E244 Fall 2012 Introduction to Economic Analysis Dr. Steven Myers

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You are studying economics at a time of enormous change This is a meaningless statement – always true, but economic principles do not change (only our understanding)

You are studying economics at a time of enormous change The next few slides are to illustrate some of that change. What policies can and will lead to better times ahead?

See graph galleries at These lines represent all of the recessions in the post WWII era. They start at zero job losses and end when that point is again attained. Each are centered on the trough or low point of the recession. The horizontal axis depicts the number of months it took to get to the deepest part of that recession and the number of months after to recover. A steep increase from the dotted line (trough) means the recession ended quickly and typically with much growth. Click once to see the graph Then click again to see the last or Great Recession included.

We typically fully recover within 1 year or less. Most estimates show this not recovering until 2016 or later. See graph galleries at

9/11 Attack 11/2007 Financial Crisis

All economic questions arise because we want more than we can get (wants always are greater then needs) scarcity Make tradeoffs Make choices Everything is scarce and that is why we economize Things that are scarce end to be more valuable.

All economic questions arise because we want more than we can get. Incentives matter! a reward that encourages an action or a penalty that discourages an action. Your first question in all economic analyses must be what are the incentives for the various parties involved?

Develop an Economic Way of Thinking To paraphrase a former President of the US – “It is not that people do not know economics, it is that they know so much of economics that isn’t so”

Can destruction be good? Can it lead to jobs and capital investment? If you think so, you have made A broken window fallacy of economic reasoning. Don’t feel bad… you are sadly in good company. watch The Broken Window Fallacy

The broken window fallacy is described in Chapter 2 of “Economics in One Lesson.” That’s right, one easy lesson, which is Chapter 1. In fact, Hazlett purports to only need one sentence…

“the whole of economics can be reduced to a single lesson… a single sentence.” “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups. (p.2)” (1946!) Free: get the book -

Economics is haunted by more fallacies than any other study known to man. …While every group has certain economic interests identical with those of all groups, every group has also, as we shall see, interests antagonistic to those of all other groups. Free: get the book -

The BAD economist sees only what is seen The GOOD economist sees both what is seen and what is unseen This principle is from It is still relevant. But Hazlett got it from Frederic Bastiat in 1850 Free: get the book -

That Which is Seen, and That Which is Not Seen by Frederic Bastiat, 1850 In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil.

That Which is Seen, and That Which is Not Seen by Frederic Bastiat, 1850 In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil.

So Hazlett wrote in 1946, and Bastiat in 1850, but both got it earlier from Adam Smith in 1776.

© 1776

You are studying economics at a time of enormous change economic principles do not change (only our understanding may change) A reminder from the beginning of this presentation: Which is also why we will get along fine with an older book (and you will save money):

When you think of the broken window we are actually considering the opportunity cost of an action taken. Thinking about a choice as a tradeoff emphasizes cost as an opportunity forgone. The highest-valued alternative that we give up to get something is the opportunity cost of the action chosen.

When you (and everyone else) make choices they evaluate or analyze the consequences of making incremental changes in the use of their resources. These incremental changes are: marginal benefits - The value or benefit from pursuing an incremental increase in an activity marginal costs - The opportunity cost of pursuing an incremental increase in an activity

Lets let MB stand for marginal benefits and MC represent marginal costs Then here is how you succeed in economic analysis…

The answer to all questions has at their core: If MB > MC then do it If MB < MC then don’t do it If MB=MC that is just right!

We act voluntarily and not coerced in our self-interest Self-interested actions are not necessarily selfish actions. But if people pursue self-interest, how can the social interest be served? Society creates institutions that create incentives to behave in the social interest.

And the number one Institution? the rule of law that protects private property and facilitates voluntary exchange in markets.

Thanks for sticking with this introduction. Dr. Myers