Topic #2: Thinking Like an Economist

Dr David Penn

Associate Professor of Economics and Director of the Business and Economic Research Center

Thinking Like an Economist

Economics – the study of how a society allocates scarce resources.

With limited resources and unlimited wants, we must make choices.

There is no free lunch (there is always a cost)

Thinking Like an Economist

Positive economics – deals with ‘what is’ Normative economics – has to do with ‘what

should be’

Thinking Like an Economist

Normative or Positive? The unemployment rate is 5.5 percent. The price of gasoline is too high. Sales taxes are worse than income taxes. Wages are the largest component of income. When gasoline prices rise, consumption drops. The government should be more involved in

health care.

Thinking Like an Economist

Microeconomics – focuses on individual markets and industries; ‘little picture’ Competition Efficiency Trade Market failures

Thinking Like an Economist

Macroeconomics – issues for the whole economy; ‘big picture’ Unemployment Economic growth Inflation Trade Business cycles

Thinking Like an Economist

Macroeconomics or microeconomics? Standard Oil once was the prime example of

monopoly. Unemployment is still a major problem for the

economy. Inflation is less of a problem than it has been in

years. A tax on imported oil will increase the price of

gasoline. Anti-trust laws are needed to prevent the

concentration of market power in a particular industry.

Households benefit when they can purchase a good for a price that is less than they are willing to pay.

Market economy Most of the economies in the world are market

economies to at least some degree. Market economies are characterized by

individuals and businesses making decisions based on incentives.

Example: price is a powerful incentive When the price of gasoline rises:

Consumers use less Refiners make more

Did society or government have to require consumers to use less gasoline or refiners to make more?

Command economy Very few economies rely on government direction to

determine what goods are produced and in what quantities. North Korea Cuba

In many economies, however, government rules govern the prices of some goods and services.

Example: the price of gasoline is subsidized in Iran Result: consumers use too much and local refiners do not

make enough gasoline The degree of government intervention varies from

nation to nation. Not all government intervention in the economy is bad.

Thinking Like an Economist

Economics is a social science It is difficult to use experiments to test

economic theories (but the field of experimental economics is growing rapidly)

Consequently, economists use economic models to test theories

Thinking Like an Economist

Three important economic models: Production possibilities frontier Circular flow diagram Gains from trade analysis

These models will be examined in the next three presentations.