1 Chapter 1 The Economic Approach Is life getting better or worse o What objectives should we measure Life expectancy Health Income Education Entertainment o Just look at the changes in our transportation our technology our medicine our entertainment they have all made our quality of life better than before What is economics o Economics the study of how we make choices under scarcity Choice the act of selecting among alternatives Scarcity and choice are two essential ingredients of an economic topic Scarcity people would like Ex time money textbooks the concept that there is less of a good freely available from nature than Scarcity o It is not the same thing as poverty The absence of poverty An absence of scarcity would imply that all of our desires for goods are fully implies some basic level of need has been met We may someday eliminate poverty but scarcity will always be with us o Goods are scarce because desire for them far outstrips their availability from nature o Scarcity forces us to choose among available alternatives o Scarcity necessitates rationing allocating scarce goods to those who want them In a market economy price is used to ration goods Rationing Every society must have a means to ration scarce resources among competing Resources and goods can be rationed in various ways e g first come first satisfied uses served In a market setting price is used to ration goods and resources When price is used the good or resource is allocated to those willing to give up other things in order to obtain ownership rights When price is used to ration goods people have a strong incentive to earn income so they will be able to pay the required price o Scarcity leads to competitive behavior Competition is a natural outgrowth of the need to ration scarce goods Changing the rationing method used by society will change the form of competition but it will not eliminate competitive tactics Resources o Resources an input used to produce an economic good 1 Human resources human capital 2 Physical resources physical capital 2 3 Natural resources human made resources used to produce other goods and services Ex Albert o Capital Einstein Chuck Norris 8 guideposts to economic thinking o The use of scarce resources to produce a good or service is always costly Someone must give up something if we are to have more of a scarce good The highest valued alternative that must be sacrificed is the opportunity cost of o Individuals choose purposefully therefore they will economize Economizing gaining a specific benefit at the least possible cost o 1 Resources are scarce so decision makers must make trade offs no such thing as a free the choice lunch Opportunity cost choosing an option Ex an hour of your time guns and butter the highest valued alternative that must be sacrificed when o 2 Individuals are rational they try to get the most from their limited resources Ex red wine vs spiced rum welfare vs education Greatest benefit at least possible cost What is rational for one person may not be rational for everyone o 3 Incentives matter choice is influenced in a predictable way by changing incentives Ex economic lesson from my father prices As personal benefits costs from choosing an option increase other things constant a person will be more less likely to choose that option o 4 Individuals make decisions at the marking Economic reasoning focuses on the impact of marginal changes Decisions will be based on marginal costs and marginal benefits utility Marginal describes the effect of a change in the current situation Ex Olive Garden trip to Taco Bell outweigh the marginal costs Ex Airport Security vs Lead Clean Up one will undergo an action when the marginal benefits Cost benefit analysis o 5 Information helps us make better choices but is costly Ex new house vs new notebook effects Since information is scarce uncertainty is a face of life o 6 Beware of secondary effects economic actions generate both direct and indirect In addition to their initial impact economic events often generate secondary effects that may be felt only with the passage of time The value of a good is subjective and varies with individual preferences The test of an economic theory is its ability to predict and explain events in the real world Secondary effects easily and immediately observable Ex fuel efficiency regulations trade restrictions the indirect impact of an event or policy that may not be o 7 The value of a good or service is subjective Because goods are subjective voluntary trade creates value Ex how much would you pay for a pack of gum right now 3 Moving goods and services to those who value them most is a primary source of economic progress o 8 The test of a theory is its ability to predict If real world events are consistent with a theory then that theory is valid Positive vs Normative Economics o Positive economics the scientific study of what is Testable The scientific study of what is among economic relationships Positive economic statements can be proved either true or false Ex the inflation rate rises when the money supply is increased o Normative economics judgments about what people think ought to be Not testable Judgments about what ought to be in economic matters Normative statements reflect subjective values o They cannot be proven true or false o Ex the inflation rate should be lower 4 Pitfalls to avoid in economic thinking o 1 Violation of ceteris paribus principle Ceteris paribus Latin term meaning other things constant Ex buying eggs When describing the effect of a change the outcome may be influenced by changes in other things o 2 Good intentions do not guarantee desirable outcomes Ex suicide warnings on antidepressant medication C H Taxi An unsound proposal will lead to undesirable outcomes even if it is supported by proponents with good intentions Politicians may be able to gain by focusing attention on a problem even if their policy response is ineffective or even harmful o 3 Association is not causation Ex superstitions sunspots and economic activity Statistical association alone cannot establish causation o 4 Fallacy of composition belief that what is true for one might not be true for all Ex when you get a raise vs when everyone gets a raise The erroneous view that what is true for the individual or part is also true for Microeconomics vs Macroeconomics the group or the whole o Microeconomics individually defined units such as households or firms the trees focuses on how human behavior affects
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