What is economics Economics is the study of how people make decisions or choices when faced with
The Scientific Method the method used to determine things in economics
We Have a question, we want an answer
Second we must engage in hypothesis and observation of the world around us
Third we need to test our hypothesis
Fourth we may need to go back and revise our original hypothesis
Natural Experiment occurs when in everyday life something happens and we are able to collect data to
allow us to compare peoples behavior before or after the event
Normal goods goods that people buy more of when they experience an increase in income (new cars)
Inferior goods goods that people buy less of when they experience an increase in income (used cars)
Model collection or system of our well established rules
Behavioral economics combines psychology and brain imaging to better understand the decision
making process and better improve our models
What is the purpose of models designed to help us make better predictions
Economists often disagree with one another on many issues
A positive statement a statement which is potentially testable and provable.
REMEMBER THAT positive statements are potentially testable and provable even though they may
be wrong Normative statement one that is not potentially testable or provable.
A normative statement can be identified by
Using words, ought, should, good, bad, fair, unfair, etc.
These statements depend on peoples definition of standards and other things.
Every science has their own particular jargon
Words are often imprecise and do not give enough information
The field of economics developed becasuse people have to make choices as a result of scarcity
Scarcity means that there is not enough of something to satisfy everyone who wants some
We must find a way to ration these scarce resources
We use price as a rationing device
The scarcer the good is, the higher the price is; and the higher the price is, the greater the incentive to
me to produce more
Debeers diamonds is an example of causing demand in the market for a product that is scarce.
Needs food, housing, clothing, air, water, etc
Wants TV, cars, Jewelry,etc
Our wants are unlimited
We are forced to make choices in order to determine what we should buy, or pass on.
Opportunity cost scarcity causes us to make choices and making choices results in lost opportunities
and these lost opportunities represent the cost of our choices You must be careful when determining next best opportunity since it is not always limited to one lost
Rules for how the world works
We generally believe that people are rational
Rational people make their decisions in a consistent manner
We assume everyones rational decision making goal is to make yourself as happy as possible
Economic Surplus happiness, welfare, benefit
Cost benefit analysis You considered the benefit you feel you would get from something compared to
the costs that you will have to pay for the good
Things to note about cost benefit analysis
The list will be different for every person
Your list will be based on your expectations
We can get you to change your decision by offering incentives
Economists use a unit of measurement called util which measures the amount of utility we get from
We assume that people make their decisions on the margin.
On the margin we generally make a small decision, evaluate whether that was still the right the decision
to make and so on and so on.
Expected marginal economic surplus= expected marginal benefit + expected marginal costs
Section 8 Good decision making requires us to ignore sunk cost
People make this mistake all the time with stocks. They refuse to sell stocks below the price which they
purchased the stock, even though they could reinvest the stock into a better performing stock and make
up for their sunk cost.
Though the goal of society is to maximize the happiness of society, we cannot possibly satisfy
everyone’s needs but the goal is to use our resources as efficiently as we can so that we can create the
greatest well being for our society. – we refer to this as maximizing the Economic pie.
Economic Efficiency creating the greatest amount of wealth as possible for our society
The problem with attempting to divide the economic pie more equally is that it actually shrinks the size of
the economic pie.
The economic question is:
What to produce?
How to produce?
Who gets what is produced?
Production efficiency means that given the resources we have available how do we best use them
Consumption efficiency means that, of the goods and services we have chosen to produce, how do we
decide who will get them?
Produce what people want most Command economy
Letting people bid on items in the free market, the more you desire it.
Pick the lowest cost producer
Competition is good for the consumer because we’ll see it results in lower prices for us and competition
is good for society because it results in less waste of resources
Profit is often a signal in the free market that the producer is the efficient producer and bankruptcy is
often the signal in the free market system that the producer is not the efficient producer
Monopoly situation where there is only one producer of this product
Labor intensive using lots of workers and very little machinery
Capital intensive very few workers and a lot of machinery
Make sure goods and services go to those people who value them the most
Adam Smith called the father of economics, described the workings of the free market system as one in
which there seemed to be some invisible hand directing things so that the right goods got produced
We only do things if the expected marginal benefit is at least as great as the expected marginal cost
The most important job for the government with respect to the economy with respect to the economy is
defining and protecting property rights
We have a market failure due to imperfect information
Externality an externality exists when a consumption or production decision impacts people other than
the actual consumer or producer and that consumer or producer ignores the impact on other people
Private cost benefit analysis is trying to do what’s best for me without considering what is best for
society overall Positive consumption externalities because they come about from your consumption decision, and
because they positively impact others and because you ignore them
We will let the government try to induce you to internalize the externality through pigovian
The best subsidy amount will be exactly equal to the externality
There are four classifications of externality we have to consider. Positive consumption, negative
consumption, positive production, and negative production
Negative consumption externality is a side effect from something that you do that negatively affects
others that you do not consider when making the decision.
The best pigovian tax amount is exactly equal to the externality
Negative production externality any time a producer pollutes it is a result of the production process, it
hurts people around the producer and the producer ignores it when deciding on how much to produce
Positive production externalities occur whenever the production process benefits people around the
producer and this benefit is not included in the producers private cost benefit analysis.
Markets exist whenever there is at least one person who wants to buy the product and at least one
person who wants to produce and sell the product