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An Introduction to Economic Reasoning Chapter 1

Joshua Hall Department of Economics West Virginia University

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Hi!
Joshua Hall Please call me Josh Ph.D. in economics, WVU Go Mountaineers! B.B.A. from Ohio U. Yes, thats degrees from 2 top 5 party schools

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Syllabus: The Basics

Joshua Hall

An Introduction to Economic Reasoning

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Introduction Bureaucracy Definitions Big Questions

Syllabus: The Basics

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Some Basics

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

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.

Joshua Hall

An Introduction to Economic Reasoning

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Expected Learning Outcomes, Part I

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Expected Learning Outcomes, Part 2

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

General Course Policies and Expectations

Joshua Hall

An Introduction to Economic Reasoning

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Introduction Bureaucracy Definitions Big Questions

Grading

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Grading

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Grading Scale

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An Introduction to Economic Reasoning

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Exam Policy, Part 1

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Exam Policy, Part 2

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Make Up Exam Policy

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An Introduction to Economic Reasoning

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Inclusivity Statement

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Academic Dishonesty

Joshua Hall

An Introduction to Economic Reasoning

Joshua Hall

An Introduction to Economic Reasoning

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Introduction Bureaucracy Definitions Big Questions

What Is Economics? (Alfred Marshall edition)

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

Source: Marshall, Principles of Economics.

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

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

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

What Is Economics? (Greg Mankiw edition)

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

Source: Mankiw, Principles of Economics.

Joshua Hall

An Introduction to Economic Reasoning

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Introduction Bureaucracy Definitions Big Questions

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.

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

What Is Economics (Steven Landsburg edition)

People respond to incentives. Everything else is commentary.

Source: Landsburg, The Armchair Economist.

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

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.

Joshua Hall

An Introduction to Economic Reasoning

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Introduction Bureaucracy Definitions Big Questions

What Economics Is Not

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Big Questions

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

Disparities in Growth Are Still With Us

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Will Also Help You With Personal Decision-Making

Joshua Hall

An Introduction to Economic Reasoning

Introduction Bureaucracy Definitions Big Questions

And Avoiding Mistakes

Joshua Hall

An Introduction to Economic Reasoning

Scarcity and Choice Economic Way of Thinking Guideposts

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.

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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

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

Scarcity Is Not The Same As Poverty

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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
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Rationing Results From Scarcity

Any time peoples demands outstrip a goods availability, rationing will result Who gets the scarce goods depends on the method of rationing

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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-topay
Joshua Hall Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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
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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

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

Rationing Method Cannot Eliminate Competition

Competition follows from scarcity Changing how goods are allocated only changes the form of competition, it doesnt eliminate it

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

The Final Word on Scarcity and Poverty

Eliminating Poverty can be accomplished Eliminating scarcity not likely to happen

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The Economic Way of Thinking

funny, but not what I mean

Joshua Hall Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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)

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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

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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

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Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

Guidepost #3 Incentives Matter

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

Joshua Hall

Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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.
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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
Joshua Hall Scarcity, Choice, & The Economic Way of Thinking

Scarcity and Choice Economic Way of Thinking Guideposts

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
Joshua Hall Scarcity, Choice, & The Economic Way of Thinking

Guideposts Positive vs Normative Pitfalls

Guidepost #7 Value Is Subjective

Economists are methodological individualists We work with the individual We take their preferences as given
A goods value therefore is subjective and varies with the individual
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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
Joshua Hall Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

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
Joshua Hall Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

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
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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?
Joshua Hall Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

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?

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Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

We Dont 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

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Guideposts Positive vs Normative Pitfalls

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

Joshua Hall

Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

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

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Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

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
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Pitfall #3 Association Is Not Causation

Statistical association alone cannot establish causation

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Guideposts Positive vs Normative Pitfalls

Example #1 Drinking and Earnings

Source: Peters and Stringham (2006) No Booze, You May Lose? J Labor Research Joshua Hall Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

Example #2

Source: Messerli (2012) Chocolate Consumption, Cognitive Function, and Nobel Laureates, N Eng J Med Joshua Hall Guideposts and 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
Joshua Hall Guideposts and Pitfalls

Guideposts Positive vs Normative Pitfalls

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)
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