Micro Chapter 1
The Economic Approach
4 Learning Goals
1) Identify and list the critical components of
economics.
2) List and provide examples of the eight
guideposts of economic thinking.
3) Distinguish between two types of
economic statements
4) Avoid making four common mistakes
Compare and Contrast:
A. All the possessions you have right now
B. All the possessions you had 10 years ago
Which group would you rather have? Why?
Improving standards of living
doesn’t just happen by accident
Actually, they don’t have to improve at all
Watch Video: Hans Rosling- 200
countries 200 years
Would you give up the internet for the rest
of your life for $1 million right now?
Watch Video: Would you give up the
internet
What Is Economics
About?
Economics tries to explain and predict the
behavior of consumers, firms, and
government.
John M. Keynes:
“Economics does not furnish a body of
settled conclusions immediately applicable
to policy. It is a method rather than a
doctrine, an apparatus of the mind, a
technique of thinking which helps its
possessor to draw correct conclusions.”
Steven Levitt & Stephen Dubner
Super Freakonomics
The economic approach isn’t meant to
describe the world as any one of us might
want it to be, or fear that it is, or pray that it
becomes- but rather to explain what it
actually is. Most of us want to fix or
change the world in some fashion. But to
change the world, you first have to
understand it.
Steven Levitt & Stephen Dubner
Super Freakonomics
Instead of thinking of such stories as “economics,” it is
better to see them as illustrating “the economic
approach.” That’s a phrase made popular by Gary
Becker, the longtime University of Chicago economist
who was awarded a Nobel Prize in 1992. In his
acceptance lecture, he explained that the economic
approach “does not assume that individuals are
motivated solely by selfishness or gain. It is a method of
analysis, not an assumption about particular
motivations.. .Behavior is driven by a much richer set of
values and preferences.”
Optional Video: RSAnimate-Freakonomics
Scarcity and Tradeoffs
Scarcity leads to tradeoffs which result in
making choices
Scarcity and Tradeoffs
Thomas Sowell: “In the world that people
live in, and are likely to live in for centuries
to come, trade-offs are inescapable. Even
if we refuse to make a choice,
circumstances will make choices for us, as
we run out of resources for many
important things that we could have had, if
only we had taken the trouble to weigh
alternatives. ”
Historically, mechanisms that have been
used to deal with the problem of scarcity:
1. Force
2. Tradition (emphasized past ways, relied
on families)
3. Authority (government and church)
4. Market
5. Combinations of 1-4
Scarcity and Tradeoffs
Scarcity requires that some wants remain
unfulfilled
Issues of equity, justice, and fairness are
embedded with scarcity
Class Perspective
We will focus on the market process of
dealing with scarcity.
At times we will compare and contrast with
the government or collectivist process.
Do not confuse the market process as
being the same as politically conservative.
Do you think the world will ever run
out of oil?
Watch Video: Stossel- Oil supplies
The Economic Way of
Thinking
Milton Friedman:
“The only person who can truly persuade
you is yourself. You must turn the issues
over in your mind at leisure, consider the
many arguments, let them simmer, and
after a long time turn your preferences into
convictions.”
Always have these guidelines in
your economic thought process:
The text lists 8 guidelines.
(1) There are always tradeoffs.
What you give up is your opportunity costvalue of next best alternative
Common mistake: opportunity cost is NOT
the sum of everything you give up
There is no such thing as a free lunch!
(1) There are always tradeoffs.
Optional Video: Milton Friedman- free
lunch myth
(2) Individuals choose purposefully
Referred to as economizing behavior-try to
get the most benefits for the least cost or
effort
Also known as rational behavior
Alfred Marshall:
“It is deliberateness, and not selfishness,
that is the characteristic of the modern
age.
Steven Levitt & Stephen Dubner
Super Freakonomics
Human behavior is influenced by a dazzlingly
complex set of incentives, social norms, framing
references, and the lessons gleaned from past
experience- in a word, context. We act as we do
because, given the choices and incentives at
play in a particular circumstance, it seems most
productive to act that way. This is also known
as rational behavior, which is what economics is
all about.
(3) Incentives matter
As the incentive goes up, you will be
more likely to do something (or try to),
and vice versa
The incentive doesn’t have to be money
Watch Video: Freakonomics- potty
training incentives
Steven Levitt & Stephen Dubner
Super Freakonomics
If John List’s research proves anything, it’s that a
question like “Are people innately altruistic?” is
the wrong kind of question to ask. People aren’t
“good” or “bad.” People are people, and they
respond to incentives. They can nearly always
be manipulated-for good or ill- if only you find
the right levers. So are human beings capable
of generous, selfless, even heroic behavior?
Absolutely. Are they also capable of heartless
acts of apathy? Absolutely.
(3) Incentives Matter
Optional Video: RSAnimate-surprising
truth about what motivates
(4) Think on the margin, not in total
or on average
Marginal means additional or incremental
Marginal _______ is additional _______.
Rule to live by:
Continue to engage in an activity as long
as the expected marginal benefit is greater
than the expected marginal cost.
(5) More information leads to better
decision-making, but more
information is costly to get
Refer back to (1) through (4)
1)
2)
3)
4)
There are always tradeoffs
Individuals choose purposefully
Incentives matter
Think on the margin
(6) Many choices create a
secondary effect.
The primary effect is often immediate and
visible
The secondary effect usually comes later
and is not as visible
Watch Video: Stossel Micro 01opportunity costs and tradeoffs
(7) Value is subjective
Beauty is in the eyes of the beholder
Value is determined by the purchaser
(8) Economic thinking is scientific
thinking
Economists use data and information
generated by people to explain and predict
actions
Class Activity: Do you believe that red
cars receive more traffic tickets? Why or
why not?
Watch Video: 20/20 Myths- red cars get
more tickets
Steven Levitt & Stephen Dubner
Super Freakonomics
But while there are exceptions to every rule, it’s
also good to know the rule. In a complex world
where people can be atypical in an infinite
number of ways, there is great value in
discovering the baseline. And knowing what
happens on average is a good place to start. By
so doing, we insulate ourselves from the
tendency to build our thinking- our daily
decisions, our laws, our governance- on
exceptions and anomalies rather than on reality.
Positive and Normative
Economics
Reading: Milton Friedman-Essays in
Positive Economics
The introduction and Section 1 (pages 1
through 3) are relevant; you may skip the
rest.
Pitfalls To Avoid in
Economic Thinking
Don’t make one of these errors:
(1) Violation of ceteris paribus.
– Ceteris paribus is Latin for “other things
constant.”
– We want to isolate variables so we typically
allow only one to change at a time.
Errors:
(2) Good intentions do not necessarily
result in good outcomes
Milton Friedman: “There is nothing that
does so much harm as good intentions”
Errors:
(3) Association is NOT causation
Watch Video: Freakonomics- polio cause
and effect
Errors:
(4) Fallacy of Composition
– Assumption: what’s good for the individual is
good for the group.
– Making this assumption is the fallacy.
– Watch Video: Seinfeld-Fire clip