Economics and Economic Reasoning

1
Economics and Economic Reasoning

• Chapter 1

2
Laugher Curve

• Q. Why did God create economists?
• A. In order to make weather forecasters look
  good.

3
ECONOMICS ANDECONOMIC REASONING

• Chapter 1

4
You will need to

• Define economics.
• Examine three economic (coordinating) problems
  all economies must solve.
• Compare marginal costs and marginal benefits to
  make economic decisions.
• Define and explain opportunity costs.

5
You will need to

• Explain how economic, social, and political
  forces influence real-world events.
• Distinguish between
• microeconomics and macroeconomics.
• positive economics, normative economics, and the
  art of economics.

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What Economics Is

• Economics is the study of how human beings
  coordinate their wants and desires, given the
  decision-making mechanisms, social customs, and
  political realities of the society.

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What Economics Is

• One of the key words in the definition is
  coordination.

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What Economics Is

• Any economic system must solve three central
  coordination problems

• What, and how much, to produce.
• How to produce it.
• For whom to produce it.

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What Economics Is

• Scarcity exists because individuals want more
  than can be produced.

• Scarcity the goods available are too few to
  satisfy individuals desires.

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What Economics Is

• The degree of scarcity is constantly changing.

• The quantity of goods, services, and usable
  resources depends on technology and human action.

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What Economics Is

• Economics is the study of how to get people to do
  things they're not wild about doing and not to do
  things they are wild about doing.

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What Economics Is

• To understand the economy, you need to learn

• Economic reasoning.
• Economic terminology.
• Economic insights economists have about issues,
  and theories that lead to those insights.

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What Economics Is

• To understand the economy, you need to learn
• Information about economic institutions.

• Information about the economic policy options
  facing society today.

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A Guide to Economic Reasoning

• Economic reasoning is making decisions by
  comparing costs and benefits.

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Marginal Costs and Marginal Benefits

• The relevant costs and benefits that matter are
  the expected incremental, or additional, costs
  incurred and the expected incremental benefits of
  a decision.

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Marginal Costs and Marginal Benefits

• Economist use the term marginal when referring to
  additional or incremental.

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Marginal Costs and Marginal Benefits

• Marginal cost the additional cost to you over
  and above the costs you have already incurred.

• This means not counting sunk costs costs that
  have already been incurred and cannot be
  recovered.

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Marginal Costs and Marginal Benefits

• Marginal benefit the additional benefit above
  and beyond what youve already accrued.

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Marginal Costs and Marginal Benefits

• According to the economics decision rule

• If the relevant benefits of doing something
  exceed the relevant costs, do it.
• If the relevant costs of doing something exceed
  the relevant benefits, dont do it.

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Economics and Passion

• Economic reasoning is based on the premise that
  everything has a cost.
• It leads to a better society for the majority of
  people.

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Opportunity Cost

• Opportunity cost is the basis of cost/benefit
  economic reasoning
• It is the benefit foregone, or cost, of the
  next-best alternative to the activity you have
  chosen.

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Opportunity Cost

• In economic reasoning, opportunity cost must be
  less than the benefit of what you have chosen.

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Opportunity Cost

• Opportunity costs are not limited to individual
  decisions but to government decisions as well.

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Economics and Market Forces

• The opportunity cost concept applies to all
  aspects of life.
• It is fundamental to understanding how society
  reacts to scarcity.

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Economics and Market Forces

• When goods are scarce, they must be rationed.

• That means a mechanism must be chosen to
  determine who gets what.

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Economics and Market Forces

• Economic forces are the necessary reactions to
  scarcity.

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Economics and Market Forces

• A market force is an economic circumstance that
  is given relatively free rein by society to work
  through the market.

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Economics and Market Forces

• Market forces ration by changing prices.

• When there is a shortage, the price goes up.
• When there is a surplus, the price goes down.

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Economics and Market Forces

• Economic reality is controlled by three forces

• Economic forces (the invisible hand).
• Social and cultural forces.
• Political and legal forces.

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Economics and Market Forces

• The invisible hand is the price mechanism, the
  rise and fall of prices, that guides our actions
  in a market.

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Economics and Market Forces

• Social, cultural, and political forces play a
  major role in deciding whether to allow market
  forces to predominate.

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Economics and Market Forces

• Political and social forces often work together
  against the invisible hand.

• Social and political forces are active in all
  parts of your life.

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Economics and Market Forces

• What happens in society can be seen as a reaction
  to, and interaction of, economic forces,
  political forces, social forces, and historical
  forces.

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Economic Terminology

• Youll need to learn economic terminology.
• Hundreds of economic terms will be introduced in
  this book.

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Economic Insights

• General insights into how economies work are
  often based on generalizations called economic
  theories.

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Economic Insights

• Theory ties together economists terminology and
  knowledge about economic institutions and leads
  to economic insights.

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Economic Insights

• Economic theories are too abstract to apply to
  specific cases.

• A theory is often embodied in an economic model
  or an economic principle.

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Economic Insights

• Economic model a framework that places the
  generalized insights of the theory in a more
  specific contextual setting.

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Economic Insights

• Economic principle a commonly held insight
  stated as a law or general assumption.

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Economic Insights

• Economists cannot test their models with
  controlled experiments.

• It is impossible to hold other things constant,
  as is done in laboratory experiments.

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Economic Insights

• Theories, models, and principles must be combined
  with a knowledge of real-world economic
  institutions to arrive at a specific policy
  recommendation.

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The Invisible Hand Theory

• Economist have come to the following insight
• Price has a tendency to fall when the quantity
  supplied is greater than the quantity demanded.
• Price has a tendency to rise when the quantity
  demanded is greater than the quantity supplied.

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The Invisible Hand Theory

• According to the invisible hand theory, a market
  economy, through the price mechanism, will
  allocate resources efficiently.

• Efficiency means achieving a goal as cheaply as
  possible.

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Economic Theory and Stories

• Economic theory and its models are a shorthand
  means of telling a story.
• If you cant translate a theory into a story, you
  dont understand the theory.

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Microeconomics and Macroeconomics

• Economic theory is divided into two parts
  microeconomic theory and macroeconomic theory.

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Microeconomics

• Microeconomics is the study of individual choice,
  and how that choice is influenced by economic
  forces.

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Microeconomics

• Microeconomics studies such things as

• The pricing policy of firms.
• Households decisions on what to buy.
• How markets allocate resources among alternative
  ends.

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Macroeconomics

• Macroeconomics is the study of the economy as a
  whole.
• It considers the problems of inflation,
  unemployment, business cycles, and economic
  growth.

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Economic Institutions

• To apply economic theory to reality, youve got
  to have a sense of economic institutions.
• Economic institutions laws, common practices,
  and organizations in a society that affect the
  economy.

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Economic Institutions

• Economic institutions differ significantly among
  nations.

• They sometimes seem to operate in ways quite
  different than economic theory predicts.

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Economic Policy Options

• Economic policies are actions (or inactions)
  taken by government to influence economic actions.

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Economic Policy Options

• To carry out economic policy effectively, one
  must understand how the economic policy might
  change institutions.

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Objective Policy Analysis

• Good objective policy analysis keeps the value
  judgments separate from the analysis.
• Subjective policy analysis is that which reflects
  the analysts view of how things should be.

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Objective Policy Analysis

• To make clear the distinction between objective
  and subjective analysis, economics is divided
  into three categories

• Positive economics
• Normative economics
• Art of economics

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Objective Policy Analysis

• Positive economics the study of what is, and
  how the economy works.

• Normative economics the study of what the goals
  of the economy should be.

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Objective Policy Analysis

• Art of economics the application of the
  knowledge learned in positive economics to
  achieve the goals determined in normative
  economics.

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Objective Policy Analysis

• Maintaining objectivity is easier in positive
  economics harder in normative economics.

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Objective Policy Analysis

• It is hardest to maintain objectivity in the art
  of economics.

• It embodies the problems of both positive and
  normative economics

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Policy and Social and Political Forces

• The choice of policy options depends on more than
  economic theory.
• As soon as economists apply economy theory to
  policy, political and social forces must be taken
  into account.

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Economics and Economic Reasoning Summary

• In solving the economic problem of scarcity, any
  economy must answer the questions
• what should be produced
• how should it be produced
• who should get it
• Economic reasoning compares marginal benefits
  with marginal costs. Do something if its
  marginal benefits gt its marginal costs.
• The opportunity cost of an activity is the
  benefit you would have gained from the next best
  alternative.

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Economics and Economic Reasoning Summary

• The market, which rations scarce resources by
  changing prices, is efficient under certain
  conditions.
• Economics can be divided into
• Microeconomics the study of individual choice
• Macroeconomics the study of the economy as a
  whole
• Economics can be subdivided into
• Positive economics the study of what is
• Normative economics the study of what should be
• The art of economics relating positive to
  normative economics

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Review Exercise 1-1
Suppose that you are considering going to a
concert. Tickets cost 60. If you go to the
concert, you will have to miss 4 hours of work,
where you are making 10 an hour. What is your
total opportunity cost of going to the concert
measured in dollars given up?
The total opportunity cost of going to the
concert is 100, 60 for the ticket and 40 lost
income from missing work.
Review Exercise 1-2
Suppose that after studying 7 hours for an
economics test, you are confident that you know
enough to make a B. However, if you study one
more hour instead of watching your favorite TV
show, you will probably improve your grade to an
A. Identify the marginal costs and benefits in
this situation.
The marginal benefit is the improvement in your
grade from a B to an A. The marginal cost is the
hour of lost entertainment.
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Economics and Economic Reasoning

• End of Chapter 1