Economics and Economic Reasoning
In my vacations, I visited the poorest quarters of several cities and walked through one street after another, looking at the faces of the poorest people. Next
I resolved to make as thorough a study as I could of
Political Economy .
— Alfred Marshall
Chapter Goals
Define economics
Discuss ways in which economists use economic reasoning
Explain real-world events in terms of:
•
Economic forces
•
Social forces
•
Political forces
Explain how economic insights are developed and used
Distinguish among:
•
Positive economics
•
Normative economics
•
The art of economics
1-2
Economics and
Economic Reasoning
11
What Economics Is
Economics is the study of how human beings coordinate their wants and desires, given the decision-making mechanism, social customs, and political realities of the society
The three central coordination problems any economy must solve:
1. What, and how much, to produce
2. How to produce it
3. For whom to produce it
1-3
Economics and
Economic Reasoning
11
Scarcity
Scarcity exists because individuals want more than can be produced • Scarcity means the goods available are too few to satisfy individuals’ desires
The degree of scarcity is constantly changing
The quantity of goods, services and usable resources depends on technology and human action
1-4
Economics and
Economic Reasoning
11
Microeconomics and Macroeconomics
Economic theory is divided into two parts:
• Microeconomics is the study of individual choice, and how that choice is influenced by economic forces • Macroeconomics is the study of the economy as a whole
1-5
Economics and
Economic Reasoning
11
A Guide to Economic Reasoning
Steve Levitt’s bestseller, Freakonomics, contains many examples of “thinking like an economist”
• Levitt uses economic reasoning to explain why people become drug dealers
• The potential financial benefit of selling drugs is much higher than the cost of giving up a minimum wage job
1-6
Economics and
Economic Reasoning
11
Marginal Costs and Marginal Benefits
Using economic reasoning, decisions are often made by comparing marginal costs and marginal benefits
•
Marginal cost is the additional cost over and above costs already incurred
•
Marginal benefit is the additional benefit above and beyond what has already accrued
The economic decision rule:
•
•
If the marginal benefits of doing something exceed the marginal costs, do it.
If the marginal costs of doing something exceed the marginal benefits, don’t do it.
MC > MB Don’t do it!
1-7
Economics and
Economic Reasoning
11
Opportunity Cost
Opportunity cost is the benefit forgone of the next-best alternative to the activity you have chosen
Opportunity cost should always be less than the benefit of what you have chosen
Opportunity cost is the basis of cost/benefit economic reasoning 1-8
Economics and
Economic Reasoning
11
Economic, Social, and Political Forces
Economic forces are mechanisms that ration scarce goods
A market force is an economic force that is given relatively free rein by society to work through the market
The invisible hand is the price mechanism that guides our actions in a market. The invisible hand is an example of a market force.
• If there is a shortage, prices rise
• If there is a surplus, prices fall
1-9
Economics and
Economic Reasoning
11
Using Economic Insights
Theories tie together economists’ terminology and knowledge about economic institutions
Theories are too abstract to apply in specific cases and are often embodied in economic models and principles
• An economic model is a framework that places the generalized insights of the theory in a more specific contextual setting
• An economic principle is a commonly held insight stated as a law or general
