Introduction:

Thinking Like an Economist 1 Introduction:

Thinking Like an Economist 1
CHAPTER 1
Chapter Goals
Economics and Economic Reasoning • Define economics
• Examine the three coordination problems all
economies must solve
In my vacations, I visited the poorest quarters of several
cities and walked through one street after another, looking • Explain how to make decisions by comparing
at the faces of the poorest people. Next I resolved to make marginal costs and marginal benefits
as thorough a study as I could of Political Economy .

— Alfred Marshall • Define opportunity costs and explain its relationship

to economic reasoning

McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. 1-2

Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Chapter Goals What Economics Is

• Explain real-world events in terms of: Economics is the study of how human beings coordinate their
wants and desires, given the decision-making mechanism,
• Economic forces social customs, and political realities of the society
• Social forces
• Political forces • The three central coordination problems any economy
must solve:
• Distinguish between:
1. What, and how much, to produce
• Microeconomics and macroeconomics
2. How to produce it
• Positive economics, normative economics,
3. For whom to produce it
and the art of economics

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Scarcity Modern Economics

• Scarcity exists because individuals want more than can • Economics, like any field of study, evolves and changes
be produced
• Modern economics is based both on deduction and
• Scarcity means the goods available are too few induction
to satisfy individuals’ desires • Deduction is a method of reasoning in which
one deduces a theory based on a set of almost
• The degree of scarcity is constantly changing
self-evident principles
• The quantity of goods, services and usable resources • Induction is a method of reasoning in which
depends on technology and human action one develops general principles by looking for
patterns in the data
• Abduction is the combination of deduction and induction

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 Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

A Guide to Economic Reasoning Marginal costs and marginal benefits

An example of the economic decision rule: • Using economic reasoning, decisions are often made by
comparing marginal costs and marginal benefits
• Steve Levitt’s bestseller, Freakonomics, contains many
examples of “thinking like an economist” • Marginal cost is the additional cost over and
above costs already incurred
• Levitt uses economic reasoning to explain why
people become drug dealers • Marginal benefit is the additional benefit above
and beyond what has already accrued
• The potential financial benefit of selling drugs is
much higher than the cost of giving up a
minimum wage job

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Marginal costs and marginal benefits Opportunity Cost

The economic decision rule:
• Opportunity cost is the benefit forgone of the next-best
• If the marginal benefits of doing something exceed the alternative to the activity you have chosen
marginal costs, do it.
• Opportunity cost should always be less than the benefit
MB > MC Æ Do it! of what you have chosen

• If the marginal costs of doing something exceed the • Opportunity cost is the basis of cost/benefit economic
marginal benefits, don’t do it. reasoning

MC > MB Æ Don’t do it!

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Opportunity Cost Economic and Market Forces

Examples of opportunity cost: • Economic forces are mechanisms that ration scarce goods

1. Individual decisions • A market force is an economic force that is given

• The opportunity cost of college includes:
• Items you could have purchased with the
money spent for tuition and books
• Loss of the income from a full-time job
2. Government decisions
• The opportunity cost of money spent on the war
on terrorism is less spending on health care or
education
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relatively free rein by society to work through the market
• The invisible hand is the price mechanism that guides
our actions in a market. The invisible hand is an example
of a market force.
• If there is a shortage, prices rise
• If there is a surplus, prices fall
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 Introduction:
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Thinking Like an Economist 1

Economic and Market Forces Economic Terminology

• What happens in society can be seen as a reaction to, • Goal of this class is to describe how economics works
and interaction of: in the real world
• Economic forces • You will be introduced to many terms that occur in
• Social forces business and in discussions of the economy
• Historical forces • For example:
• Social, cultural, and political forces influence market • Opportunity cost
forces • Marginal benefit and marginal cost
• Political and social forces often work together against • The invisible hand
the invisible hand • Market and economic forces
• … and many more

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Economic Insights The Invisible Hand Theory

• Theories tie together economists’ terminology and
knowledge about economic institutions
• Theories are too abstract to apply in specific cases and
are often embodied in economic models and principles
• An economic model is a framework that places
the generalized insights of the theory in a more
specific contextual setting
• According to the invisible hand theory, a market
economy, through the price mechanism, will allocate
resources efficiently
• Prices fall when quantity supplied is greater than
quantity demanded
• Prices rise when the quantity demanded is greater
than the quantity supplied

• An economic principle is a commonly held • Efficiency means achieving a goal as cheaply as possible
insight stated as a law or general assumption

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Microeconomics and Macroeconomics Microeconomics and Macroeconomics

• Economic theory is divided into two parts; • Microeconomics studies such things as:
• Microeconomics is the study of individual choice, • The pricing policy of firms
and how that choice is influenced by economic • Household’s decisions on what to buy
forces • How markets allocate resources among
alternative ends
• Macroeconomics is the study of the economy
as a whole
• Macroeconomics studies such things as:
• Inflation
• Unemployment
• Economic growth

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 Introduction:
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Economic Institutions Economic Policy Options

• To apply economic theory to reality, you've got to have
• Economic policies are actions (or inactions) taken by
a sense of economic institutions the government to influence economic actions
• Economic institutions are laws, common practices,
• Objective policy analysis keeps value judgments
and organizations in a society that affect the economy
separate from the analysis
• Economic institutions differ significantly among nations
• Subjective policy analysis reflects the analyst’s views
• They sometimes seem to operate differently than of how things should be
economic theory predicts

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Economic Policy Options Chapter Summary

Objective Policy Analysis • Three coordination problems are what to produce,
how to produce it, and for whom to produce it
• To distinguish between objective and subjective analysis,
economics is divided into three categories • Scarcity exists
• Modern economists use abduction
1. Positive economics is the study of what is
2. Normative economics is the study of what • Economic reasoning structures all questions in a
should be cost/benefit framework
3. Art of economics is using the knowledge • Opportunity costs exist
of positive economics to achieve the goals
determined in normative economics

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Introduction:
Thinking Like an Economist 1 Introduction:
Thinking Like an Economist 1

Chapter Summary Preview of Chapter 2:

• Economic, political, and social forces are always
at work
• Under certain conditions, the market, through the price
mechanism, will allocate scarce resources efficiently
• Economics is divided into micro and macroeconomics
• Precepts are the guides for policies based on theorem
The Production Possibility Model, Trade, and
Globalization
• Demonstrate opportunity cost with a production
possibility curve
• Discuss the increasing marginal opportunity cost
• Relate the concept of comparative advantage to the
production possibility curve

• Economics can be subdivided into positive economics, • Show how through comparative advantage and trade, a
normative economics, and the art of economics country can consume beyond their production possibility
• Explain how globalization and outsourcing are part of a
global process guided by the law of one price

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