Economic Thinking and Economic Tools

1. Economic Thinking andEconomic Tools Chapter 2

2. 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

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

4. 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

5. 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

6. 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

7. 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”

8. 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

9. 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

10. 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

11. Economic Thinking • In the Summer of 2003 the Supreme Court upheld the University of Michigan’s Law school admission policy but not that of its undergraduate program • Difference in the policies

12. Economic Thinking • In writing for the majority, Justice O’Connor indicate that “American businesses have made clear that the skills needed in today’s 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

13. 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.”

14. 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

15. 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

16. 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

17. 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

18. MicroeconomicsThe Basic Approach (Cont) • The Law of Demand • ΔD1/ΔP1 <0 • Substitutes vs. Compliments • ΔD1/ΔP2 < or > 0? • Normal vs. Inferior Goods • ΔD1/ΔI < or > 0?

19. 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

20. Demand and Supply • Things that may impact demand (Cont.) • Preferences • Number of buyers • Etc.

21. Demand P Increase in quantity demanded Decrease in quantity demanded D Q

22. Demand P Exogenous variable increases demand D Q

23. Demand P Exogenous variable decreases demand D Q

24. 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

25. Demand and Supply • Things that may impact supply (Cont.) • technology • Number of sellers • Etc.

26. Supply P S Q

27. Supply P S Increase in supply Q

28. Supply P S Decrease in supply Q

29. Demand and Supply P S P* D Q Q*

30. Demand and Supply (Increase in Demand) P S Equilibrium Price increases and equilibrium quantity also increases P* P D Q Q Q*

31. Demand and Supply (Increase in Supply) P S Equilibrium Price decreases and equilibrium quantity increases P* P D Q Q* Q

32. Demand and Supply (Decrease in Demand) P S Equilibrium Price decreases and equilibrium quantity also decreases P* P D Q Q* Q

33. Demand and Supply (Decrease in Supply) P S Equilibrium Price increases and equilibrium quantity decreases P P* D Q Q* Q

34. Demand and Supply P S Excess Demand D Q

35. Demand and Supply P S Excess Supply D Q

36. Demand and Supply of Labor S w D L

37. Demand for Labor • Reasons why it slopes downward: • Law of Diminishing Marginal Returns • Substitution Effect • Scale Effects

38. Supply of Labor and Equilibrium • Why Supply Slopes Upwards then downwards • Income and Substitution Effect • Stable Equilibrium

39. Equilibrium • If w > we then there is an Excess Supply which implies there is unemployment • If w < we then there is an Excess Demand which implies there is an tight labor market

40. Shocks to Equilibrium:Demand • DEMAND • Output becomes more or less “popular” • Shift to more efficient capital • Competitiveness in output market changes • Technology

41. Shocks to Equilibrium:Supply • Supply • Change in Labor size • Women enter the market place • Immigration • Taxes • Change in Quality of Labor • Education • Cultural Change

42. 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)

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

44. 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

45. 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.

46. How Would Arm Forces Differ Under No Draft • No Draft: • Smaller • Maybe Lower Opportunity Cost • Low Education • “taste” for soldiering • Perhaps Racial Component

47. Equity vs. Efficiency • No Draft: • Efficient • In other words Draft is inefficient • Draft: • Could be more equitable

48. Economic Thinking andEconomic Tools • More about regression analysis later • More about experimental economics later