Micro Chapter 1

The Economic Approach

3 Learning Goals

1) Identify and list the critical components of economics.

2) List and provide examples of the eight guideposts of economic thinking.

3) Avoid making four common mistakes

What Is Economics About?

Economics tries to explain and predict the behavior of consumers, firms, and government.

John M. Keynes:“Economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions.”

Steven Levitt & Stephen DubnerSuper Freakonomics

The economic approach isn’t meant to describe the world as any one of us might want it to be, or fear that it is, or pray that it becomes- but rather to explain what it actually is. Most of us want to fix or change the world in some fashion. But to change the world, you first have to understand it.

Steven Levitt & Stephen DubnerSuper Freakonomics

Instead of thinking of such stories as “economics,” it is better to see them as illustrating “the economic approach.” That’s a phrase made popular by Gary Becker, the longtime University of Chicago economist who was awarded a Nobel Prize in 1992. In his acceptance lecture, he explained that the economic approach “does not assume that individuals are motivated solely by selfishness or gain. It is a method of analysis, not an assumption about particular motivations.. .Behavior is driven by a much richer set of values and preferences.”

Alfred Marshall:

Economics is “a study of mankind in the ordinary business of life.”

What does the term “scarcity” or “scarce” mean to you?

Can we eliminate scarcity?

If we can’t, what must we do?

Historically, mechanisms that have been used to deal with the problem of scarcity:

1. Force

2. Tradition (emphasized past ways, relied on families)

3. Authority (government and church)

4. Market

5. Combinations of 1-4

Scarcity and Tradeoffs

Scarcity leads to tradeoffs which result in making choices

Scarcity and Tradeoffs

Scarcity requires that some wants remain unfulfilled

Issues of equity, justice, and fairness are embedded with scarcity

The Economic Way of Thinking

Always have these guidelines in your economic thought process:

(1) There are always tradeoffs.

(1) There are always tradeoffs.

What you give up is your opportunity cost-value of next best alternative

Common mistake: opportunity cost is NOT the sum of everything you give up

(1) There are always tradeoffs.

There is no such thing as a free lunch!

Video: Friedman free lunch myth

(2) Individuals choose purposefully

Referred to as economizing behavior-try to get the most benefits for the least cost or effort

Also known as rational behavior

What’s the difference between rational behavior and greed?

Example: drug addict

Steven Levitt & Stephen DubnerSuper Freakonomics

Human behavior is influenced by a dazzlingly complex set of incentives, social norms, framing references, and the lessons gleaned from past experience- in a word, context. We act as we do because, given the choices and incentives at play in a particular circumstance, it seems most productive to act that way. This is also known as rational behavior, which is what economics is all about.

(3) Incentives matterAs the incentive goes up, you will be more likely to do something (or try to), and vice versa

The incentive doesn’t have to be money

Steven Levitt & Stephen DubnerSuper Freakonomics

If John List’s research proves anything, it’s that a question like “Are people innately altruistic?” is the wrong kind of question to ask. People aren’t “good” or “bad.” People are people, and they respond to incentives. They can nearly always be manipulated-for good or ill- if only you find the right levers. So are human beings capable of generous, selfless, even heroic behavior? Absolutely. Are they also capable of heartless acts of apathy? Absolutely.

(4) Think on the margin, not in total or on average

Marginal means additional or incremental

Marginal _______ is additional _______.

Example: water/diamond paradox

Example: Would you travel 3 blocks to save $20 on a $100 product?

Would you travel the same 3 blocks to save $20 on a $1,000 product?

(4) Think on the margin, not in total or on average

Rule to live by:

Continue to engage in an activity as long as the marginal benefit is greater than the marginal cost.

(5) More information leads to better decision-making, but more information is costly to get

Refer back to (1) through (4)1) There are always tradeoffs

2) Individuals choose purposefully

3) Incentives matter

4) Think on the margin

The Great Economics Mysteries BookChapter 4 Lesson 11 Why Can’t You Buy a Car on Sunday?

Economics Mystery activities.pdf

The Great Economics Mysteries BookChapter 4 Lesson 11 Why Can’t You Buy a Car on Sunday?

Information isn’t free. It costs something to collect information- your time, if nothing else (Clues 3 and 5). By keeping closed on Sundays, car dealerships narrow the window of time within which potential buyers may gather information about the price of a car and its other features. You can walk around a dealer’s lot on a Sunday afternoon and kick tires and examine sticker prices, of course, but sticker prices reveal little about actual sale prices or the complicated details of leasing arrangements (Clue 4). The check such details out, and to do comparison shopping, potential customers have to shop during the week or on Saturdays- times when they most likely have many other things they’d like to do. Keeping closed on Sundays, in other words, increases the cost to the potential buyer who wants to collect information. He or she must take time off from work or give up time on Saturday in order to visit car dealerships when they are open. Some buyers are not willing to pay this cost. Car dealerships benefit accordingly, since buyers who operate on the basis of limited information are apt to pay more for the cars they buy or lease. Keeping closed on Sundays helps the dealerships in maintaining this edge (Clue 9).

(6) Many choices create a secondary effect.

The primary effect is often immediate and visible

The secondary effect usually comes later and is not as visible

The Great Economics Mysteries BookChapter 3 Lesson 4 Why Airborne Infants Aren’t Required

to Buckle Up

Economics Mystery activities.pdf

The Great Economics Mysteries BookChapter 3 Lesson 4 Why Airborne Infants Aren’t Required

to Buckle Up

Parents respond to incentives when they decide how to travel. If traveling by air meant that parents would have to purchase an extra air ticket for their infant, they might make other plans- deciding, perhaps, to drive to their destination instead (Clue 3). Even for airborne infants sitting on their parents’ laps and not in a safety seat, flying is safer than riding in a car (Clue 4). Thus, the Federal Aviation Administration is saving infant lives by refusing to require the use of safety seats for infants on airplanes. This is a case where doing nothing is the better option when it comes to saving lives.

Video: Stossel opportunity costs and tradeoffs

(7) Value is subjective

Beauty is in the eyes of the beholder

Value is determined by the purchaser

(8) Economic thinking is scientific thinking

Economists use data and information generated by people to explain and predict actions

Do you believe that red cars receive more traffic tickets? Why or why not?

Video: 20 20 Myths red cars get more tickets

Steven Levitt & Stephen DubnerSuper Freakonomics

But while there are exceptions to every rule, it’s also good to know the rule. In a complex world where people can be atypical in an infinite number of ways, there is great value in discovering the baseline. And knowing what happens on average is a good place to start. By so doing, we insulate ourselves from the tendency to build our thinking- our daily decisions, our laws, our governance- on exceptions and anomalies rather than on reality.

(8) Economic thinking is scientific thinking

Economists “do it with models”

Key principles rap:

Pitfalls To Avoid in Economic Thinking

Don’t make one of these errors:

(1) Violation of ceteris paribus.– Ceteris paribus is Latin for “other things

constant.”– We want to isolate variables so we typically

allow only one to change at a time.– Example: stomach ache

Errors:

(2) Good intentions do not necessarily result in good outcomes

Milton Friedman: “There is nothing that does so much harm as good intentions”

Errors:

(3) Association is NOT causation

Errors:

(4) Fallacy of Composition– Assumption: what’s good for the individual is

good for the group.– Making this assumption is the fallacy.– Video: Seinfeld fire clip

END