ECONOMIC WAY OF THINKING

R. David Johnson MBAShawnee State University

ECON2202 51

ECONOMIC WAY OF THINKING“It (economics) is a method rather than a doctrine, apparatus of

the mind, a technique of thinking which helps its possessor to draw correct conclusions.”

 J.m. Keynes, 1923

ECONOMIC WAY OF THINKING

• The study of economics is relevant for many different professions since “the economic way of thinking” is a helpful tool in decision making.

• An understanding of economic events and policy alternatives is an asset to everyone living in this ever changing world of ours.

• Basic economic principles indicate that certain conditions are vitally important for economic progress.

ECONOMIC WAY OF THINKING

• Would you like some:

• New Clothes?• A New Car?• A larger Apartment?• Better Grades?• More Time to Watch

Television?• Travel Abroad?

• All of these wants are considered goods. • A Good can be defined as: anything

that people find desirable and therefore would like to have or consume.

• Human desire for goods is unlimited.

• However, we cannot have more of everything.

• Both individually and collectively, we have a constraint.

• This constraint is called scarcity.

ECONOMIC WAY OF THINKING

• Scarcity is the fundamental concept of economics which indicates that less of a good is freely available than consumers would like. • It is the most basic concept of

economics. • Used by economists to indicate that

people’s desires for things is greater than that would be freely available from nature.

• Since scarcity prevents us from having as much as we would like, we are forced to choose among a restricted set of potential alternatives.

ECONOMIC WAY OF THINKING

• Choice, therefore, is a logical consequence of scarcity. • Choice can be defined as:

the act of selecting among alternatives.

ECONOMIC WAY OF THINKINGRESOURCES

ECONOMIC WAY OF THINKING: RESOURCES

• Resources are inputs that we use to produce goods. • As defined, a Resource is: an

input used to produce economic goods.

• Land, labor, skills, natural resources, and capital are examples. • Additionally, resources are

tools that we can use to battle scarcity.

ECONOMIC WAY OF THINKINGCategories of Resources

ECONOMIC WAY OF THINKING: RESOURCES

• Human Resources: the knowledge, skill, and strength of human beings. • Education, training, and

experience can increase the future ability of human resources.

ECONOMIC WAY OF THINKING: RESOURCES

• Physical Resources: things such as tools, machines, and buildings that enhance our ability to produce goods.• Economists use the term

capital when referring to physical resources.

ECONOMIC WAY OF THINKING: RESOURCES

• Natural Resources: things such as land, mineral deposits, oceans and rivers. • The ingenuity of humans is

often required in order to transform these natural productive inputs.

ECONOMIC WAY OF THINKINGScarcity and Poverty Are Not The Same Thing!

ECONOMIC WAY OF THINKING

• Poverty implies some basic level of a need.

• Absence of poverty implies that the basic level has been attained.

• The absence of scarcity implies that we have as much of all the goods we would like.

• However, even in the wealthiest countries, production capabilities cannot keep up the pace with material desires.

• People always want more goods and services than they already have.

ECONOMIC WAY OF THINKINGEconomic Way of Thinking Explained

ECONOMIC WAY OF THINKING: EXPLAINED• Economics is a method approach, a way of thinking. • Despite the many philosophical differences of economists, there is

a common ground in the approach of economics. • This common ground is known as economic theory.

• Economic Theory: a set of definitions, postulates, and principles assembled in a manner that makes clear the “cause and effect” relationship of economics data.

• Think of it as a roadmap or a guidebook for economists. • Establishes reference points indicating what to look for, and how economic

issues are interrelated.• For the most part, the basic economic principles are merely common sense.

ECONOMIC WAY OF THINKINGEight Guideposts to Economic Thinking

ECONOMIC WAY OF THINKING: GUIDEPOSTS• The economic way of

thinking requires the incorporation of certain guidelines. • These are the basic building

blocks of economic theory.

ECONOMIC WAY OF THINKING: GUIDEPOSTS1. The use of scarce resources to produce a good is always costly. • The use of resources to produce one good diverts the

resources away from the production of other goods that are also desired.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• This is where the concept of opportunity costs comes into

play. • Opportunity Cost can be defined as: the highest valued benefit

that must be sacrificed as the result of choosing an alternative.• For Example: If you use one hour of your scarce time to study

economics, you will have one hour less time to watch television, read magazines, sleep, work at a job, or study other subjects.

• The cost of study time for other subjects may be the highest valued option that you will now have to forego because of the additional time spent studying economics.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• Central Point: Economic thinking recognizes that the use

of a scarce resource always involves a cost. • The use of more resources to do one good will force us to

reduce our production of other goods.

ECONOMIC WAY OF THINKING: GUIDEPOSTS2. Decision-makers choose purposefully; therefore, they will economize. • Individuals make decisions purposefully, always seeking to

choose the option they expect to be most consistent with their personal goals. • Purposeful decision-making leads to economizing behavior.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• Economizing Behavior can be defined as: decisions that

are based on the objective of gaining a specific benefit at the least possible cost. • A corollary of economizing behavior implies that when choosing

among items of equal cost, individuals will choose the option that yields the greatest benefit.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• Correspondingly, when choosing among alternatives of equal cost,

economizing decision-makers will select the option that yields the greatest benefit. Purposeful decision-makers will not deliberately pay more for something than is necessary.

• Purposeful choosing implies that decision makers have some basis for their evaluation of alternatives.

• Economists refer to this evaluation as utility, the benefit or satisfaction that an individual expects from the choice of a specific alternative.

• The utility of an alternative is highly subjective, often differing widely from person to person.

ECONOMIC WAY OF THINKING: GUIDEPOSTS3. Incentives matter-human choice is influenced in a predictable way by changes in economic incentives. • Incentives matter. • People will be more likely to choose an option as the

benefits expected from that option increase. • In contrast, higher costs will make an alternative less

attractive, reducing the likelihood that it will be chosen. • This guidepost to clear economic thinking might be called

the basic postulate of all economics.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• As the personal benefits from choosing an option increase,

other things constant, a person will be more likely to choose that option. • In contrast, as the personal costs associated with the

choice of an item increase, the individual will be less likely to choose that option. • For a group, this basic economic postulate suggests that

making an option more attractive will influence more people to choose it.

ECONOMIC WAY OF THINKING: GUIDEPOSTS4. Economic thinking is marginal thinking• Marginal costs and marginal benefits (utility) are fundamental

to economizing behavior. Economic reasoning focuses on the impact of marginal changes.• Economists define marginal as: a term used to describe the

effects of a change, given the current situation. • Example: The marginal cost is the cost of producing an additional unit

of a product, given the producer’s facility and production rate. • Marginal choices always involve the effects of net additions to

or subtractions from the current situations.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• The word “additional” is often used as a substitute for

marginal. • Example: What is the marginal (or additional) cost of producing one

more automobile? • Marginal decisions may involve large or small changes. • The one more unit could be a new plant or a new stapler. • It is marginal because it involves additional costs and

additional benefits.

ECONOMIC WAY OF THINKING: GUIDEPOSTS

5. While information can help us make better choices, its acquisition is costly. Thus, we will almost always make choices based on limited knowledge.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• Since information is scarce and costly to acquire, the

choices of people will be based on limited knowledge. • Information that will help us make better choices is

valuable. • Like other resources, however, it is also scarce and

therefore costly to acquire.• As a result, individuals will economize on their search for

information just as they economize on the use of other scarce resources.

ECONOMIC WAY OF THINKING: GUIDEPOSTS6. Economic actions often generate secondary effects in addition to their immediate effects. Failure to consider these secondary effects is the most common source of economic error.

In addition to their initial impact, economic events often alter personal incentives in a manner that leads to important secondary effects that may be felt only with the passage of time.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• Economists refer to the term secondary effects.

• Economic consequences of an initial economic change, even though they are not immediately identifiable.

• Secondary effects will be felt only with the passage of time. • In economics, the immediate, short term effects that are highly

visible are often quite different from the long term effects. • Changes in economic policy often alter the structure of

incentives, which indirectly affect things like how much people work, earn and invest, and care for things in the future.

ECONOMIC WAY OF THINKING: GUIDEPOSTS7. The value of a good or service is subjective. • The value of a good or service is subjective and will differ

according to the individual. • Preferences differ, sometimes dramatically, between

individuals. • Even for a given individual, circumstances can change from

day to day.

Economic Way of Thinking: Guideposts

8. The test of a theory is its ability to predict. Economic thinking is scientific thinking.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• The test of an economic theory is its ability to predict and

explain events in the real world. • The usefulness of an economic theory is proved by its

ability to predict the future consequences of economic action.

ECONOMIC WAY OF THINKING: GUIDEPOSTS• Economic theory is derived from scientific thinking.

• Development of theory from basic postulates and the testing of the implications of that theory as to their consistency with events in the real world.

• Good theories are consistent with and help explain real-world events.

• Theories that are inconsistent with the real-world are invalid and must be rejected.

ECONOMIC WAY OF THINKING: CLASS PARTICIPATION• The government should provide goods such as health care,

education, and highways because it can provide them for free. True or False? Explain.