Econ 201 Chapter 1 Lecture Notes

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Joshua Hall An Introduction to Economic Reasoning

An Introduction to

Economic Reasoning – Chapter 1

Joshua HallDepartment of EconomicsWest Virginia University

IntroductionBureaucracy

Definitions Big Questions


Hi!

Joshua Hall

Please call me Josh

Ph.D. in economics, WVU

Go Mountaineers!

B.B.A. from Ohio U.

Yes, that’s degrees from 2 top 5 party schools




Syllabus: The Basics



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Syllabus: The Basics




Some Basics




Textbook



James D. Gwartney, Richard L. Stroup, Russell S. Sobel, and David A. Macpherson. 2013. Microeconomics: Private and Public Choice. 14th edition. Southwestern/Cengage Publishers.

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Expected Learning Outcomes, Part I




Expected Learning Outcomes, Part 2




General Course Policies and Expectations



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Grading




Grading




Grading Scale



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Exam Policy, Part 1




Exam Policy, Part 2




Make Up Exam Policy



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Inclusivity Statement




Academic Dishonesty




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Joshua Hall

What Is Economics? (Alfred Marshall edition)

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

An Introduction to Economic Reasoning

Source: Marshall, Principles of Economics.



Joshua Hall

What Is Economics? (Ludwig von Mises edition)

“Economics, …, deals with all human action, i.e., with mans purposive aiming at the attainment of ends chosen, whatever these ends may be.”


Source: von Mises, Human Action.



Joshua Hall

What Is Economics? (Greg Mankiw edition)

“Economics is the study of how society manages its scarce resources.”


Source: Mankiw, Principles of Economics.



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What Is Economics? (Yoram Bauman edition)

“Economics is about the actions of optimizing individuals and the interactions between them.”


Source: Bauman, The Cartoon Introduction to Economics.



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What Is Economics (Steven Landsburg edition)

“‘People respond to incentives.’ Everything else is commentary.”


Source: Landsburg, The Armchair Economist.



Joshua Hall

What Is Economics (Joshua Hall edition)

“Economics is like a set of eyeglasses (although not this big) that help you see the world around you better.”


Source: Me.



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What Economics Is Not




Big Questions




Disparities in Growth Are Still With Us



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Will Also Help You With Personal Decision-Making




And Avoiding Mistakes



Joshua Hall

Scarcity Means Having to Make Choices

Goods are scarce because our desires for them is greater than their natural provision

Scarcity forces us to choose among available alternatives.

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and ChoiceEconomic Way of Thinking

Guideposts

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Scarcity Is Not The Same As Poverty

The economic history of the human race is essentially about the struggle to turn limited resources (land, labor, etc.) into scarce goods



Guideposts

Joshua Hall

Scarcity Is Not The Same As Poverty



Guideposts

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Wants Versus Needs

Needs are relatively objective

Ex: daily nutritional requirements

Wants are more subjective and context-dependent

Ex: air conditioning

We may someday eliminate poverty but likely never scarcity



Guideposts

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Rationing Results From Scarcity

Any time people’s demands outstrip a good’s availability, rationing will result

Who gets the scarce goods depends on the method of rationing



Guideposts

Joshua Hall

Rationing Methods and Competition

Competition over scarce resources is a fact of life

Different rationing methods produce different competitive behaviors

First-in, first-out rewards rewards waiting in line

Price rewards ability-to-pay



Guideposts

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Competition And Rationing Method

Competition can lead to economic progress

Ex: earning money for goods leads to new products and services

Not all rationing methods are created equal

Ex: queuing as a rationing method rewards waiting in line



Guideposts

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Price As A Rationing Mechanism

When price is used to ration people have to answer the question “what do I want to give up?”

Encourages conservation and judicious use of resources



Guideposts

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Rationing Method Cannot Eliminate Competition

Competition follows from scarcity

Changing how goods are allocated only changes the form of competition, it doesn’t eliminate it



Guideposts

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The Final Word on Scarcity and Poverty

Eliminating Poverty can be accomplished

Eliminating scarcity – not likely to happen



Guideposts

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The Economic Way of Thinking


…funny, but not what I mean


Guideposts

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More Like Things To Keep In Mind

These guideposts are things that are at the core of the economic way of thinking

Economics is not just applied math and statistics (and evil)



Guideposts

Joshua Hall

Guidepost #1 – Scarcity Creates Opportunity Costs

The use of scarce resources to produce a good or service is always costly

The highest valued alternative that must be sacrificed is the opportunity cost of the choice



Guideposts

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Guidepost #2 – Individuals Choose Purposefully

Individuals choose purposefully given their ends

This means that people try to optimize, i.e., do the best they can given their abilities and resources



Guideposts

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Guidepost #3 – Incentives Matter


As costs to a choice increase, a person will be less likely to make that choice


Guideposts

Joshua Hall

Guidepost #4 – What Matters Is The Margin


The economic way of thinking focuses on marginal changes

Is the marginal benefit of undertaking an activity greater than the marginal cost?

If so, do it!

In fact, keep doing it until MB = MC.


Guideposts

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Guidepost #5 – Information Is Costly


People are not omniscient (duh)

Becoming more informed has benefits and costs

Some information cannot be obtained at any cost

Uncertainty is therefore a fact of economic life


Guideposts

Joshua Hall

Guidepost #6 – Secondary Effects

In addition to their direct effects, economic activities often generate secondary effects

While economically important, these are often ignored or difficult to trace out

A related concept is the idea of unintended consequences


Guideposts


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Guidepost #7 – Value Is Subjective

Economists are methodological individualists

We work with the individual

We take their preferences as given

A good’s value therefore is subjective and varies with the individual

Guideposts and Pitfalls

GuidepostsPositive vs Normative

Pitfalls

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Value Is Subjective: One Application

Recall opportunity cost: the highest valued activity sacrificed in making a choice

What is your opportunity cost of being here?

If you asked me what might be the opportunity cost of attending college I might say

Tuition

Room and board

Books

Foregone income



Pitfalls

Joshua Hall

Value Is Subjective: A Second Application

Voluntary trade creates value

If we take subjective valuation seriously, then we know voluntary exchange creates value ex ante

It is true that sometimes good trades ex ante become bad trades ex post

However, recall that people act with purpose and have an incentive to learn from their mistakes

Just like missing a question on a test, the feedback of profit and loss creates a learning opportunity



Pitfalls

Joshua Hall

Just A Little Bit More On Trade

Transactions costs reduce our ability to produce gains from potential trades

Definition: the time, effort, and other resources needed to search out, negotiate, and consummate an exchange

The Internet has led to reduced transactions costs

A middleman is someone who earns their living off of reducing transactions cost

Definition: someone who buys and sells or arranges trades



Pitfalls

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Guidepost #8 – Models Are Only Good If They Fit The Data

Models are representations of reality

the idea is to clarify things by abstracting away from reality

The test of a model is whether or not it fits the data, i.e., does it help us explain what we see?



Pitfalls

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Models Are Only Good If They Fit The Data: An Application

Adam Smith (Wealth of Nations, Book I, Chapter V):

“The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.”

Does this fit the data?



Pitfalls

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We Don’t Mean “Good Stuff”

Positive economics is the scientific study of “what is” among economic relationships

Positive economic statements can be proved either true or false

Ex: an increase in price of cigarettes causes consumption to fall



Pitfalls

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Value Judgments All The Way Down

Normative economics is “what ought to be” among economic relationships

Normative statements cannot be proved true or false because they rest on value judgments

Ex: cigarettes prices should be increased so consumption will fall



Pitfalls

Joshua Hall

Pitfall #1 – Violation Of The Ceteris Paribus Condition

Ceteris paribus is a Latin term meaning “other things constant”

When describing the effect of a change, the outcome may be influenced by changes in other things Ex: concluding that driving is no longer in

fashion because car sales have declined for two years straight



Pitfalls

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Pitfall #2 – Good Intentions Do Not Equal Good Outcomes

Focusing only on the intentions of those proposing a policy is a recipe for error

Ex 1: better search and rescue on Mt. McKinley



Pitfalls

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Pitfall #3 – Association Is Not Causation

Statistical association alone cannot establish causation



Pitfalls

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Example #1 – Drinking and Earnings

Source: Peters and Stringham (2006) “No Booze, You May Lose?” J Labor Research



Pitfalls

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Example #2

Source: Messerli (2012) “Chocolate Consumption, Cognitive Function, and Nobel Laureates,” N Eng J Med



Pitfalls

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Pitfall #4 – Fallacy of Composition

The fallacy of composition is the erroneous view that what is true for the individual is also true for the group

Important to keep in mind when shifting from microeconomics to macroeconomics



Pitfalls

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Some Definitions

Microeconomics is the branch of economics that focuses on how human behavior affects the conduct of affairs within narrowly defined units, such as individual households or business firms (i.e., the focus of ECON 201)

Macroeconomics is the branch of economics that focuses on how human behavior affects outcomes in highly aggregated markets, such as the markets for labor or consumer products (i.e., the focus of ECON 202)



Pitfalls

Econ 201 Chapter 1 Lecture Notes

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Transcript of Econ 201 Chapter 1 Lecture Notes