1. Thinking Like an Economist
CHAPTER 1
Thinking Like an Economist
OUTLINE
1.Scarcity and Choice
2.The Cost Benefit Approach to Decisions
3.The Role of Economic Theory
4.Positive Questions and Normative Questions
5.Microeconomics and Macroeconomics
1-1

2. THE FLOW-CHART OFMICROECONOMICS
A view of the "forest"_ the course seen as a whole but beware of getting lost is in the "trees" of individual topics
¾ of the course
¼ of the course

3. The Rational Choice Model
It is important to stress at least three very important assumptions of the rational choice model.
a. Behavior is not random.
b. People have reasonably simple objectives common to most.
c. People behave rationally without regard to emotions that detract from rationality.
Where these givens are not present, the rational choice models will fail. For example, the risk aversion assumption underlying rational choice theory, uncommon objectives , irrationality are not as rare as we may sometimes think.

4. Economics Is Choosing
Focus in this course is on a short list of powerful ideas
Explain many economic issues
Predict decisions made in a variety of circumstances
Core Principles are the foundation for solving economic problems

5. The Cost-Benefit Principle
Take an action if and only if the extra benefits are at least as great as the extra costs
Costs and benefits are not just money
Marginal Benefits
Marginal Costs

6. Applying the Cost – Benefit Principle
Assume people are rational
A rational person has well defined goals and tries to fulfill those goals as best they can
Would you walk to town to save $10 on an item?
Benefits are clear
Costs are harder to define

7. Cost – Benefit Principle Examples
You clip grocery coupons but Bill and Melinda Gates do not
You speed on the way to work but not on the way to school
At the ball park, you pay extra to buy a soda from the hawkers in the stands
You skip your regular dental check-up

8. Should there be 32 separate sections of Econ 100B, with 25 students each?--- Trinity University, San Antonio, Texas
**Students learn more effectively in smaller classes.
**But smaller classes are also more expensive.

9. Or should there be only one section, with 800 students
Or should there be only one section, with 800 students?- University of Note 32x25 = 800

10. Cost-Benefit Analysis (CBA)
Should I do activity x?
C(x) = the costs of doing x or value of resources one needs to give up to do x.
B(x) = the benefits of doing x
If B(x) > C(x), do x; otherwise don't.
Should we make the econ class larger?
Benefit of making the class size larger = the reduction in cost per student = B(x)
Cost of making the class size bigger = The amount people would be willing to pay to avoid the reduced quality of instruction = C(x)

11. Some relevant costs Let the Faculty salary: $60,000 per course
Per student faculty salary cost:
1 section: $60,000/800 = $75—large class
32 sections: $60,000/25 = $2400-small class
Benefit (to the university) of increasing class size from 25 students to 800 students
= ($ $75) = $2,325 = B(x)
If you were currently in a class with 25 students, how much would you be willing to pay to avoid switching to one with 800 students? = C(x)
If C(x) < B(x)=$2,325, then it makes sense to offer the larger class.

12. The Cost-Benefit Principle
1. An individual (or a firm, or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.
2. Critics of the cost-benefit approach often object that people don’t really calculate costs and benefits when deciding what to do
3. People often behave as if they were comparing the relevant costs and benefits

13. People often make bad decisions because they fail to compare the relevant costs and benefits
“The Budweiser “or “Corona “Walk

14. Example 1.8. How much memory should your computer have?
Suppose that random access memory (RAM)can be added to your computer at a cost of $0.50 per megabyte.
How many megabytes of memory should you purchase?
"Should I do X?"
"How much X should I buy?"
"Should I buy an additional unit of X?"

15. Cost-Benefit principle
Rule:
a. Buy an additional megabyte if the marginal benefit of RAM is at least as great as its marginal cost, i.e. MB ≥MC
b. Do not buy an additional megabyte if the marginal benefit of RAM is less than its marginal cost, i.e. MB < MC
c. You are indifferent if the marginal benefit of RAM equivalent to its marginal cost, i.e. MB ≈ MC
where
Marginal benefit (MB)= added benefit from having 1 more unit
Marginal cost (MC)= added cost of having 1 more unit

16. Optimal amount of memory

17. Power Point Slides: Chapters 1-4 for now

18. Marginal Analysis Ideas
Marginal cost is the increase in total cost from one additional unit of an activity (q)
MC =∆TC/∆q
Average cost is total cost divided by the number of units, AC= TC/q
Marginal benefit is the increase in total benefit from one additional unit of an activity
MB =∆TB/∆q
Average benefit is total benefit divided by the number of units, AB = TB/q

19. Normative and Positive Economics
Positive economic principle predicts how people will behave
The average price of gasoline in May 2008 was higher than in May 2007
Building a space base on the moon will cost more than the shuttle program
Normative economic principle says how people should behave
Gas prices are too high
Building a space base on the moon will cost too much

20. Working with Equations, Graphs, and Tables
Definitions
Equation
Variable
Dependent variable
Independent variable
Parameter (constant)
Slope
Intercept

21. From Words to an Equation
Identify the variables
Calculate the parameters
Slope
Intercept
Write the equation (B)
Example: Phone bill is $5 per month plus 10 cents per minute (T =time)
B = $5 +$0.10 T

22. From Equation to Graph B = 5 + 0.10 T Draw and label axes To graph,
Horizontal is independent variable =T
Vertical is dependent variable =B
To graph,
Plot the intercept (T=0; B=5)
Plot one other point(T=30;
B=8)
Connect the points (0,5) and
(30,8) T B 5 6 A C D 12 8 10 30 70

23. From Graph to Equation Identify variables Independent (T)
Dependent (B)
Identify parameters
Intercept (=4 if T=0)
Slope (4/20=0.2)
Thus, we can write the
equation as:
B = T

24. Changes in the Intercept (from 4 to 8)
An increase in the intercept shifts the curve up
Slope is unchanged
Caused by an increase in the monthly fee
A decrease in the intercept shifts the curve down
Slope is unchanged

25. Changes in the Slope (from 4/20=0.2 to 8/20=0.4)
An increase in the slope makes the curve steeper
Intercept is unchanged
Caused by an increase in the per minute fee
A decrease in the slope makes the curve flatter
Intercept is unchanged

26. Time =T (minutes/month)
From Table to Graph
Time =T (minutes/month) 10 20 30 40
Bill ($/month) =B
$10.50
$11.00
$11.50
$12.00
Identify variables
Independent
Dependent
Label axes
Plot points
Connect points
From Graph to Equation: is B= T

27. From Table to Equation Time (minutes/month) 10 20 30 40 Bill ($/month)
B= f + bT
Time (minutes/month) 10 20 30 40
Bill ($/month)
$10.50
$11.00
$11.50
$12.00
Identify independent and dependent variables
Calculate slope
Slope = (11.5 – 10.5) / (30 – 10) = 1/20 = 0.05
Solve for intercept, f, using any point
B = f T; At B =12 and T=40
12 = f (40) = f + 2
f = 12 – 2 = 10
B = T

28. Simultaneous Equations
Two equations, two unknowns
Solving the equations gives the values of the variables where the two equations intersect
Value of the independent and dependent variables are the same in each equation
Example
Two billing plans for phone service
How many minutes make the two plans cost the same?

29. Simultaneous Equations
Plan 1 B = T
Plan 2 B = T
Plan 1 has higher per minute price ($0.04) while Plan 2 has a higher monthly fee ($20)
Find B and T for point A

30. Simultaneous Equations
Plan 1 B = T
Plan 2 B = T
Subtract Plan 2 equation from Plan 1 and solve for T
B = T
– B = – 20 – 0.02 T
0 = – T
T = 500
Find B when T = 500
B = T
B = (500)
B = $30 OR
B = T
B = (500)