Download The Economic Way of Thinking

1
WHAT IS
ECONOMICS?
Economics is…..
2



the social science that studies the production,
distribution, and consumption of goods and
services
An economy consists of the economic system of
a country or other area, the land, capital and
land resources, and the economic agents that
socially participate in the production, exchange,
distribution, and consumption of goods and
services of that area
an economy delivers the goods
The Economy of the United States:
3



US has a market economy
production and consumption are the result of
decentralized decisions by many firms and
individuals
opposite is a command economy – where there is a
centralized authority making decisions about
production and consumption (Soviet Union)
Adam Smith, The Wealth of Nations
4


individuals, in pursuing their own interests,
ended up serving the interests of society as a
whole
invisible hand – refers to the way a market
economy manages to harness the power of selfinterest for the good of society
Microeconomics:
5

Microeconomics
individuals pursuing their own interests often do promote
the interests of society as a whole
 Problems though --- Market Failure is when the
individual pursuit of self-interest leads to bad results for
society as a whole


Fluctuations
series of ups and downs which are a feature of modern
economies
 the economy just does not always run smoothly


recessions – economic downturns
Macroeconomics:
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

concerned with the overall ups and downs of the
economy
economic growth is the “growing” ability of the
economy to produce goods and services
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THE ECONOMIC
PERSPECTIVE
The Economic Perspective:
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

Economic perspective is the economic way of
thinking
There are four economic principles that underlie
the economics of a individual choice
1. Resources are scarce
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


A resource is anything that can be used to produce
something else
Countries resources: land, labor (the time of
workers), capital (machinery, buildings, and other
man-made productive assets), and human capital
(the educational achievements and skills of workers)
Scarce – there is not enough of the resource available
to satisfy all the various ways a society wants to use
it

ex. natural resources, limited quantity of human
resources, even clean air and water
2. The real cost of something is what you
must give up to get it
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

opportunity cost – what you must give up in
order to get it
every choice you make means forgoing
some other alternative
3. “How much?” is a decision at the
margin
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



usually the question Is not “whether” but “how
much”
this is a question whose answer hinges on the costs
and benefits of dong a bit more or bit less
decision usually involves a trade-off – a comparison
of the costs and benefits
marginal decisions – decisions about whether to do a
bit more or a bit less of an activity and the study of
such decisions is known as marginal analysis
4. People usually exploit opportunities to
make themselves better off
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

it is a good bet that people will exploit
opportunities to make themselves better off
incentives – anything that offers rewards to
people who change their behavior
13
THE ECONOMIC WAY OF
THINKING
1. Everything has a cost
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


“there is no such thing as a free lunch”
Everything action costs someone time, effort or
lost opportunities to do something else
Opportunity costs
2. People choose for good reasons
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


Everyone faces choices and everyone should
chose the alternative that gives them the most
advantageous combination of costs and benefits
Normative economics –economic analysis that
makes predictions about the way the economy
should work
Positive economics – economic analysis that
describes the way the economy actually works
3. Incentives matter
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




Economics is all about incentives
Supply and demand analysis if about incentives
Theory of the firm and factor markets are about
incentives
Government decision making is about incentives
When incentives change, people’s behavior
changes in predictable ways
4. People create economic systems to
influence choices and incentives
17



Cooperation among people is governed by
written and unwritten rules that are the core of an
economic system
As rules change, incentives and behavior change
The success of market systems and the failures of
communism are rooted in incentives
5. People gain from voluntary trade
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Economics is about trade
 People trade when they believe the trade
makes them better off, if there are no
benefits, they won’t trade
 People, not countries, trade
 Market system is about trade
 Economics is about trade

6. Economic thinking is marginal
thinking
19

Marginal choices involves the effects of
additions and subtractions from current
conditions
7. The value of a good or service is affected
by people’s choices
20


Goods and services do not have intrinsic value –
value is determined by the preferences of buyers
and sellers
Price of a good or service is set by supply and
demand
8. Economic actions create
secondary effects
21


Good economics involves analyzing secondary
effects
Example:
 Rent
controls make apartments more affordable to
some consumers
 Controls make it less profitable to build and maintain
apartments
 Secondary effect is a shortage of apartments and
houses for rent
9. The test of a theory is its ability to
predict correctly
22


If the theory correctly predicts the consequences
of actions it is a good theory
Nothing is “good in theory but bad in practice”
23
WHAT IS
ECONOMICS?
Economics is…..
24


the social science that studies the production,
distribution, and consumption of goods and
services
An economy consists of the economic system of
a country or other area, the land, capital and
land resources, and the economic agents that
socially participate in the production, exchange,
distribution, and consumption of goods and
services of that area
The Economy of the United States:
25





US has a market economy
production and consumption are the result of
decentralized decisions by many firms and
individuals
individual consumers make what they think will be
most profitable
each consumer buys what he or she chooses
opposite is a command economy
Adam Smith, The Wealth of Nations
26


individuals, in pursuing their own interests,
ended up serving the interests of society as a
whole
invisible hand –
Microeconomics:
27

Microeconomics
 individuals
pursuing their own interests often do
promote the interests of society as a whole
 Problems though --- Market Failure is when the
individual pursuit of self-interest leads to bad results
for society as a whole

Fluctuations
 series
of ups and downs which are a feature of
modern economies
 the economy just does not always run smoothly
Macroeconomics:
28


concerned with the overall ups and downs of the
economy
economic growth is the “growing” ability of the
economy to produce goods and services
29
THE ECONOMIC
PERSPECTIVE
The Economic Perspective:
30

Economic perspective is the economic
way of thinking
1. Resources are scarce
31



A resource is anything that can be used to
produce something else
Countries resources: land, labor (the time of
workers), capital (machinery, buildings, and other
man-made productive assets), and human capital
(the educational achievements and skills of
workers)
Scarce – there is not enough of the resource
available to satisfy all the various ways a society
wants to use it
2. The real cost of something is what you
must give up to get it
32

opportunity cost –
3. “How much?” is a decision at the
margin
33



usually the question is not “whether” but “how
much”
decision usually involves a trade-off – a
comparison of the costs and benefits
marginal decisions – decisions about whether to
do a bit more or a bit less of an activity and the
study of such decisions is known as marginal
analysis
4. People usually exploit opportunities to
make themselves better off
34

incentives – anything that offers rewards to
people who change their behavior
35
THE ECONOMIC WAY OF
THINKING
1. Everything has a cost
36


“there is no such thing as a free lunch”
Everything action costs someone time, effort or
lost opportunities to do something else
2. People choose for good reasons
37


Normative economics –economic analysis that
makes predictions about the way the economy
should work
Positive economics – economic analysis that
describes the way the economy actually works
3. Incentives matter
38


Economics is all about incentives
When incentives change, people’s behavior
changes in predictable ways
4. People create economic systems to
influence choices and incentives
39


Cooperation among people is governed by
written and unwritten rules that are the core of an
economic system
As rules change, incentives and behavior change
5. People gain from voluntary trade
40

Economics is about trade

People, not countries, trade
6. Economic thinking is marginal
thinking
41

Marginal choices involves the effects of
additions and subtractions from current
conditions
7. The value of a good or service is affected
by people’s choices
42


Goods and services do not have intrinsic value –
value is determined by the preferences of buyers
and sellers
Price of a good or service is set by supply and
demand
8. Economic actions create
secondary effects
43


Good economics involves analyzing secondary
effects
Example:
9. The test of a theory is its ability to
predict correctly
44


If the theory correctly predicts the consequences
of actions it is a good theory
Nothing is “good in theory but bad in practice”