Thinking Like an Economist

Thinking Like an Economist Every field of study has its own terminology Mathematics integrals  axioms  vector spaces Psychology ego  id  cognitive dissonance History Bias  point of view  cause and effect Law Precedent  torts  codification Economics supply  opportunity cost  elasticity  consumer surplus  demand  comparative advantage  deadweight loss

Thinking Like an Economist Economics trains you to. . . . Think in terms of alternatives. Evaluate the cost of individual and social choices. Examine and understand how certain events and issues are related. 2

The economist as a scientist The economic way of thinking . . . Involves thinking analytically and objectively. Makes use of the scientific method. 3

The Role of Assumptions Economists make assumptions in order to make the world easier to understand. The art in scientific thinking is deciding which assumptions to make. Economists use different assumptions to answer different questions.

The Basic Economic Problem: Scarcity Scarcity occurs when people’s wants and needs are unlimited while the resources needed to produce goods and services are limited Unlimited wants and needs is the human characteristic of never having all wants and needs satisfied Limited resources means that there are never enough resources to fulfill all wants and needs Limited resources available to satisfy unlimited wants and needs creates scarcity

Scarcity  Allocation Allocation is the process of choosing which needs will be satisfied and how much of our resources we will use to satisfy them Making trade-offs (choosing among alternatives) When you allocate, you make trade-offs in deciding how to use your resources Economics: the science that deals with how society allocates its scarce resources among its unlimited wants and needs

Costs & Benefits Teresa and Maria work at The Sports Machine, a sporting goods store near their school. Teresa spends most of what she earns on clothes and jewelry. The rest she uses for going out on the weekends. When she asks Maria why she never goes out on the weekends, Maria tells her that she’s saving for a used car so she can drive to school and work. Teresa says she’ll just keep riding the bus.

Costs & Benefits Economics consider the opportunity costs and opportunity benefits of each choice Opportunity cost: the value of the opportunity lost by making a decision Example:

Opportunity Cost: Case Study Assume you have a weekly income of $30 and that you spend that income on only 2 different goods: movies and paperback books. Assume you have only 2 choices: Alternative A or Alternative B Alternative A: 4 books @ $5 = $20 1 movie @ $10 = $10 Total = $30 Alternative B: 2 books @ $5 = $10 2 movies @ $10 = $20

Best way to make a choice between choosing Alternative A or B is to look at the opportunity cost With A, what do you have to give up to move to option B? The opportunity cost of one movie is two books. Make your decision based on how much you like movies compared with how much you like books Do you like one movie enough to give up two books? Or do you like two books enough to give up one movie?

Opportunity Benefit Opportunity benefit is what is gained by making a particular choice If, in the previous case, the opportunity cost of moving from Combo A to Combo B is 2 books, then the opportunity benefit is one movie. In the case of choosing to study rather than to ski, the opportunity benefit is receiving a better grade on your test Every economic choice has an opportunity benefit and an opportunity cost

What do you think? Do you think Maria and Teresa considered the opportunity costs of their choices before they reached their decisions? Why do you think Teresa and Maria made different decisions? What would you have decided? Why?

Economic branches and choices Microeconomics: the branch of economics that examines the choices of individuals concerning one product, one firm, or one industry Concerned with the individual The unit of analysis is one person, one product, one industry, etc. Individual consumers must decide whether they wish to buy more, less, or the same amount of a product

Economic branches and choices Macroeconomics: the branch of economics that examines the behavior of the whole economy at once (government) Macroeconomic choice: how the government of a country deals with inflation Could cut back its spending Make credit more difficult for consumers to get Raise taxes to encourage consumers to cut spending