What is Economics?

1. What is Economics? Lesson 4: Economic Thinking Learning How to Speak “Economics”

2. Joke of the Day Q:How many ears did Davy Crockett have?

3. Joke of the Day Q: How many ears did Davy Crockett have? A: Three - his left ear, his right ear, and his WILD FRONT EAR.

4. Readings and Assignments • “The Broken Window” • Bastiat’s “Petition” • “Freedom’s Theory of Value” • Economic Reasoning Chapter 2-3 • “Man and Society” • “Trashman Cometh” • Lessons for the Young Economist 2-3

5. Why Study Economics? • Alfred Marshall (1842-1924) • …[I]t is the “ordinary business of life.”

6. Remember the Rules • The rules of the game determine the outcome. • The rules of the game shape how decisions are made. • Decisions determine outcomes.

7. Economic Reasoning Principle #1: People choose, and individual choices are the source of social outcomes. Scarcity necessitates choices: not all of our desires can be satisfied. People make these choices based on their perceptions of the expected costs and benefits of the alternatives.

8. Economic Reasoning Principle # 2: Choices impose costs; people receive benefits and incur costs when they make decisions. The cost of a choice is the value of the next-best alternative foregone, measurable in time or money or some alternative activity given up.

9. Economic Reasoning Principle # 3: People respond to incentives in predictable ways. Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, behavior changes in predictable ways.

10. Economic Reasoning Principle # 4: Institutions are the “rules of the game” that influence choices. Laws, customs, moral principles, superstitions, and cultural values influence people’s choices. These basic institutions controlling behavior set out and establish the incentive structure and the basic design of the economic system.

11. Opinions matter and are of equal value at the ballot box. But on matters of rational deliberation the value of an opinion is determined by the knowledge and evidence on which it is based. Statements of opinion should initiate the quest for economic understanding, not end it. Economic Reasoning Principle #5: Understanding based on knowledge and evidence imparts value to opinions.

12. Social versus Natural Sciences • Studies people and aspects of society • Psychology, sociology, and anthropology • Purposeful actions • Natural sciences study aspects of the natural world • Physics, chemistry, biology, astronomy, and meteorology • Mindless behavior

13. How?? • Economics is however, mainly a deductive discipline, not an experimental (inductive) subject. • A mind experiment. • Axioms • Praxeology • Catallactics

14. Economic Thinking • Economic Analysis • John Maynard Keynes: “It [economics] is a method…an apparatus of the mind, a technique of thinking…”

15. What is Economics? (Continued) • Economics is form of applied logic (reasoning). • Economists study the reasoning that drives economic decisions and outcomes. • One might think of economics as the study of unintended consequences. (Broken Windows) • Understanding causes and effects is critical to: • understanding the ultimate consequences of economic events and • effective and responsible policy making.

16. Positive vs. Normative Economics • Positive Economics • Focuses on “what is” • Analyzes actual, measurable outcomes • Does not impose value judgments, person feelings or convictions • Positive economics is economics as a science • Normative Economics • Focuses on what someone thinks “ought to be” or “should be” • Makes ethical judgments—value judgments

17. Pitfalls to Objective Thinking • Biases: Preconceptions that are not based on facts • Loaded terminology • Definitions

18. Common Analytical Mistakes (Logical Fallacies) • Causation Fallacies • Post hoc fallacy: When two events occur in time sequence, the first event is not necessarily the cause of the second event.

19. Common Analytical Mistakes (Logical Fallacies) For example, if one observed that many people at the race track were betting on a particular horse and then observed that that particular horse won the race, it would be erroneous to conclude that the horse won because many people bet on it. Rather, people expected the horse to win so they bet on the horse.

20. Common Analytical Mistakes (Logical Fallacies) • Fallacy of Composition • The mistaken assumption that what is true of a part is also true of the whole.

21. Common Analytical Mistakes (Logical Fallacies) • ICU (Interpersonal Comparisons of Utilities) • The ridiculous assumption that utility can be compared between individuals • Remember Utility cannot be measured, only ordered personally > ?????

22. Common Analytical Mistakes (Logical Fallacies) • Violation of Ceteris Paribus • Ceteris Paribus: Latin for “all else equal”. • This occurs when one attempts to analyze the effect of one thing while holding everything else constant, when in fact other things have changed.

24. How do people know things? • a priori • regularity • logic • causality • time • change • value • a posteriori

25. Deductive Logic • All communists have two heads. • Karl Marx is a communist. • Therefore, Karl Marx is two-headed. • Check your premises. • A is A

26. Laws of Logic • A = A: The Law of Identity • Not (A and not A): The Law of Non-Contradiction • A or not A: The Law of Excluded Middle

27. Some stuff to remember!! • Validity!! • Self-evident • Truth is not the same as valid • True premises can lead only to true conclusions. • But not necessarily Valid ones. • Man has no nobler function than to defend the truth. Ruth McKenne

28. Economic Models • Simplify uncertainty • Text • Graphs • Tables • Independent variable • Dependent variable • Direct or positive relationship • Inverse or negative relationship • Scientific method??

29. Pictures (graphs)

30. Let’s See

31. The Austrian Model • All human act • Consciously • Deliberately • Every action has a goal or purpose • Man uses available means to achieve that purpose

32. So? What can we now say? • Remember we can deduce from what we already know. • The future is uncertain • We would not act if certain • We act to be better off • Utility and welfare • Again it is ordinal • There is no such thing as “more utility”

33. Complex, Uncertain Choices • Lots of choices amongst goals • Lots of means • Lots of ends • Lots of doubt • Lots of freedom

34. There is no such thing as not choosing!!

35. Scales of Value • The actor decides how to achieve and in what priorities. • Thus preferences are subjective. • We always choose our highest-valued goal. • Marginal unit value: that which is devoted to the least valuable use • There is no such thing as indifference

36. We know things about the nature of conscious action because we are all acting individuals ourselves. • Men act purposively to attain ends. • Their wants are endless. • Their means are limited. • Their values are personal (subjective). • Their ideas, values and goals are always changing. • They may make mistakes. • At any instant in time, they are always aiming at what they consider most important. • They always try to use the easiest and simplest way to get what they want; in other words, they "economize."

37. Order in the House • Regularity • Logic • Causality • Time • Change • Value

38. Only Individuals Act The first truth to be discovered about human action is that it can be undertaken only by individual “actors.” Only individuals have ends and can act to attain them. There are no such things as ends of or actions by “groups,” “collectives,” or “States,” which do not take place as actions by various specific individuals. “Societies” or “groups” have no independent existence aside from the actions of their individual members. Thus, to say that “governments” act is merely a metaphor; actually, certain individuals are in a certain relationship with other individuals and act in a way that they and the other individuals recognize as “governmental.” —Murray Rothbard, Man, Economy, and State

39. Three conditions need to act. • Some dissatisfaction, a "felt uneasiness" • An idea concerning a better situation • The hope that action can accomplish something worthwhile • Subjective!!!!

40. Three requirements for acting. • Planning • Time • The necessary resources (tools, knowledge, etc.)

41. Individuals are always pondering and experimenting to find easier and better ways to accomplish the things they want. • They have found they can accomplish more of their goals better, easier, or better and easier if they respect the rights of individuals to acquire, hold and use private property as they wish • By specializing, cooperating and exchanging with one another, everyone can have more than if he lived and labored in isolation • It becomes apparent that the basic economic concepts follow "naturally" and logically from the nature of man and the universe

42. The Austrian Techniques • Marginal utility is ordinal. • 1st • 2nd • 3rd • 29th

43. The Austrian Techniques • To accomplish a goal one needs planning, time, resources (information, skills, tools, labor, knowledge about the physical world). • Why do some fail to achieve their goals? • Accidents • Natural phenomena • Actions of others • Passage of time • We are fallible

44. Never Forget!!! • Everything has a cost. • People choose for good reasons. • Incentives matter. • People create economic systems to influence choices and incentives. • People gain from voluntary trade. • Economic thinking is marginal thinking. • The value of a good or service is affected by people’s choices. • Economic actions create secondary effects. • The test of a theory is its ability to predict correctly.

45. Essential Economic Questionsof a Society • What to Produce? • How to produce? • Who gets it? • Who decides those choices? • Opportunity Costs (TANSTAAFL)

46. Study Questions • If someone sneezes when pepper is thrown in his face, is that a purposeful action? • Does “purposeful action” include mistakes? • *Are brain and mind interchangeable terms? • Can we perform controlled experiments to test economic theories? • **Would you classify Intelligent Design theory as a natural or social science?

47. Some other to Think About • Why is it questionable to say, “Germany attacked France”? • Why do statements about a man’s actions (implicitly) involve his beliefs as well? • Can purposeful action be based on a faulty belief? Give examples. • What does it mean when economists say preferences are subjective? • *Does economics say you shouldn’t give money to charity?

48. Some other to Think About Does economics assume that people act in isolations from the rest of society? What does it mean to say Crusoe creates goods with his “mind powers”? Can leisure be more physically demanding than work? Why does Crusoe need to worry about depreciation of his capital goods? How do expectations affect someone’s decisions?