Micro Chapter 1

The Economic Approach

4 Learning Goals

1) Identify and list the critical components of economics.

2) List and provide examples of the eight guideposts of economic thinking.

3) Distinguish between two types of economic statements (on your own)

4) Avoid making four common mistakes

Compare and Contrast:

A. All the possessions you have right now

B. All the possessions you had 10 years ago

Which group would you rather have? Why?

Improving standards of living doesn’t just happen by accident

Actually, they don’t have to improve at all

Video:

A Deal for You:

Would you give up the internet for the rest of your life for $1 million right now?

A Deal for You:

Would you give up the internet for the rest of your life for $1 million right now?

Video:

What Is Economics About?

Economics doesn’t have to be like this:

Economics tries to explain and predict the behavior of consumers, firms, and government.

John M. Keynes:“Economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions.”

Steven Levitt & Stephen DubnerSuper Freakonomics

The economic approach isn’t meant to describe the world as any one of us might want it to be, or fear that it is, or pray that it becomes- but rather to explain what it actually is. Most of us want to fix or change the world in some fashion. But to change the world, you first have to understand it.

Supplemental video: RSAnimate-Freakonomics (on Blackboard)

Scarcity and Tradeoffs

Scarcity leads to tradeoffs which result in making choices

Scarcity and Tradeoffs

Thomas Sowell: “In the world that people live in, and are likely to live in for centuries to come, trade-offs are inescapable. Even if we refuse to make a choice, circumstances will make choices for us, as we run out of resources for many important things that we could have had, if only we had taken the trouble to weigh alternatives. ”

Historically, mechanisms that have been used to deal with the problem of scarcity:

1. Force

2. Tradition (emphasized past ways, relied on families)

3. Authority (government and church)

4. Market

5. Combinations of 1-4

Scarcity and Tradeoffs

Scarcity requires that some wants remain unfulfilled

Issues of equity, justice, and fairness are embedded with scarcity

Class Perspective

We will focus on the market process of dealing with scarcity.

At times we will compare and contrast with the government or collectivist process.

Do not confuse the market process as being the same as politically conservative.

The Economic Way of Thinking

Always have these guidelines in your economic thought process:The text lists 8 guidelines.

(1) There are always tradeoffs

(1) There are always tradeoffs

What you give up is your opportunity cost-value of next best alternative

Common mistake: opportunity cost is NOT the sum of everything you give up

(1) There are always tradeoffs

There is no such thing as a free lunch!

(1) There are always tradeoffs

Supplemental video: Milton Friedman- free lunch myth (on Blackboard)

(2) Individuals choose purposefully

Referred to as economizing behavior-try to get the most benefits for the least cost or effort

Also known as rational behavior

Example: drug addict

Alfred Marshall:

“It is deliberateness, and not selfishness, that is the characteristic of the modern age.

Steven Levitt & Stephen DubnerSuper Freakonomics

Human behavior is influenced by a dazzlingly complex set of incentives, social norms, framing references, and the lessons gleaned from past experience- in a word, context. We act as we do because, given the choices and incentives at play in a particular circumstance, it seems most productive to act that way. This is also known as rational behavior, which is what economics is all about.

Clicker question next

When economists say that people choose rationally, this means

1. they gather all relevant information before making their purchases

2. once a pattern of behavior has been established, people tend to become set in their ways

3. people respond in predictable ways to changes in costs and benefits

4. people rarely make errors when they are permitted to make transactions

(3) Incentives matterAs the incentive goes up, you will be more likely to do something (or try to), and vice versa

The incentive doesn’t have to be money

Class Activity: What are some of your incentives?

(3) Incentives Matter

Video:

(3) Incentives matterIllustration: Dancing

(3) Incentives matterIllustration: Dancing

1:

(3) Incentives matterIllustration: Dancing

1: 2: 3:

Thank you!

(3) Incentives Matter

Supplemental reading: Flamboyant male dancing attracts women best

Supplemental video: RSAnimate-surprising truth about what motivates (on Blackboard)

(4) Think on the margin, not in total or on average

Marginal means additional or incremental

Marginal _______ is additional _______.

Marginal _______ is additional _______.

Example: water/diamond paradox

Example: Would you travel 3 blocks to save $20 on a $100 product?

Would you travel the same 3 blocks to save $20 on a $1,000 product?

(4) Think on the margin, not in total or on average

Rule to live by:

Continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost.

When should you break up with your boyfriend?

(5) More information leads to better decision-making, but more information is costly to get

Refer back to (1) through (4)1) There are always tradeoffs

2) Individuals choose purposefully

3) Incentives matter

4) Think on the margin

(6) Many choices create a secondary effect

The primary effect is often immediate and visible

The secondary effect usually comes later and is not as visible

Video:

(7) Value is subjective

Beauty is in the eyes of the beholder

Value is determined by the purchaser

(8) Economic thinking is scientific thinking

Economists use data and information generated by people to explain and predict actions

Clicker question next

Do you believe red cars receive more traffic tickets?

1. Yes

2. No

(8) Economic thinking is scientific thinking

Economists use data and information generated by people to explain and predict actions

Class Activity: Do you believe that red cars receive more traffic tickets? Why or why not?

Video:

Steven Levitt & Stephen DubnerSuper Freakonomics

But while there are exceptions to every rule, it’s also good to know the rule. In a complex world where people can be atypical in an infinite number of ways, there is great value in discovering the baseline. And knowing what happens on average is a good place to start. By so doing, we insulate ourselves from the tendency to build our thinking- our daily decisions, our laws, our governance- on exceptions and anomalies rather than on reality.

(8) Economic thinking is scientific thinking

Do you believe that students who regularly attend class earn higher grades? How could you support (or fail to support) that?

See David Romer’s article “Do students go to class? Should they?” on Blackboard

Positive and Normative Economics

4 Learning Goals

3) Distinguish between two types of economic statements (on your own)

Please read “Essays in Positive Economics” by Milton Friedman on Blackboard

The introduction and Section 1 (pages 1 through 3) are relevant; you may skip the rest.

Pitfalls To Avoid in Economic Thinking

Don’t make one of these errors:

(1) Violation of ceteris paribus.– Ceteris paribus is Latin for “other things

constant.”– We want to isolate variables so we typically

allow only one to change at a time.– Example: stomach ache

Errors:

(2) Good intentions do not necessarily result in good outcomes

Milton Friedman: “There is nothing that does so much harm as good intentions”

Errors:

(2) Good intentions do not necessarily result in good outcomes

Example: using someone else’s device for clicker credit

Errors:

(3) Association is NOT causation

Video:

Errors:

(3) Association is NOT causation

Some examples

Video:

Errors:

(4) Fallacy of Composition– Assumption: what’s good for the individual is

good for the group.– Making this assumption when it’s false is the

fallacy.– Video:

Class Activity

Provide at least one example of the fallacy of composition.

4 Learning Goals

1) Identify and list the critical components of economics.

2) List and provide examples of the eight guideposts of economic thinking.

3) Distinguish between two types of economic statements (on your own)

4) Avoid making four common mistakes