Thinking Like
an Economist
what is Economics
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Thinking Like an Economist

Economists:
– People who specialize in economics
– People who have extensive knowledge in
economics
– http://nobelprize.org/nobel_prizes/economics/laure
ates/

Economics:
– Subject about the economy

Economy:
– A system that coordinates economic activities
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Core Economic Activities
 Production:
–Transforming inputs into outputs
–Using resources to get products
 Inputs (resources): L, K, N, etc
 Output (products): goods and
services
 Technology: the body of knowledge
and techniques used in the process
of transforming inputs into outputs
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Scarcity:
The basis of all economic problems

Goal:
– satisfy human needs and wants
• Unlimited

Means: resources
– L, K, N, E
• Limited
Principle of Scarcity

Scarcity: resources available are not enough
to satisfy all human needs and wants

Since we have boundless needs and wants,
but the resources available to us are limited,
or the resources are not enough relative to
our needs and wants. Therefore, having more
of a good thing usually means having less of
another.

When getting something good, there is
always sacrifices involved.
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Final Purpose of Production

To satisfy consumer desires (needs and
wants):
– To create what people want
– To get what people want to the people who
want them
– To get what people want to who want them
when they want them
Economics: Redefined

Economics is the subject that studies
how to allocate and utilize the limited
resources to produce goods and
services that best satisfy the various,
unlimited, competing human desires
What to Do under Scarcity?

Having more of a good thing means
having less of another
– Choose

How to make choices?
– Compare cost and benefit of having more
of a good thing

Cost-benefit analysis: compare the
extra cost to the extra benefit of taking
an action
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Principles of Cost-Benefit Analysis

Compare marginal cost to marginal benefit:
– If MC < MB, should take the action
– If MC > MB, should not take the action

Not to compare average cost to average benefit
Higher average benefit does not mean higher extra
benefit
 Marginal cost / benefit:
 the increase in total cost / benefit that results from taking
one additional unit of an activity
 The additional cost incurred / benefit gained when taking
one more unit of an activity
 The extra cost / benefit from taking an action
 Average cost / benefit:
 The total cost / benefit of undertaking N units of an activity
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Principles of Cost-Benefit Analysis

Should consider opportunity cost (example 1.3)
– The value of the next-best alternative that has to
be forgone in order to take an activity
– the value of the next best alternative sacrificed
– the value of what must be given up to get what
you decide to have
– The implicit value of the activity that did not
happen
• The Value of best alternative, not combined value of
all alternative
• “The dog that did not bark in the night ”
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Principles of Cost-Benefit Analysis

Should not consider sunk cost (example
1.4)
– A cost that is beyond recovery at the time
when a decision must be made
– Irrelevant to the decision of whether or not
to take an action
• The only costs to consider when making a
decision about whether or not to take an action
are those that we can avoid by taking no action
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Recap: Cost-Benefit Principle

Economic Surplus:
– The benefit of taking an action minus the
cost of taking the action

Cost-benefit analysis:
– An action should be taken if and only if the
extra (marginal) benefit of taking the action
is at least as great as the extra (marginal)
cost of taking the action
– An action should be taken if and only if the
economic surplus is non-negative
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Economist: specializes in Economics

Economics:
– A study of mankind in the ordinary
business of life
– How to use limited resources to satisfy
needs and wants as many and best as
possible
•
•
•
•
mainly concerned with ordinary things
not the body of concrete truth
a way of thinking
an engine for the discovery of concrete truth.
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Economics:
a science of decision-making
Economic activities require decision
making
 Decision making because choices
have to be made
 Choices because resources are
scarce relative to human needs and
wants
(Scarcity Principle)

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Choices to make:

what and how many
– Should I spend the money on a movie or on a dinner?
– Should the firm product chips for handphone or for computer?
– Should the country encourage more investment or more
consumption?

How
– How goods and services are produced?
– How does the economic system work?
– When and why economic system does not work?
– When do people become counterproductive?

For whom
– How should the results of economic growth be distributed?

…
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Basic Fields of Economics:Macro vs. Micro

Macroeconomics:
– overall ups and downs of the national economy
•
•
•
•

GDP, growth, inflation, unemployment,
International trade. International finance
Monetary policies, fiscal policies
…
Microeconomics:
– how individuals make decisions and how these
decisions interact
• individual consumers and producers as decision
makers
• single products
• single
market
•…
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Microeconomics

Individual decisions about what to do and what not to
do.

Decisions about production and consumption made by
individual firms and consumers (market economy)

How individuals’ pursuit of self interest leads to good
results as a whole (the invisible hand).

Market usually leads to efficiency, but not necessarily
equity.

When market fails, it calls for government interventions.

Proper “incentives” may help reach society’s goals.
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Homework

Exercise 1.6, P. 18 (Optional, extra credit)
– In 500 words or less, use cost-benefit analysis to
explain some pattern of events or behavior you
have observed in your own environment.
– Due Monday, 3/8/2010

Reading: REQUIRED
– Chapter 1: Thinking Like an Economist
– Appendix to Chapter 1: Working with Equations,
Graphs, and Tables
– Chapter 2: Comparative Advantage: the Basis for
Exchange
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