Economic Thinking and Economic Tools

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Economic Thinking andEconomic Tools

• Chapter 2

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Economic Thinking

• Normative vs. Positive Statements
• Normative What Should be
• Positive What is
• In Principles of Economics we stated
• Economics uses positive statements
• In this Course we state
• Economics attempts to be about Positive
  Statements

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Economic Thinking

• Problem In Analyzing Economic Problems is that
• Perceptions may confuse issues
• Personal Bias
• Cultural Bias
• Other Issues
• Conventional Wisdom

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Economic Thinking

• Example
• In May of 2003, Jayson Blair a reported for the
  New York Times is fired because of numerous false
  information in his articles.
• He was discovered because he plagiarized an
  article from the San Antonio Express
• Mr. Blair is an African American

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Economic Thinking

• Example (cont)
• The fact that Mr. Blair is an African American is
  to some proof that affirmative action leads firms
  to promote based on race or ethnicity and not on
  merit

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Economic Thinking

• Example (cont)
• Columnists Howard Kurtz (CNN), William Safire
  (New York Times), and Tim Rutten (Los Angeles
  Times), among others conclude that race was a
  factor in the continuation of Mr. Blair as a
  reporter even after internal memos indicated
  there was grave problems with his reporting

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Economic Thinking

• Example (cont)
• To those opposing affirmative action this is
  clear evidence of the problem it creates
• The evidence is clear, he was only promoted
  because of the race thing

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Economic Thinking

• Example (cont)
• Those who support affirmative action, on the
  other hand, indicate this is an example of how
  only when minorities are involved in the same
  mistakes committed by non-minorities is race
  become an issue.
• For instance, Terry Neal (Washington Post) and
  Seth Mnookin (Newsweek) argue that race was not
  an issue

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Economic Thinking

• Example (cont)
• Terry Neal relates the example of Stephen Glass
  (New Republic) who not only fabricated stories as
  Mr. Blair has done but went as far as creating
  Web sites and voice mails to support his
  fabrications
• Also, R. Foster Winans (Wall Street Journal) who
  in 1985 was convicted for writing false articles
  for the purpose of making money in the stock
  market

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Economic Thinking

• Example (cont)
• In none of these cases was there a condemnation
  that a system that is not minority friendly
  results in lower quality white reporters not
  being fired earlier
• Who is right?
• Both arguments are probably right and wrong at
  the same time

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Economic Thinking

• In the Summer of 2003 the Supreme Court upheld
  the University of Michigans Law school admission
  policy but not that of its undergraduate program
• Difference in the policies

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Economic Thinking

• In writing for the majority, Justice OConnor
  indicate that American businesses have made
  clear that the skills needed in todays
  increasingly global marketplace can only be
  developed through exposure to widely diverse
  people, cultures, ideas, and viewpoints. She
  went on to say that she expected that in 25 years
  these type of procedures would not be needed

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Economic Thinking

• On the other hand, writing a dissenting opinion
  Justice Thomas states these programs
  affirmative action stamp minorities with a
  badge of inferiority and may cause them to
  develop dependencies or to adopt an attitude that
  they are entitled to preferences.

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Economic Thinking

• Economics of the science of how individuals go
  about the business of satisfying their wants
  given scarce resources
• The word Scarcity is crucial
• Scarcity leads to Opportunity Cost

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MicroeconomicsThe Basic Approach

• Choices
• Opportunity Cost
• Maximization
• Constraint Maximization
• Example
• Choose X to maximize V(X) subject to the
  constraint involving X and Z
• Max U(X1,X2) s.t. I P1 X1 P2 X2

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MicroeconomicsThe Basic Approach (Cont)

• We have two sets of variables
• Endogenous (solved by the system)
• In this case X1 and X2
• Exogenous (values given outside the system)
• In this case I, P1, and P2

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MicroeconomicsThe Basic Approach (Cont)

• From the utility maximization we derive the
  demand curve.
• In this case,
• D1 F(P1, P2, M)
• Next, we are interested on how the the solutions
  change when an exogenous variable changes

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MicroeconomicsThe Basic Approach (Cont)

• The Law of Demand
• ?D1/?P1 lt0
• Substitutes vs. Compliments
• ?D1/?P2 lt or gt 0?
• Normal vs. Inferior Goods
• ?D1/?I lt or gt 0?

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Demand and Supply

• Law of Demand
• Relative Price
• Income and Substitution Effect
• Things that may impact demand
• Price of own good,
• Price of substitute and compliment goods
• Income

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Demand and Supply

• Things that may impact demand (Cont.)
• Preferences
• Number of buyers
• Etc.

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Demand
P
Increase in quantity demanded
Decrease in quantity demanded
D
Q
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Demand
P
Exogenous variable increases demand
D
Q
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Demand
P
Exogenous variable decreases demand
D
Q
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Demand and Supply

• Law of Supply
• Relative Price
• Income and Substitution Effect for Labor
• Things that may impact supply
• Price of own good,
• Price of substitute and compliment goods
• Cost of Inputs

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Demand and Supply

• Things that may impact supply (Cont.)
• technology
• Number of sellers
• Etc.

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Supply
P
S
Q
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Supply
P
S
Increase in supply
Q
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Supply
P
S
Decrease in supply
Q
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Demand and Supply
P
S
P
D
Q
Q
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Demand and Supply (Increase in Demand)
P
S
Equilibrium Price increases and equilibrium
quantity also increases
P
P
D
Q
Q
Q
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Demand and Supply (Increase in Supply)
P
S
Equilibrium Price decreases and equilibrium
quantity increases
P
P
D
Q
Q
Q
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Demand and Supply (Decrease in Demand)
P
S
Equilibrium Price decreases and equilibrium
quantity also decreases
P
P
D
Q
Q
Q
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Demand and Supply (Decrease in Supply)
P
S
Equilibrium Price increases and equilibrium
quantity decreases
P
P
D
Q
Q
Q
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Demand and Supply
P
S
Excess Demand
D
Q
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Demand and Supply
P
S
Excess Supply
D
Q
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Demand and Supply of Labor
S
w
D
L
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Demand for Labor

• Reasons why it slopes downward
• Law of Diminishing Marginal Returns
• Substitution Effect
• Scale Effects

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Supply of Labor and Equilibrium

• Why Supply Slopes Upwards then downwards
• Income and Substitution Effect
• Stable Equilibrium

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Equilibrium

• If w gt we then there is an Excess Supply which
  implies there is unemployment
• If w lt we then there is an Excess Demand which
  implies there is an tight labor market

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Shocks to EquilibriumDemand

• DEMAND
• Output becomes more or less popular
• Shift to more efficient capital
• Competitiveness in output market changes
• Technology

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Shocks to EquilibriumSupply

• Supply
• Change in Labor size
• Women enter the market place
• Immigration
• Taxes
• Change in Quality of Labor
• Education
• Cultural Change

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Draft vs. No Draft

• Assume that the military in this economy is
  deciding whether to ask civilian government
  whether to institute a draft or not.
• Clearly wages will be lower with the draft and
  will not cause an excess demand (since there is a
  draft)

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Draft vs. No Draft
S
w
wND
wD
D
L
LND
LD
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Draft vs. No Draft

• Is Draft Cheaper?
• Government
• Yes if Yellow box is larger than brown box
• No if the opposite is true
• Society
• No, since the opportunity cost of some of those
  drafted are likely to have higher

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How Would Arm Forces Differ Under the Draft

• Draft
• Larger, could have soldiers with higher
  opportunity cost.
• May not be better due to the possibility of low
  moral.

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How Would Arm Forces Differ Under No Draft

• No Draft
• Smaller
• Maybe Lower Opportunity Cost
• Low Education
• taste for soldiering
• Perhaps Racial Component

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Equity vs. Efficiency

• No Draft
• Efficient
• In other words Draft is inefficient
• Draft
• Could be more equitable

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Economic Thinking andEconomic Tools

• More about regression analysis later
• More about experimental economics later