Topic #2: Thinking Like an Economist

1. Topic #2: Thinking Like an Economist Dr David Penn Associate Professor of Economics and Director of the Business and Economic Research Center

2. Thinking Like an Economist • Economics – the study of how a society allocates scarce resources. • With limited resources and unlimited wants, we must make choices. • There is no free lunch (there is always a cost)

3. Thinking Like an Economist • Positive economics – deals with ‘what is’ • Normative economics – has to do with ‘what should be’

4. Thinking Like an Economist • Normative or Positive? • The unemployment rate is 5.5 percent. • The price of gasoline is too high. • Sales taxes are worse than income taxes. • Wages are the largest component of income. • When gasoline prices rise, consumption drops. • The government should be more involved in health care.

5. Thinking Like an Economist • Microeconomics – focuses on individual markets and industries; ‘little picture’ • Competition • Efficiency • Trade • Market failures

6. Thinking Like an Economist • Macroeconomics – issues for the whole economy; ‘big picture’ • Unemployment • Economic growth • Inflation • Trade • Business cycles

7. Thinking Like an Economist • Macroeconomics or microeconomics? • Standard Oil once was the prime example of monopoly. • Unemployment is still a major problem for the economy. • Inflation is less of a problem than it has been in years. • A tax on imported oil will increase the price of gasoline. • Anti-trust laws are needed to prevent the concentration of market power in a particular industry. • Households benefit when they can purchase a good for a price that is less than they are willing to pay.

8. Market economy • Most of the economies in the world are market economies to at least some degree. • Market economies are characterized by individuals and businesses making decisions based on incentives. • Example: price is a powerful incentive • When the price of gasoline rises: • Consumers use less • Refiners make more • Did society or government have to require consumers to use less gasoline or refiners to make more?

9. Command economy • Very few economies rely on government direction to determine what goods are produced and in what quantities. • North Korea • Cuba • In many economies, however, government rules govern the prices of some goods and services. • Example: the price of gasoline is subsidized in Iran • Result: consumers use too much and local refiners do not make enough gasoline • The degree of government intervention varies from nation to nation. • Not all government intervention in the economy is bad.

10. Thinking Like an Economist • Economics is a social science • It is difficult to use experiments to test economic theories (but the field of experimental economics is growing rapidly) • Consequently, economists use economic models to test theories

11. Thinking Like an Economist • Three important economic models: • Production possibilities frontier • Circular flow diagram • Gains from trade analysis • These models will be examined in the next three presentations.