Micro Chapter 1 The Economic Approach

4 Learning Goals Identify and list the critical components of economics. List and provide examples of the eight guideposts of economic thinking. Distinguish between two types of economic statements (on your own) Avoid making four common mistakes

What Is Economics About?

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 Dubner Super 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.

Steven Levitt & Stephen Dubner Super Freakonomics Instead of thinking of such stories as “economics,” it is better to see them as illustrating “the economic approach.” That’s a phrase made popular by Gary Becker, the longtime University of Chicago economist who was awarded a Nobel Prize in 1992. In his acceptance lecture, he explained that the economic approach “does not assume that individuals are motivated solely by selfishness or gain. It is a method of analysis, not an assumption about particular motivations.. .Behavior is driven by a much richer set of values and preferences.”

Alfred Marshall: Economics is “a study of mankind in the ordinary business of life.”

What does the term “scarcity” or “scarce” mean to you? Can we eliminate scarcity? If we can’t, what must we do?

Scarcity and Tradeoffs Scarcity leads to tradeoffs which result in making choices

The Economic Way of Thinking

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

(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 There is no such thing as a free lunch!

(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

Steven Levitt & Stephen Dubner Super 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.

(3) Incentives matter As 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

Steven Levitt & Stephen Dubner Super Freakonomics If John List’s research proves anything, it’s that a question like “Are people innately altruistic?” is the wrong kind of question to ask. People aren’t “good” or “bad.” People are people, and they respond to incentives. They can nearly always be manipulated-for good or ill- if only you find the right levers. So are human beings capable of generous, selfless, even heroic behavior? Absolutely. Are they also capable of heartless acts of apathy? Absolutely.

(4) Think on the margin, not in total or on average Marginal means additional or incremental Marginal _______ is additional _______.

(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 marginal benefit is greater than the marginal cost.

(5) More information leads to better decision-making, but more information is costly to get Refer back to (1) through (4) There are always tradeoffs Individuals choose purposefully Incentives matter 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

(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

Steven Levitt & Stephen Dubner Super 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.

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.

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: (3) Association is NOT causation

Errors: (4) Fallacy of Composition Assumption: what’s good for the individual is good for the group. Making this assumption is the fallacy.