.
 The bar graph
in panel (b)
compares
income in four
countries. The
height of each
bar represents
the average
income in each
country.
 The time-series
graph in panel
(c) traces the
rising
productivity in
the U.S.
business sector
over time. The
height of the
line shows
output per hour
in each year.
 Graphs of Two Variables: The
Coordinate System
 Economists are often concerned with the
relationships between variables. Thus, they need
to display two variables on a single graph. The
coordinate system makes this possible.
 Suppose you want to examine the relationship between study time and grade point
average. For each student in your class, you could record a pair of numbers: hours
per week spent studying and grade point average. These numbers could then be
placed in parentheses as an ordered pair and appear as a single point on the
graph.
 We can graph these ordered pairs on a two-dimensional grid. The first number in
each ordered pair, called the x-coordinate, tells us the horizontal location of the
point. The second number, called the y-coordinate, tells us the vertical location of
the point. The point with both an x-coordinate and a y-coordinate of zero is known
as the origin. The two coordinates in the ordered pair tell us where the point is
located in relation to the origin: x units to the right of the origin and y units above it.
 This type of graph is called a scatter plot because it
plots scattered points.
 Because study time and grade point average typically move in the
same direction, we say that these two variables have a positive
correlation.
By contrast, if we were to graph party time and grades, we would
likely find that higher party time is associated with lower grades.
Because these variables typically move in opposite directions, we
say that they have a negative correlation.
Curves in the Coordinate System
 Often, economists prefer looking at how one variable affects another,
holding everything else constant. To see how this is done, let’s
consider one of the most important graphs in economics: the
demand curve. The demand curve traces out the effect of a good’s
price on the quantity of the good consumers want to buy.
 The following table shows how the number of novels that Emma buys
depends on her income and on the price of novels.
 We hold Emma’s income constant and show how the number of
novels she buys varies with the price of novels.
 Suppose that Emma’s income is $40,000 per year. If we place
the number of novels Emma purchases on the x-axis and the
price of novels on the y-axis, we can graphically represent the
middle column of the table.
 The demand curve is downward-sloping, indicating that a higher price reduces the quantity of novels
demanded. Because the quantity of novels demanded and the price move in opposite directions, we say

that the two variables

are negatively related.
(Conversely, when two
variables move in the
same direction, the
curve relating them is
upward-sloping, and we
say that the variables
are positively related.)
 Emma’s demand
curve for novels
shifts to the right
when her income
increases. Likewise,
if Emma’s income
were to fall to
$30,000 per year,
she would buy fewer
novels at any given
price and her
demand curve would
shift to the left (to
curve D3).
 In economics, it is important to distinguish between movements
along a curve and shifts of a curve.
 There is a simple way to tell when it is necessary to shift a curve:
When a relevant variable that is not named on either axis changes,
the curve shifts. (Income, any change that affects Emma’s purchasing
habits)
Slope
 To answer questions about how much one variable responds to changes in another
variable, we can use the concept of slope.
 The slope of a line is the ratio of the vertical distance covered to the horizontal
distance covered as we move along the line. This definition is usually written out in
mathematical symbols as follows:

 For an upward-sloping line, the slope is a positive number because the changes in x
and y move in the same direction. For a fairly flat upward-sloping line, the slope is a
small positive number. For a steep upward-sloping line, the line is a large positive
number.
 For a downward-sloping line, the slope is a negative number because the changes in
x and y move in opposite directions. For a fairly flat downward-sloping line, the slope
is a small negative number. For a steep downward-sloping line, the slope is a large
negative number.
 A horizontal line has a slope of zero
because in this case the y-variable
never changes. A vertical line is said
to have an infinite slope because the
y-variable can take any value without
the x-variable changing at all.
 What is the slope of Emma’s demand
curve for novels? To calculate a
numerical value for the slope, we must
choose two points on the line. we are
concerned with the difference between
them, which lets us know that we will
have to subtract one set of values
from the other, as follows:
 The slope of Emma’s demand curve tells us something about how
responsive her purchases are to changes in the price. A small slope (a
negative number close to zero) means that Emma’s demand curve is
relatively flat; in this case, she adjusts the number of novels she buys
substantially in response to a price change. A larger slope (a negative
number farther from zero) means that Emma’s demand curve is
relatively steep; in this case, she adjusts the number of novels she
buys only slightly in response to a price change.
Cause and Effect
 To Economists often use graphs to advance an argument about
how the economy works. In other words, they use graphs to
argue about how one set of events causes another set of events.
With a graph like the demand curve, there is no doubt about
cause and effect. 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 studying the relationship between two variables.
(omitted variable )
 The second problem is reverse causality.
Omitted Variables
 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.
 What should we make of this result?
Recommends:

(1) the government discourage the ownership of

cigarette lighters by taxing their sale.
(2)The government require warning labels: “Big Brother
has determined that this lighter is dangerous to your health.”
 In judging the validity of Big Brother’s analysis, one question is key: Has Big
Brother held constant every relevant variable except the one under consideration?
If the answer is no, the results are suspect. An easy explanation for the Figure is
that people who own more cigarette lighters are more likely to smoke cigarettes
and that cigarettes, not lighters, cause cancer.
 This story illustrates an important principle: When you see a graph used to support
an argument about cause and effect, it is important to ask whether the movements
of an omitted variable could explain the results you see.
Reverse Causality
 Economists can also make mistakes about causality by misreading
its direction. To see how this is possible, suppose the Association
of American Anarchists commissions a study of crime in America
and arrives at Figure A-7, which plots the number of violent crimes
per thousand people in major cities against the number of police
officers per thousand people.
 The Anarchists note the curve’s upward slope and argue that because police
increase rather than decrease the amount of urban violence, law enforcement
should be abolished.
 The figure, however, does not prove the Anarchists’ point. The graph simply shows
that more dangerous cities have more police officers. The explanation may be that
more dangerous cities hire more police. In other words, rather than police causing
crime, crime may cause police. We could avoid the danger of reverse causality by
running a controlled experiment. In this case, we would randomly assign different
numbers of police to different cities and then examine the correlation between police
and crime. Without such an experiment, establishing the direction of causality is
difficult at best.
 It might seem that we could determine the direction of causality by examining
which variable moves first. This approach, however, is also flawed: Often, people
change their behavior not in response to a change in their present conditions but in
response to a change in their expectations about future conditions. A city that
expects a major crime wave in the future, for instance, might hire more police now.
This problem is even easier to see in the case of babies and minivans.