Econ 1 - Inputting Perm Number
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Power on your Clicker
When Autoscan begins, press * to stop it
Press * to display Setup Menu
Scroll ↓ or ↑ to display the ID: menu option
Press green key with arrow (→) to select it
Input your perm number
Press green key with arrow (→) to save
“Joining”
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Power on clicker
Clicker scans classes
Hit “D” to direct clicker to this class
When you see EC1Camp, press green key
with arrow to join
Clicker Practice
A) I have a clicker and it is working.
B) I have a clicker and I hope it works.
C) I don’t have a clicker, but when I pull my
left ear…
Do You Expect to Score Above
Average on the Final?
• A. Yes
• B. No
Will Your Neighbor (to the Right)
Score Above Average on the Final?
• A. Yes
• B. No
Which of the following is true?
A) I hope to major in economics or business
economics
B) I am majoring in a different subject and
am required to take an economics
course
C) I am majoring in a different subject. I am
not required to take economics but
decided to try it.
D) I don’t know what I will major in.
This year I am a
A)
B)
C)
D)
E)
Freshman
Sophomore
Junior
Senior
Other
Where did you go to high school?
A) In California, North of Santa Barbara
B) In California, Santa Barbara or South of
Santa Barbara
C) In U.S., outside of California
D) Outside of U.S.
Thinking like an economist
People trained in economics think differently
about some things.
• Avoiding percentage confusion
• Distinguishing average from marginal
• Accounting for Opportunity Cost
• Thinking clearly about Sunk Costs
Percentages and absolutes
A piece of software costs $40 at the
bookstore. You can get it at a 25%
discount in downtown Santa Barbara.
A laptop computer costs $1000 at the
bookstore. You can get it for $990 in
downtown Santa Barbara.
Would you drive downtown for the software?
For the computer?
Same saving either way
• Rational answer is either Yes for both or
No for both.
• Same as the answer to “Would you drive
downtown to save $10.
• Many people are fooled by the “framing” of
a problem. Economists try to see through
to the essentials.
More percentages
• A publisher raises his textbook price from
$90 to $120, a 30% increase.
• A spokesperson explains that the reason
they had to do this is because printing
costs increased by 50% when he moved
to four-color printing.
What is wrong with this argument?
• Price of book went up by $30.
• Total printing cost of book is less than $10.
A 50% increase in printing costs is less
than $5 per book.
• Lesson: when people start flinging around
percentages, ask “Percent of what?”, then
convert to absolute numbers to see what
is really going on.
Opportunity Cost
• Opportunity cost of a resource is the value of its
next best use.
• You were given a free frequent flyer ticket that
you could use to fly to Paris over spring break.
• Roundtrip airfare to Paris is $1000.
• If you don’t use the ticket to fly to Paris, you
would use it to fly home. Roundtrip fare home is
$600
• What is the opportunity cost of flying to Paris?
Answer
• Opportunity cost is $600. This is the value
of the next best use of your frequent flyer
ticket.
• It is unrelated to what you paid for the
ticket--$0
• It is unrelated to price of flying to Paris so
long as that is more than $600.
• Fly to Paris if and only if it is worth more
than $600 to you to do so.
Average and Marginal
• NASA supporter estimates gains from
current space shuttle are $24 billion per
year from 4 flights.
• Total costs are $20 billion per year.
• Does this imply that more flights would be
justified?
Not necessarily
• We know that average benefit is $24/4=$6
And that average cost is $20/4=$5.
But what would be the gain from an
additional flight and what would be the
cost?
Relevant comparison is marginal benefit and
marginal cost.
Basketball example
• Player A makes 60% of the shots that he
attempts.
• The team average is only 40%.
• Does this imply that Player A should be
encouraged to shoot more often?
Not necessarily
• If Player A takes more shots, these will be at
times when he is better guarded. It may be that
his success percentage would be much lower on
these shots.
• The relevant comparison is whether a marginal
shot by A is more likely to be made than a
marginal shot by B.
• Extra consideration. If A takes more shots he
will probably be guarded more carefully and
have fewer easy shots.
Sunk Costs
• You have spent $500 on a nonrefundable
airline ticket to a vacation spot over spring
break. As the time arrives, you are not
feeling well and you have a lot of work to
do. You reluctantly decide to go
“because otherwise the $500 would be
wasted.”
• Is this a mistake?
It depends
You regret having bought the ticket, given how
you feel now. You ask yourself the following
question:
• Suppose I had not bought the nonrefundable
ticket, but was offered a free ticket to that
destination today. Would I go?
A) What if the answer is yes?
B) What if the answer is no?
Rational answer
• If you regret buying the nonrefundable
ticket but would use a free ticket, then you
should go.
• If you wouldn’t use a free ticket, you
shouldn’t go.
Housing Slump
• When the housing market slumps, houses
sell much more slowly than in boom times.
• Why is that? Sellers don’t want to accept
the reality that their house is not worth as
much as it was a year ago.
• But value a year ago is not relevant if you
want to sell in the future.
• See New York Times column by Goolsbee
on class website. Also see Mankiw blog.
Another situation
• You are a middle manager. You approved
a costly project whose prospects seemed
good when you started.
• Half of the money has been spent when
bad news arrives about the project.
• The probability is 2/3 that any more money
plowed into the project will be wasted and
1/3 that the project will pay back further
investment.
Rational decision-maker
• If you had not spent the first half of the
money, you would not choose to assume
the risk of the second half.
• Should you cancel the project after having
spent half the money.
• Rationality says Yes.
Face-saving tactics
• Suppose that if you cancel the project, you
will be fired for having started a failing
project.
• If you “stay the course”, there is a chance
of 1/3 that the project will succeed and you
will be praised and a chance of 2/3 that
the project will fail and you are fired.
• What will a self-interested manager do?
Agency problem
• Manager in this example is acting
rationally in his own behalf, but not
rationally on behalf of owners’ interests.
• Owners’ interest is for him to cancel the
project.
“Stay the course” vs “Cut and run”
• Does sunk cost reasoning help us to
reason about the Iraq War controversy?
• Recognize fallacious arguments:
A) We should stay in Iraq because otherwise
4000 U.S. soldiers will have died in vain.
B) Iraq was a terrible mistake. Therefore we
should get out now.
Forward-looking planning
• Relevant questions are of this kind:
• Do the benefits from a “surge” in troops in
Iraq exceed the costs?
• Regardless of whether we should have
invaded Iraq, do the benefits from keeping
troops there exceed the costs?
Analogy to middle-manager
example
• Is President Bush caught in the dilemma
of the middle manager in our earlier
example?
• Is he advocating increased investment in a
bad project, just to avoid admitting failure
while hoping for some very unlikely good
luck?
See you next time…