Thinking Economically Ch. 1, pg 5-20

An Economic Conundrum…  There are 100 hungry people  There are 100 hamburgers  What do we do with the 100 hamburgers?

 1 person takes 40 hamburgers  2 people take 25 hamburgers  4 people take 12 hamburgers  43 people take 22 hamburgers  50 people get 1 hamburger

Economic Reality  Humans act on their own self-interest  We spend money on what we want.  We don’t spend money on what we don’t want.  The world is exactly the way it is because that is exactly how we want it to be. Because we spend money on what we want And we don’t spend money on what we don’t want 

“For where your treasure is, there your heart will be also” [Matthew 6:21]

What is Economics?  The study of how individuals, families, businesses, and societies attempt to satisfy insatiable wants with limited resources.

Scarcity & Choice  Scarcity and choice are the two essential ingredients of an economic topic.  Goods are scarce because desire for them far exceeds their availability from nature.  Scarcity forces us to choose among available alternatives.  Economics is the study of those choices.

Economics is…  Watching people  attempt  To fill a bucket  With a hole in it  With water  And there isn’t enough water  To fill the bucket  Even if  There wasn’t a hole  Dear Liza, dear Liza  Well fix it, dear Henry, dear Henry

Scarcity Necessitates Rationing  Every society must have a means to ration scarce resources among competing uses.  Resources and goods can be rationed in various ways (e.g. first-come, first served). In a market setting, price is used to ration goods and resources. When price is used, the good or resource is allocated to those willing to give up “other things” in order to obtain ownership rights. When price is used to ration goods, people have a strong incentive to earn income so they will be able to pay the required price.

Competition  Competition is a natural outgrowth of the need to ration scarce goods.  Changing the rationing method used will change the form of competition, but it will not eliminate competitive tactics.

The Foundations of Economic Thinking

FOUNDATION #1  The use of scarce resources to produce a good is always costly. Someone must give up something if we are to have more of a scarce good. The highest valued alternative that must be sacrificed is the opportunity cost of the choice.  “TINSTAAFL”  “There Is No Such Thing As A Free Lunch”

FOUNDATION #2  Individuals always choose purposefully & rationally.  Rational Choice: one in which the benefits outweigh the costs  Irrational Choice: one in which the costs outweigh the benefits

FOUNDATION #3  Incentives matter.  As benefits/costs from choosing an option increase, a person will be more/less likely to choose that option.

FOUNDATION #4  Individuals make decisions at the margin. describes the effects of a change in the current situation  Decisions are based on marginal benefits and marginal costs.

FOUNDATION #5 Although information can help us make better choices, its acquisition is costly. Time needed to gather information is scarce.

JUMP START Suppose you were spending your own money to buy a new entertainment center (TV, DVD player, etc) for your apartment. Would you have an incentive to economize? Suppose your parents had given you permission to buy which ever entertainment center you wanted with their money. Would that influence what you would buy? Why or why not?

FOUNDATION #6  In addition to their initial impact, economic events often generate secondary effects that may be felt only with the passage of time.

FOUNDATION #7  The value of a good is subjective and varies with individual preferences.  Value is different than cost.

FOUNDATION #8  The test of an economic theory is its ability to predict.  Economic conditions do change from time to time.

Pitfalls to Avoid

PITFALL #1  Violating Ceteris Paribus Latin phrase meaning “other things constant”  Economic situations are influenced my many factors; economists often describe the effects of just one change.

PITFALL #2  Good Intentions Do Not Guarantee Desirable Outcomes  An unsound proposal will lead to undesirable outcomes even if it is supported by proponents with good intentions.

PITFALL #3  Association is not Causation  Skirt lengths tend to rise during prosperous times (1920s and 1960s, for example) and fall during bad times (1930s). Therefore, prosperity is caused by short skirts, whereas hard times result from low hemlines.

PITFALL #4  Fallacy of Composition: what is true for one may not be true for all.  “Jack, a Kansas wheat farmer, doubled his income this year when he doubled his production of wheat. If all wheat farmers doubled their production of wheat, they could double their annual income.”

TWO DISCIPLINES  Microeconomics: focuses on how human behavior affects the conduct of affairs within narrowly defined units, such as individuals or households or business firms  Macroeconomics: focuses on how human behavior affects outcomes in highly aggregated markets, such as the markets for labor or consumer products

End Chapter 1