Economics and Economic Reasoning

1. Economics and Economic Reasoning Chapter 1

2. Laugher Curve • Q. Why did God create economists? • A. In order to make weather forecasters look good.

3. What Economics Is • Economics is the study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs, and political realities of the society.

4. What Economics Is • One of the key words in the above definition is “coordination.”

5. What Economics Is • Three central coordination problems any economic system must solve are: • What, and how much, to produce. • How to produce it. • For whom to produce it.

6. What Economics Is • Scarcity ensues because individuals want more than can be produced. • Scarcity – the goods available are too few to satisfy individuals’ desires.

7. What Economics Is • The degree of scarcity is constantly changing. • The quantity of goods, services, and usable resources depends on technology and human action.

8. What Economics Is • Economics is the study of how to get people to do things they're not wild about doing and not to do things they are wild about doing.

9. What Economics Is • The following are the five important things to learn in economics: • Economic reasoning. • Economic terminology. • Economic insights economists have about issues, and theories that lead to those insights.

10. What Economics Is • The following are the five important things to learn in economics: • Information about economic institutions • Information about the economic policy options facing society today.

11. A Guide to Economic Reasoning • Economic reasoning is making decisions by comparing costs and benefits.

12. Marginal Costs and Marginal Benefits • The relevant costs and benefits that matter are the expected incremental or additional costs incurred and the expected incremental benefits of a decision.

13. Marginal Costs and Marginal Benefits • If the marginal costs of doing something exceeds the marginal benefits, don’t do it.

14. Marginal Costs and Marginal Benefits • In economists’ jargon, marginal refers to additional or incremental. • Think of it as one more.

15. Marginal Costs and Marginal Benefits • Marginal cost – the additional cost to you over and above the costs you have already incurred. • This means eliminating sunk costs – costs that have already been incurred and cannot be recovered.

16. Marginal Costs and Marginal Benefits • Marginal benefit – the additional benefit above and beyond what you’ve already accrued.

17. Marginal Costs and Marginal Benefits • According to the economics decision rule: • If the relevant benefits of doing something exceed the relevant costs, do it. • If the relevant costs of doing something exceed the relevant benefits, don’t do it.

18. Economics and Passion • Economic reasoning is based on the premise that everything has a cost.

19. Economics and Passion • Although economists can be as passionate as the next person, they must squelch this normal human response in order to do their work with objectivity.

20. Opportunity Cost • Opportunity cost – the basis of cost/benefit economic reasoning; it is a cost of the activity you have chosen measured by the benefit foregone, of the next-best alternative to the activity you have chosen.

21. Opportunity Cost • In economic reasoning, opportunity cost must be less than the benefit of what you have chosen.

22. Opportunity Cost • Opportunity costs are not limited to individual decisions but to government decisions as well.

23. Opportunity Cost • The opportunity cost concept applies to all aspects of life and is fundamental to understanding how society reacts to scarcity.

24. Economics and Market Forces • When goods are scarce, they must be rationed. • Rationing is a mechanism chosen to determine who gets what.

25. Economics and Market Forces • One of the important choices that a society must make is to what extent economic forces are allowed free rein.

26. Economics and Market Forces • A market force is an economic circumstance that is given relatively free rein by society to work through the market. • Market forces ration by changing prices.

27. Economics and Market Forces • Economic reality is controlled by three forces: • Economic forces (the invisible hand). • Social and cultural forces. • Political and legal forces. • Market forces ration by changing prices.

28. Economics and Market Forces • Economic forces: • The invisible hand is the price mechanism—the rise and fall of prices—that guides our actions in a market. • When there is a shortage, the price goes up. • When there is a surplus, the price goes down.

29. Economics and Market Forces • Social and cultural forces, political and legal forces: • Political and social forces often work together against the invisible hand. • What happens in society can be seen as a reaction to, and interaction of, the invisible hand, political and legal forces, and social and cultural forces.

30. Economic Terminology • Learning economic terminology takes repetition and memorization, hardly a fun things to do.

31. Economic Terminology • Hundreds of economic terms will be introduced in this book. • You will learn them as we go along.

32. Economic Insights • General insights into how economies work are often based on economic theory. • Economic theory – generalizations about the workings of an abstract economy.

33. Economic Insights • Theory ties together economists’ terminology and knowledge about economic institutions and leads to economic insights.

34. Economic Insights • Because theories are too abstract to apply to specific cases, a theory is often embodied in an economic model or an economic principle. • Economic model – a framework that places the generalized insights of the theory in a more specific contextual setting.

35. Economic Insights • Because theories are too abstract to apply to specific cases, a theory is often embodied in an economic model or an economic principle. • Economic principle – a commonly held insight stated as a law or general assumption.

36. Economic Insights • Theories, and the models and principles used to represent them, are abstract but efficient means of conveying information.

37. Economic Insights • In order to understand the theory you must understand the assumptions underlying the theory.

38. The Invisible Hand Theory • The invisible hand theory states that markets are efficient in coordinating individuals’ decisions, allocating scarce resources to their best possible use.

39. The Invisible Hand Theory • This insight is called the invisible hand theory – a market economy through the price mechanism will allocate resources efficiently.

40. Economic Theory and Stories • Economic theory and its models are a shorthand means of telling a story. If you can’t translate a theory into a story, you don’t understand the theory.

41. Microeconomics and Macroeconomics • Economic theory is divided into two parts: microeconomics and macroeconomics.

42. Microeconomics and Macroeconomics • Economic theory is divided into two parts: microeconomics and macroeconomics. • One must simultaneously develop a microfoundation of macro and a macrofoundation of micro.

43. Microeconomics • Microeconomics is the study of individual choice, and how that choice is influenced by economic forces.

44. Microeconomics • Microeconomic theory considers economic reasoning from the viewpoint of individuals and firms and builds up from there to an analysis of the entire economy.

45. Microeconomics • Microeconomics studies such things as: pricing policy of firms, households’ decisions on what to buy, and how markets allocate resources among alternative ends.

46. Microeconomics • Microeconomics analyses from the parts to the whole.

47. Macroeconomics • Macroeconomics is the study of inflation, unemployment, business cycles, and economic growth. • Macroeconomics analyzes from the whole to the parts.

48. Economic Institutions • Corporations, governments, and cultural norms are all economic institutions. They differ significantly among nations. • Economic institutions sometimes seem to operate in ways quite different than economic theory predicts.

49. Economic Institutions • In applying economic theory to reality, you’ve got to have a sense of economic institutions.

50. Economic Policy Options • Economic policies are actions (or inactions) taken by government to influence economic actions.