1. Economic Theory 1.2 Objectives: 1.Explain the goal of economic theory 2.Understand the role of marginal analysis 3.Explain how market participants interact (Circular-flow model)

2. Key Terms  Economic theory – economic model  Marginal  Market Economics (micro )  National Economics ( macro )  Market

3. Everybody uses theories

4. Economic Theory  Predict what ppl will do Example: How does the consumption change when the price changes?  Simplify economic reality to make sense of things  Other things constant: assume only 1 thing changes at a time.  Explain how & why the economy works

5. Making economic Choices Do people ever act of complete self less ness?

6. Rational self-interest – (behavioral assumptions) you make choices based on your best self- interest and based on information available

7. How do we make economic decisions? Behavioral Theory: how ppl act – Rational self interest: we want to Max imize benefit & Min imize cost

8. Checkpoint Explain the goal of economic theory

9. What would you do? Clean class after school Reward: – 20 mins- 1 movie ticket – 40 mins- 2 movie tickets – 60 mins - 3 movie tickets – 80 mins - 4 movie tickets

10. Marginal : Change by increment: one more, extra, additional “Marginal benefit: w/each additional unit, what is the EXTRA benefit? Marginal cost: w/each additional unit, what is the EXTRA cost?  Few choices are “all or nothing” Decisions.

11. Marginal cost & benefit Buy 4 tacos, get the 5 th for free! – MC: – MB: Buy one pair of jeans, get the second at 50% off! – MC: – MB: Rational self-interest: Would most ppl buy 5 tacos: Would most ppl buy 2 pairs of jeans?

12. Your Grades – time spent studying 1 hour of studying - Earn a D 2 hours of studying - Earn a C 4 hours of studying - Earn a B 6 hours of studying - Earn an A How much time would your spend studying? Why?

13. Checkpoint Describe the role of marginal analysis in making economic choices.

14. Markets  Market economics (microeconomics)  National economics (macroeconomics)

15. Market Participants 4 types (decision makers). Their interaction determines how an economy’s resources get allocated.  Households  Firms  Governments  The rest of the world.

16. Circular-Flow Model A circular-flow model describes the flow of resources, products, income, and revenue among economic decision makers. Page 16 of text

17. CONTEMPORARY ECONOMICS: LESSON 1.2 17 Circular-Flow Model

18. Checkpoint How do market participant interact?