Chapter 1 – The Economic ApproachWhat is economics about?Economics is about scarcity and the choices we have to make because our desire for goods and services is far greater than their availability from natureFour major types of resourcesResources are the ingredients/inputs that people use to produce goods and servicesThe four major types are:Resource (Input)TypeReturn (Output)LandNaturalRentLaborMental/PhysicalWageCapitalPhysical/FinancialInterestsEntrepreneurshipProfitScarcity vs. PovertyScarcityPovertyPositive EconomicsNormative EconomicsTestableOpinionObjectiveSubjectiveTrue/FalseOpinion BasedScarcityAsks the question: if the price were to be $0 would there be enough?Indicates there is less of a good freely available from nature than people would likePositive economics – testable – concrete yes/noPovertyThe number set to define poverty is based off of some statistics but primarily based off of opinionHas to do with choiceI.e. In 2010 $21,000 (total income) for a family of 4 was the cut off for povertyImagine that same family living in Haiti with $21,000/yearEconomic Way of Thinking – Principles of Economic Thinking1. There is always a trade-offWe call this “trade-off” our opportunity costOpportunity cost is what you give up when you do something elseWhen you use resources, you’re always giving up the opportunity to use them in a different wayIt is the most highly valued alternative you could be doing when you are doing somethingIf we subsidize losses (bailouts) the government is supporting the misuse of resourcesI.e. seatbelts – cost $50 billion/year and save ~400 lives/year. Could that $50 billion/year be used for something like cancer research that could potentially save ~500 lives/year?Everything has a cost2. Individuals choose purposefully and therefore, economically“Trying to get the most for least”When things cost the same what gives you the most satisfaction in the end or utilityUtility – the subjective benefit or satisfaction a person expects from a choice or course of actionPeople behave rationallyI.e. if three things give you the same utility you choose the one that costs the leastThis cost is a total cost; it includes transaction cost, opportunity cost, etc.Transaction cost – total cost that it takes to make the transaction3. Incentives MatterYou can get anything you want with the right incentivesPositive vs. negative incentivesPositive incentives – i.e. I will pay you $50 if you do thisNegative incentives – i.e. you will pay me $50 if you do this (handicapped parking spots)People respond to incentives in a predictable wayIntended consequences vs. actual consequences4. Economic Thinking is Marginal ThinkingPeople make decisions at the marginWhat it costs to do one additional thingDescribes the effects of a change in the current situationI.e. what the extra cost is for the producer to produce one additional unitChange from the status quo5. Information is a Costly GoodImplies rational ignoranceRational ignorance – after the cost/benefit analysis if it costs more to learn something than the benefit of learning it, rationally we shouldn’t learn it, so people are sometimes people make decisions without total and perfect informationI.e. When something costs you a lot you gain more information about it than when something costs you a little (pencil vs. car)6. Beware of Secondary EffectsIn addition to immediately visible effects people’s decisions produce secondary effectsSecondary effects – the indirect impact of an event or policy that may not be easily/immediately observable. In areas of policy these are often overlooked and unintendedI.e. taxing the windows on homes – end up with windows with no homes and the government generates no tax7. The Value of a Good or Service is SubjectivePeople have different preferences and values for goods/services8. Economics is a ScienceEconomics is scientific thinkingScientific Thinking – developing a theory from basic principles and testing it against events in the real world. Good theories are consistent with and help explain real-world events.It is testable and we can see if the theories we make help predict future/current eventsPitfalls to Avoid in Economic ThinkingViolation of Ceterus ParibusCeterus paribus - A Latin term meaning “other things constant” that is used when the effect of one change is being described, recognizing that if other things changed, they also could affect the result. Economists often describe the effects of one change, knowing that in the real world, other things might change and also exert an effect.Violation of this condition can lead one to draw the wrong conclusionWe must always assume Ceterus paribusGood Intentions do not Guarantee Good ResultsThere is a tendency to believe if the supporters of a policy have good intentions then their results will be sound as well, however this is not always the caseI.e. In Africa the government said poaching is illegal (good intention) however the numbers of elephants continued to dwindle because the law did not stop poachers (bad result). So in some countries in Africa the government sold elephants to individuals and if someone wants to hunt an elephant they must purchase that right from the owner of the elephant, result was a huge decrease in number of elephants poachedAssociation is not CausationJust because two things are associated with each other does not mean there is a causal relationship and if there is, we must make sure the direction of causation is correctI.e. It’s raining b/c I’m carrying my umbrella (causation in the wrong direction)Fallacy of compositionAssuming what’s true for one thing is true for the groupHowever, what’s true for one thing does not imply truthfulness for the groupI.e. Rick Perry, “I’ve done a lot right in Texas, elect me and I’ll do the same in the U.S.”Doesn’t work like that, what’s good/true for Texas may not be good/true for the whole of the U.S.Chapter 2 – Some Tools of the EconomistEvery economy (free market to command market) must answer the following questions:1. What to produce?2. How to produce it?3. Who gets what? (How do we allocate produced goods?)Command market/Demand economy – Government answers questionsFree market – Market answers questionsTools of the economist used to answer those three questionsOpportunity costTime and moneySubjective – opinion – no one else can tell you what your opportunity cost is. Therefore, since no one else is telling
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