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Lecture Two: The Economic Way of Thinking

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ECON 1000
George Georgopoulos

Lecture Two: The Economic Way of Thinking September 15, 2011 The Economic Way of Thinking Choosing at the Margin People make choices at the margin, which means that they evaluate the consequences of making incremental changes in the use of their resources. The benefit from pursuing an incremental increase in an activity is its marginal benefit. The opportunity cost of pursuing an incremental increase in an activity is its marginal cost. The efficient allocation of resources is achieved when the marginal benefit equal the marginal cost. Responding to Incentives Our choices respond to incentives. For any activity, if marginal benefit exceeds the marginal cost, people have an incentive to do more of that activity. If marginal cost exceeds marginal benefit, people have an incentive to do less of that activity. Incentives are also the ket to reconciling self interest and the social interest. Social Science and Policy Tool Economics as a Social Science Economists distinguish between two types of statements - What is: positive statements - What ought to be: normative statements A positive statement can be tested using scientific facts. A normative statement is not possible to prove or test because it is an ideal scenario. Unscrambling Cause and Effect The task of economic science is to discover what positive statements that re consistent with what we observe in the world and that enable us to understand how the economic world works. Economic Models An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand. Exogenous - the change of the cause Endogenous - the effect of the variables A model is tested by comparing its predictions with the facts. Testing an economic model is difficult, so economists also use - Natural experiments - Statistical investigations - Economic experiments Economics as a Policy Tool Economics is a way of approaching problems in all aspects of out lives. Three broad areas are: - Personal economic policy - Business economic policy - Government economic policy (tax breaks, incentives, encouraging industry, f
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