Chapter 1 An Introduction to the Economic Way of Thinking Introduction to Economics: Social Issues and Economic Thinking Wendy A. Stock PowerPoint Prepared by Z. Pan Chapter 1 An Introduction to the Economic Way of Thinking Copyright © 2013 John Wiley & Sons, Inc. / Photo Credit: © Shuan Lowe/iStockphoto

After studying this chapter, you should be able to: Define economics Explain how scarce resources influence choices Describe the influence of benefits and costs on deciding among alternatives Identify the decision rules individuals and firms use to make choices Explain why decisions are made “at the margin” Assess the general conditions that generate maximum utility or profits Copyright © 2013 John Wiley & Sons, Inc.

Definition of economics Economics is the study of choices. Economics is a tool or way of looking at the world Economics help us to understand all kinds of choices Copyright © 2013 John Wiley & Sons, Inc.

Microeconomics and Macroeconomics Macroeconomics deals with choices that societies make. Microeconomics deals with the choices individuals, households, and businesses make. Copyright © 2013 John Wiley & Sons, Inc.

Copyright © 2013 John Wiley & Sons, Inc. Why Study Economics? Improve decision-making skills Improve critical thinking skills Develop analytical and quantitative skills Understand many current issues Approach controversial issues with objectivity and clarity Prepare for graduate school in many fields Better job opportunities Copyright © 2013 John Wiley & Sons, Inc.

Copyright © 2013 John Wiley & Sons, Inc. Scarcity Scarcity occurs when we have fewer resources than we have uses for those resources. Scarcity implies choices Copyright © 2013 John Wiley & Sons, Inc.

Three basic economic resources Labor – laborers combine time and energy to produce goods or services Land – including natural resources, water, and clean air Capital - long-lasting tools or skills used in producing goods and services Copyright © 2013 John Wiley & Sons, Inc.

Copyright © 2013 John Wiley & Sons, Inc. How choices are made? Decision makers make choices by comparing benefits and costs. Benefit of a choice is what you gain when you make the choice. Cost of a choice is what you give up to make the choice. Utility - the satisfaction or happiness individuals get from their choices. Profit - the difference between the earnings and the costs of production. Copyright © 2013 John Wiley & Sons, Inc.

Copyright © 2013 John Wiley & Sons, Inc. Opportunity cost The opportunity cost of a choice is the value of the next-best alternative foregone. Opportunity cost is a valuation of the next-best alternative opportunity not chosen. What’s the opportunity cost of going to college? Copyright © 2013 John Wiley & Sons, Inc.

Opportunity cost of college Private Public Tuition & fees $27,000 $7,600 Books and Supplies $1,000 Estimated wages with HS Diploma $28,000 Annual Total $56,000 $36,600 Four Years Total $224,000 $146,400 Class days: 32 weeks x 5 = 160 days/yr. x 4 = 640 days Cost of Missing One Day Class: $350.00 $228.75 Copyright © 2013 John Wiley & Sons, Inc.

economic way of thinking “Incentives Matter” When people respond to incentives and consider costs and benefits of their possible choices in order to maximize their utility or profit, they engage in the economic way of thinking. As the benefits of making a particular choice increase, you are more likely to make the choice. As the costs of making the choice increase, you are less likely to make the choice. Copyright © 2013 John Wiley & Sons, Inc.

Ceteris paribus assumption Ceteris paribus means “all other things remaining constant or all else equal.” e.g. If the correct amount of fertilizer is added to a crop and at the same time there is a heat wave and drought, the crop yield may actually fall. Thinking the fertilizer is not effective is a violation of ceteris paribus assumption. Copyright © 2013 John Wiley & Sons, Inc.

Decisions Are Made “At the Margin” The marginal cost of a choice is the additional or incremental cost associated with the choice. The marginal benefit of a choice is the additional or incremental benefit associated with the choice. ? Marginal Benefits ≷ Marginal Costs Copyright © 2013 John Wiley & Sons, Inc.

Law of Diminishing Marginal Benefits The Law of Diminishing Marginal Benefits: Ceteris paribus, as more and more of an activity is done, the marginal benefits derived from the activity tend to diminish. Copyright © 2013 John Wiley & Sons, Inc.

Law of Diminishing Marginal Benefits Copyright © 2013 John Wiley & Sons, Inc.

Law of increasing Marginal costs The Law of Increasing Marginal Costs: Ceteris paribus, as more and more of an activity is done, the marginal costs of the activity tend to increase. Copyright © 2013 John Wiley & Sons, Inc.

Law of increasing Marginal costs Copyright © 2013 John Wiley & Sons, Inc.

Marginal decision rule The Marginal Decision Rule states that you can maximize the net benefit you receive from an activity when you engage in that activity until the marginal benefits are equal to the marginal costs. MB = MC The Net benefit of an activity is equal to its total benefit minus its total cost. Copyright © 2013 John Wiley & Sons, Inc.

Marginal decision rule The Marginal Decision Rule: MB = MC Copyright © 2013 John Wiley & Sons, Inc.

Copyright © 2013 John Wiley & Sons, Inc. Sunk cost A Sunk Cost is a cost that, once incurred, cannot be recovered. Sunk costs are irrelevant when making decisions at the margin. Copyright © 2013 John Wiley & Sons, Inc.

Questions/Discussions Discuss the costs and benefits of each of the following activities; include at least one nonmonetary cost and benefit in your discussion of each: a. Studying for an exam b. Going skiing on a class day c. Taking a job d. Watching television Copyright © 2013 John Wiley & Sons, Inc.

Copyright © 2013 John Wiley & Sons, Inc. Key Concepts Economics Opportunity cost Macroeconomics Ceteris paribus Microeconomics Marginal cost Basic economic resources Marginal benefit Law of diminishing marginal benefits Scarcity Cost Law of increasing marginal cost Benefit Net benefit Utility Marginal decision rule Profit Sunk cost Copyright © 2013 John Wiley & Sons, Inc.