The Economic Approach What is Economics 12 08 2012 Economics does not have to be like Farris Buller Economics is the study of how we make choices under scarcity o Scarcity The condition that arises because the available resources are insufficient to satisfy wants Resources are scarce when the collective desires of a society for the resources exceed the amount of the resources available in nature Two comments 1 Scarcity requires more than physical limitation 2 Scarcity is not the same thing as a shortage What do economists study o Everything almost economic variables and behavior prices employment production profits labor supply consumption and savings housing international trade auctions Non economic variable behavior marriage gender fertility crime discrimination health politics and voting The economic way of thinking Scarcity necessitates rationing o Rationing Allocating scarce goods to those who want them 1 In a market economy price is used to ration goods 2 Scarcity leads to competitive behavior Choice o Scarcity necessitates choice If a resource is scarce there is not enough of it to satisfy all of our desires for it Therefore we must choose how the resource will be used Individuals always have choices about the use of scarce resources Individuals have wants They do not have needs There are no true necessities Resources an input used to produce an economic good o 1 Human resources human capital o 2 Physical resources physical capital o 3 Natural resources Capital Human made resources used to produce other goods and services Conclusion about the effect of a variable require other things Ceteris Paribus unchanged o To determine the effect of a change in one variable on another variable requires that other things remain constant o Ceteris Paribus means other things remain the same Guideposts to Economic Thinking 1 Resources are scarce so trade offs must be made o No such thing as a free lunch o Opportunity Cost the opportunity cost of something is the highest valued alternative forgone o Choice and Opportunity Cost When we choose to use a resource in a particular way we simultaneously choose not to use it in an alternative way The opportunity cost of our choice is the value of the thing we choose not to due with the same resource Money is NOT an opportunity cost 2 Individuals are rational they try to get the most from their limited resources o greatest benefit at least possible cost beer liquor wine what is rational for one person may not be rational for everyone 3 Incentives matter incentives o choice is influenced in a predicable way by changing people are rational they choose so as to maximize the net gain from each and every activity in choosing how to use scarce resources they respond to incentives 4 Individuals make decisions at the margin o Economic thinking is marginal thinking Choices are made at the margin In economics at the margin means Small or incremental small changes from what you are currently doing Cost benefit analysis one will undergo an action when the marginal benefits outweigh the marginal costs 5 Information helps us make better choices but is costly 6 Beware of secondary effects economic actions generate both direct and indirect effects o Secondary effects the indirect impact of an event or policy that may not be easily and immediately observable Yacht tax trade restrictions 7 The value of a good or service is subjective o ex FSU Football Tickets o ex How much would you pay for a bottle of water right now 8 The test of a theory is its ability to predict The Economic Approach Positive economics o The scientific study of what is testable Normative economics o Judgments about what ought to be not testable Pitfalls to Avoid 1 Violation of ceteris paribus principle 2 The belief that good intensions guarantee desirable outcomes 3 The belief that association is causation o cause and effect relationships methodological fallacy Correlation does not imply causation correlation is the tendency for the values of two variables to move in a predictable and related way o There are four possible explanations for any observed correlation Cause and effect Reverse causation Omitted variables Spurious correlation Do red cars get more speeding tickets 4 Fallacy of composition belief that what is true for one might not be true for all o standing at a football game The Economic Approach Microeconomics focuses on how human behavior affects the conduct of affairs within individually defined units such as household or firms Macroeconomics Focuses on how human behavior affects outcomes in highly aggregated markets such as the nations market for labor Production Possibilities and Comparative Advantage 12 08 2012 Trade and Value How trade creates value o 1 When individuals engage in voluntary exchange both parties are better off o 2 By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources Transaction Costs Middleman o The time effort and other resources needed to search out negotiate and complete an exchange o High transaction costs lead to a barrier to trade Ex You had to pay a quarter for each candy trade o Transaction cost leave room for a middle A person group who buys sells goods or services or arranges trades Middleman can reduce transactions costs Property Rights Property Rights Involve o 1 Rights to exclusive use of a property o 2 Legal protection against invasion from other individuals o 3 Right to sell transfer or mortgage the property Four incentives of property rights o 1 Incentive to use resources in ways that are considered beneficial to others the owners bear the cost of ignoring the wishes of others o 2 Private owners have an incentive to care for an mange their property o 3 Private owners have an incentive to conserve for the future o 4 Private owners have an incentive to make sure their property does not damage your property keeping your dog on a leash Production Possibilities Curve PPC o The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced given the available resources and the state of technology o The PPC is a valuable tool for illustrating the effects of scarcity and its consequences o Available resources the land Land both raw land and natural resources taken from Capital Machines tools other equipment buildings and business inventories Labor Force All people willing and able to work weather they are
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