Thinking Like an Economist

Thinking Like an Economist what is Economics

Thinking Like an Economist Economists: People who specialize in economics People who have extensive knowledge in economics http://nobelprize.org/nobel_prizes/economics/laureates/ Economics: Subject about the economy Economy: A system that coordinates economic activities

Core Economic Activities Production: Transforming inputs into outputs Using resources to get products Inputs (resources): L, K, N, etc Output (products): goods and services Technology: the body of knowledge and techniques used in the process of transforming inputs into outputs

Scarcity:The basis of all economic problems • Goal: • satisfy human needs and wants • Unlimited • Means: resources • L, K, N, E • Limited

Principle of Scarcity Scarcity: resources available are not enough to satisfy all human needs and wants Since we have boundless needs and wants, but the resources available to us are limited, or the resources are not enough relative to our needs and wants. Therefore, having more of a good thing usually means having less of another. When getting something good, there is always sacrifices involved.

Final Purpose of Production • To satisfy consumer desires (needs and wants): • To create what people want • To get what people want to the people who want them • To get what people want to who want them when they want them

Economics: Redefined • Economics is the subject that studies how to allocate and utilize the limited resources to produce goods and services that best satisfy the various, unlimited, competing human desires

What to Do under Scarcity? Having more of a good thing means having less of another Choose How to make choices? Compare cost and benefit of having more of a good thing Cost-benefit analysis: compare the extra cost to the extra benefit of taking an action

Principles of Cost-Benefit Analysis Compare marginal cost to marginal benefit: If MC < MB, should take the action If MC > MB, should not take the action Not to compare average cost to average benefit Higher average benefit does not mean higher extra benefit Marginal cost / benefit: the increase in total cost / benefit that results from taking one additional unit of an activity The additional cost incurred / benefit gained when taking one more unit of an activity The extra cost / benefit from taking an action Average cost / benefit: The total cost / benefit of undertaking N units of an activity divided by N

Principles of Cost-Benefit Analysis Should consider opportunity cost (example 1.3) The value of the next-best alternative that has to be forgone in order to take an activity the value of the next best alternative sacrificed the value of what must be given up to get what you decide to have The implicit value of the activity that did not happen The Value of best alternative, not combined value of all alternative “The dog that did not bark in the night ”

Principles of Cost-Benefit Analysis Should not consider sunk cost (example 1.4) A cost that is beyond recovery at the time when a decision must be made Irrelevant to the decision of whether or not to take an action The only costs to consider when making a decision about whether or not to take an action are those that we can avoid by taking no action

Recap: Cost-Benefit Principle Economic Surplus: The benefit of taking an action minus the cost of taking the action Cost-benefit analysis: An action should be taken if and only if the extra (marginal) benefit of taking the action is at least as great as the extra (marginal) cost of taking the action An action should be taken if and only if the economic surplus is non-negative

Economist: specializes in Economics Economics: A study of mankind in the ordinary business of life How to use limited resources to satisfy needs and wants as many and best as possible mainly concerned with ordinary things not the body of concrete truth a way of thinking an engine for the discovery of concrete truth.

Economics: a science of decision-making Economic activities require decision making Decision making because choices have to be made Choices because resources are scarce relative to human needs and wants (Scarcity Principle)

Choices to make: what and how many Should I spend the money on a movie or on a dinner? Should the firm product chips for handphone or for computer? Should the country encourage more investment or more consumption? How How goods and services are produced? How does the economic system work? When and why economic system does not work? When do people become counterproductive? For whom How should the results of economic growth be distributed? …

Basic Fields of Economics:Macro vs. Micro Macroeconomics: overall ups and downs of the national economy GDP, growth, inflation, unemployment, International trade. International finance Monetary policies, fiscal policies … Microeconomics: how individuals make decisions and how these decisions interact individual consumers and producers as decision makers single products single market …

Microeconomics Individual decisions about what to do and what not to do. Decisions about production and consumption made by individual firms and consumers (market economy) How individuals’ pursuit of self interest leads to good results as a whole (the invisible hand). Market usually leads to efficiency, but not necessarily equity. When market fails, it calls for government interventions. Proper “incentives” may help reach society’s goals.

Homework Exercise 1.6, P. 18 (Optional, extra credit) In 500 words or less, use cost-benefit analysis to explain some pattern of events or behavior you have observed in your own environment. Due Monday, 3/8/2010 Reading: REQUIRED Chapter 1: Thinking Like an Economist Appendix to Chapter 1: Working with Equations, Graphs, and Tables Chapter 2: Comparative Advantage: the Basis for Exchange

Thinking Like an Economist