Macro Chapter 1 The Economic Approach

4 Learning Goals 1)Identify and list the critical components of economics. 2)List and provide examples of the eight guideposts of economic thinking. 3) 3)Distinguish between two types of economic statements (on your own) 4) 4)Avoid making four common mistakes

A Deal for You:

Options: 1)Get in the DeLorean with $1 million and go back to 1914, OR 2)Stay right here with your current income, possessions, and lifestyle

Transmitter Question Next

Which option would you take? 1. 1.Get in the DeLorean with $1 million and go back to Stay right here with your current income, possessions, and lifestyle

Do you think Americans are better off today than they were 100 years ago? How would you determine or measure this? What’s the criteria? Video:

Some criteria to consider: Life expectancy (years) 47 Infant mortality (deaths per 1,000 live births) Real Per capita GDP High school completion (percent of adults) Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP High school completion (percent of adults) Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) 100 Real Per capita GDP High school completion (percent of adults) Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP High school completion (percent of adults) Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP $4,800 High school completion (percent of adults) Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP $4,800$46,350 High school completion (percent of adults) Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP $4,800$46,350 High school completion (percent of adults) 22 Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP $4,800$46,350 High school completion (percent of adults) 2290 Electrification (percent of US households)

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP $4,800$46,350 High school completion (percent of adults) 2290 Electrification (percent of US households) 8

Some criteria to consider: Life expectancy (years) 4778 Infant mortality (deaths per 1,000 live births) Real Per capita GDP $4,800$46,350 High school completion (percent of adults) 2290 Electrification (percent of US households) 899

Why did that happen?

Here’s someone who thinks we’re much better off today Video:

Would you trade your car for this? Would you trade your car for this?

Would you give up your DVD player for this? Would you give up your DVD player for this?

Would you give up your cell phone for this? Would you give up your cell phone for this?

Transmitter Question Next

Would you trade any of your current possessions for those items? 1.Yes, gladly. Those other things are cooler and better. 2.No way! Those other items are terrible.

What Is Economics About?

Economics doesn’t have to be like this:

Economics tries to explain and predict the behavior of consumers, firms, and government.

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.

Supplemental video: RSAnimate- Freakonomics (on Blackboard)

Alfred Marshall: Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing.

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

Scarcity and Tradeoffs Thomas Sowell: “We cannot opt out of economic issues and decisions. Our only options are to be informed, uninformed, or misinformed, when making our choices.”

Historically, mechanisms that have been used to deal with the problem of scarcity: 1.Force 2.Tradition (emphasized past ways, relied on families) 3.Authority (government and church) 4.Market 5.Combinations of 1-4

Scarcity and Tradeoffs Scarcity requires that some wants remain unfulfilled Issues of equity, justice, and fairness are embedded with scarcity

Class Perspective We will focus on the market process of dealing with scarcity. At times we will compare and contrast with the government or collectivist process. Do not confuse the market process as being the same as politically conservative.

The Economic Way of Thinking

Things are not always as they appear to be

Sometimes you need to step back and think a little more about the situation

Always have these guidelines in your economic thought process: 1)There are always tradeoffs 2)Individuals choose purposefully 3)Incentives matter 4)Think on the margin, not in total or on average 5)More information leads to better decision- making, but more information is costly to get 6)Many choices create a secondary effect 7)Value is subjective 8)Economic thinking is scientific thinking

(1) There are always tradeoffs. Demonstration: 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 Reading:

(1) There are always tradeoffs. Supplemental video: Paul Solman- Opportunity Cost (on Blackboard) For optional credit- find the statement of error in the video and tell me what the error is Please see me during office hours before (specify date) to earn $25

(1) There are always tradeoffs. There is no such thing as a free lunch! Example: free T shirts Supplemental video: Milton Friedman- free lunch myth (on Blackboard)

(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

Alfred Marshall: “It is deliberateness, and not selfishness, that is the characteristic of the modern age.

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 Class Activity: What are some of your incentives?

(3) Incentives Matter Video:

Demonstration: Dancing 1:2:3:

Thank You!

(4) Think on the margin, not in total or on average Marginal means additional or incremental Marginal _______ is additional _______. Example: Why men cheat on their wives

(4) Think on the margin, not in total or on average Class Activity: Why are newspapers, but not soft drinks, sold in vending machines that allow customers to take more units than they pay for?

(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 expected marginal benefit is greater than the expected marginal cost. How long should you study for a midterm?

(5) More information leads to better decision-making, but more information is costly to get Refer back to (1) through (4) 1)There are always tradeoffs 2)Individuals choose purposefully 3)Incentives matter 4)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 Example: fatal car crashes and fuel efficiency fatal car crashesfuel efficiencyfatal car crashesfuel efficiency

(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.

(8) Economic thinking is scientific thinking Economists “do it with models” MC_CampusMap.pdf

(8) Economic thinking is scientific thinking Do you believe that students who regularly attend class earn higher grades? How could you prove (or disprove) that? See David Romer’s article “Do students go to class? Should they?” on Blackboard

Positive and Normative Economics

4 Learning Goals 3) 3)Distinguish between two types of economic statements (on your own)

Please read “Essays in Positive Economics” by Milton Friedman on Blackboard The introduction and Section 1 (pages 1 through 3) are relevant; you may skip the rest.

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. –Example: race to campus

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: (2) Good intentions do not necessarily result in good outcomes Example: using someone else’s clicker

Errors: (3) Association is NOT causation Video:

Errors:

Errors: Video:

Errors: (4) Fallacy of Composition Assumption: what’s good for the individual is good for the group. Making this assumption when it’s false is the fallacy. Why do women endure the discomfort of high heels? Video:

Class Activity Provide at least one example of the fallacy of composition.

Transmitter question next

Which guidepost of economic thinking do you consider to be most important? 1.There are always tradeoffs 2.Individuals choose purposefully 3.Incentives matter 4.Think on the margin 5.Information is costly to acquire 6.Secondary effects 7.Value is subjective 8.Scientific method 60

4 Learning Goals 1)Identify and list the critical components of economics. 2)List and provide examples of the eight guideposts of economic thinking. 3) 3)Distinguish between two types of economic statements (on your own) 4) 4)Avoid making four common mistakes