An Economic Way of Thinking Chapter 1 An Economic Way of Thinking

Introduction Economics – how people use limited resources to satisfy their unlimited wants Adam Smith – The Wealth of Nations Consumer driven Self interest – invisible hand Father of modern economics Economy – the system to manage production, distribution & consumption of goods & services

What Is Economic All About? Economic enigmas – riddles or puzzles answered through analysis Find the hidden side of economics Resource – anything used to produce a good or a service Microeconomics – individual to businesses Macroeconomics – whole economy

An economic enigma is a sometimes comical question asked about an odd occurrence in economy. Why pay $10 for 4 liters of bottled water when you can get around 1000 gallons of tap water for the same price? Why put a store a mile or so away from the exact same store? Why use braille on drive up ATM machines?

Why do people use a tanning bed when you can tan for free? Why do people spend more money on name brand products when they can spend less for similar generic products? Why do people buy fast food even though they know it is bad for their health? Why do brides spend so much money on a wedding dress that they will wear once, when a groom could wear his tux that he rents over and over again?

Why do economy seats on an airplane cost different amounts? Why do police officers get paid so much less than professional baseball players?

What Is Economic All About? Economics – science of how people choose to use their resources Science of decision making Positive economics – use of objective analysis to see how the world works (how things work) Normative economics – analyzes data, investigate actions and recommend policies (advise a course of action)

Seven Principles Scarcity forces Tradeoffs principle – limited resources forces people to make choices Scarcity – limited resources matched with unlimited human wants Tradeoff – exchange of one benefit for a better benefit No free lunch principle – someone had to pay Time is scarce

Seven Principles Cost benefit analysis – people chose something when the benefits are greater than the costs Costs – what you spend – time, money, effort, & other sacrifices Benefits – what you gain – money, experience, & other improvements Chose by what side “outweighs” the other

Seven Principles Thinking at the margin principle – most decisions are made about a little more or less, not a whole sale change (operate at the margin) Marginal cost – what is given up for one additional unit Marginal benefit – what is gained by adding one additional unit

Seven Principles

Seven Principles Incentive matter principle – people respond to incentives in predictable ways Incentive – something that motivates a person to choose a particular course of action Positive incentives – such as higher grades or job promotion Negative incentive – jail time and fines

Seven Principles Trade makes people better off principle – focusing on what a person does well then trading with others provides better choices than doing everything by oneself

Seven Principles Market coordinate trade principle – market is better at coordinating exchanges between buyers & sellers Market – arrangement that brings buyers & sellers together to do business Invisible hand – consumer driven economy Markets coordinate trade with remarkable efficiency

Seven Principles Future consequences count principle – decision made today has future consequences People are shortsighted – look at only the immediate costs & benefits Law of unintended consequences – actions of people & governments has an effect that was unexpected and unintended

What Tools Do Economists Use? Scientific method Collect data Factual information

What Tools Do Economists Use? Graph – visual representation of the relationship between two variables (sets of data) Variable – quantity that can change Axis – two perpendicular lines – horizontal = x, and vertical = y Curve – line representing data points plotted on a graph

What Tools Do Economists Use? Economic model – representation of reality that allows economists to focus on the effects of one change at a time Rational behavior model – people behave in a rational manner (based on reason) People make decisions to serve their own interests without taking into account the well-being of others

What Tools Do Economists Use? Models cannot accurately predict all behavior all the time Models make assumptions Ceteris paribus – other things being equal (other relevant factors remain unchanged)