Econ 201 Lecture 1.3 Economic Way of Thinking 1-7-2009.
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Transcript of Econ 201 Lecture 1.3 Economic Way of Thinking 1-7-2009.
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Econ 201Lecture 1.3
Economic Way of Thinking
1-7-2009
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Overview
• What is Economics– Trying to define it
• The scientific method
• The economic way of thinking– “organizing your facts”– Applying the scientific method to a problem– Narrow versus broad economics– Fundamental basis for economic theory
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What is Economics?
• “Theory of Economics does not furnish a body of settled conclusions inevitably applicable to policy. It is a method … a way of thinking ..to draw correct conclusions.” – John Maynard Keynes
• It is both descriptive of what has happened as well as predictive
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What is Economics?
• A Science?– Consists of theories that help us understand
and make valid predictions about the real world (J. Hirschliefer, UCLA)
• Test, validate and accept/reject theories – subjecting theories to empirical analysis
• What does it seek to explain?– How a market societies organizes and
coordinates itself to:• Produce and allocate goods and services
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What is Economics?
• Social/Market Coordination– For individuals:
• How individuals make choices among various goods, how to allocate time, with a scarcity constraint (e.g., income, time)
– For firms:• How firms decide to enter which markets• How firms decide how much and what to produce in
response to the market’s price signal
– For the market• How does the market’s price get determined?
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Who are the Principal Actors?
• Consumers– Supply labor to the market to earn income– Purchase goods from firms
• Firms– Which goods are produced in response to consumer
demand– What technology and which inputs are used
• Government– Establishes the “rules” of the game, e.g. property
rights and illegal behavior– Provide incentives (taxes, subsidies), guarantees
property and legal rights
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Scientific Method
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What is the Study of Economics?
• The study of economics involves learning how to organize facts the way economists do. – Or what Paul calls – learning the economic way of
thinking
• An alternative way of thinking– good-versus-bad" model (conspiracy theories)
• two conflicting groups: good people and bad people. • zero-sum game: one person's gain is another's loss. • evil motives, possessed by the bad people, lead to bad
results unless these people are in some way controlled. Good motives lead to good results.
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An Example
• Looking at the recent history of gas/oil prices
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Testing Economic Hypotheses
• Explaining the past increase to $4/gal (~50%)– A demand-side hypothesis
• Increase in consumption from newly industrialized nations increased (shifted) the demand for gasoline
– A supply-side hypothesis• Reduced refinery capacity reduced the supply of gas (refined oil)
– Good/Bad Guy Model (Mike Mays, 5/08 before Congress)• Increase in demand from speculators who buy and sell promises to
deliver oil at a later date is almost equal to the increase in demand from China
• Empirical evidence– World-wide consumption increased by only 3-4%
• Insufficient to account for most of the increase in price– Increase in demand by speculators even less
• Refinery capacity did diminish by ~30-40%
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Broad versus Narrow Economics
• Narrow economics– Theory of behavior based on “incentives” is restricted
to analysis of human behavior in the marketplace• E.g., impact of the “cow gas” tax
• Broad economics– Incentives are not limited to economic incentives,
such as prices, taxes or income– Behavior based on incentives is not restricted to only
markets• E.g., CIA and Afghan warlords
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Narrow Economics
• ANPR (Notification of Proposed Rule Making),– Give EPA authority to regulate greenhouse gas
• not only greenhouse gas from manmade sources like transportation and industry,
• also “stationary” sources which would include livestock.
• New York Farm Bureau estimates:– Basic facts:
• $175 per cow, and $87.50 per head of beef cattle• $20 per hog,” • Apply to >= 25 dairy cows, 50 beef cattle or 200 hogs
– Impact: add between 7 and 8 cents per gallon of milk costs to farmers
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Broad Economics
• Afghan warlords and Viagra (http://www.telegraph.co.uk/)– Whatever it takes to make friends and influence
people – whether it's building a school or handing out Viagra," one veteran CIA officer told The Washington Post.
– According to the newspaper, pills to boost the libidos of Afghan tribal patriarchs are the latest in a long line of inducements including medicine or operations for family, toys and school equipment, tooth extractions and visas
– The trick was to identify a means of pleasing the CIA source enough to guarantee his loyalty without making it obvious to others that he's being rewarded.
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What is Economic Theory Based On?
• “all social phenomena emerge from the actions and interactions of individuals who are choosing in response to expected benefits and costs” (Heyne)– Focus on choice under constraint
• Constraint scarcity– Scarcity: can’t have all of the things you want
» Even if unlimited income and no natural resource constraints => time
• In reality – all are limited and choices must be made about how to use them – or there would be no economic problem
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So What is Economics?
• Economics is the study of the:– Choices we make– Constraints that we face– Tradeoffs that are made because of scarcity
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Basic Behavioral Postulates1. For each person some goods are scarce
- have to make choices (core of the economic problem)2. Each person desires many goods and services
- tradeoffs3. Each person is willing to forsake some of an economic good to
get more of other economic goods- Opportunity costs
4. More one has of any good, the lower it personal marginal value- Diminishing marginal value
5. Not all people have the same tastes and preferences6. People are innovative and rational
- Does not mean we know everything and don’t make mistakes, but we do learn from them and don’t repeat them
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Scarcity
• Past Examples– Malthus
• Hypothesized that continued high rate of population growth would outstrip world’s ability to produce food
– Mayan and Eastern Island examples
• Current issues– Climate Change
• Affecting human health, ecosystem, moral dimension and requiring international coordination
– Water Accessibility• Increasing water stress from both supply and sanitation
– Meeting the Challenges• Economic activities and environmental problems• International cooperation
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Overview: Welcome to Economics!
• http://ingrimayne.com/econ/Introduction/Overview1.html
• After you finish this unit, you should be able to: – Explain what the term "invisible hand" means and
who first used it. – Give at least one common definition of economics. – State what Malthus thought about population growth. – Explain how Popper defines scientific statements. – Distinguish between positive and normative
statements. – Explain what scarcity, choice, and self-interest have
to do with economics.