Econ 100
Lecture 1.4
Ch. 1 Economic Way of Thinking
(Part II)
1-8-2009
Overview
• The economic way of thinking
– Narrow versus broad economics
• The CIA and Afghan warlords as an economic incentive problem
– Choice under constraint
– Summing Up
• A useful website
– http://ingrimayne.com/econ/Introduction/Overview1.html
Broad versus Narrow Economics
• Narrow economics
– Theory of behavior based on “incentives” is restricted
to analysis of human behavior in the marketplace
• E.g., impact of the “cow gas” tax
• Broad economics
– Incentives are not limited to economic incentives,
such as prices, taxes or income
– Behavior based on incentives is not restricted to only
markets
• E.g., CIA and Afghan warlords
Broad Economics
• Afghan warlords and Viagra
(http://www.telegraph.co.uk/)
– Whatever it takes to make friends and influence
people – whether it's building a school or handing out
Viagra," one veteran CIA officer told The Washington
Post.
– According to the newspaper, pills to boost the libidos
of Afghan tribal patriarchs are the latest in a long line
of inducements including medicine or operations for
family, toys and school equipment, tooth extractions
and visas
– The trick was to identify a means of pleasing the CIA
source enough to guarantee his loyalty without
making it obvious to others that he's being rewarded.
CIA and Economics
• Essentially this is an economic problem
– Goal is to maximize (or increase) the loyalty
of the Afghan warlords
• Subject to the constraint that they aren’t found out
to be collaborating with the US
– Need to design an incentive which meets:
• The objective function (loyalty), and
• The constraint (we don’t kill off our allies)
What is Economic
Theory Based On?
• “all social phenomena emerge from the actions and interactions of
individuals who are choosing in response to [maximizing] expected
benefits and costs” (Heyne) [under a constraint (e.g., time,
money, alternatives available)]
– Constraint  scarcity
• Scarcity: can’t have all of the things you want
– Even if you had unlimited income and no natural resource
constraints => time
• Without scarcity, there is no economic problem as no
one has to tradeoff some of one good for another
because of a monetary or income constraint
Another Way of Saying This
• Consumers
– Maximize their utility/satisfaction from consuming a number of
goods and services within the constraint of their budget/income
MaxU  U ( x, y )
subject to I  px Qx  p y Qy
– Where U(x,y) is the utility or value from consuming goods x and y
– Pi is the price of good i
– I is the consumer’s income
Follow the Math
• We will find that consumer will choose to consume Qx
and QY up to the point that:
MU x  Px and MU y  Py
Where MUi is the marginal utility (or value) of consuming good i
But you knew this already
So What is Economics?
• Economics is the study of the:
– Choices we make
– Constraints that we face
– Tradeoffs that are made because of scarcity
What is Economics?
• “Economic theory originated as a study or markets, of
complex exchange processes”
• Adam Smith, Wealth of Nations (1723-1790)
• “… developed to explain how order and cooperation
emerged from apparently uncoordinated interactions of
individuals pursuing their own interests in substantial
ignorance of the interests of those whom they are
cooperating”
• Adam Smith’s invisible hand
A Warning
• “Learning the mere techniques of
economic analysis is far easier than
master the art of applying them sensibly
and persuasively to actual social
problems” (Heyne, p.16)
• “..Economics does not furnish a body of
settled conclusions …It a method rather
than a doctrine, an apparatus of the
mind…” (Keynes)
Review/Discussion Questions
• Ch. 1
– #2, 6, 9, 12
A Useful Website for this Material
• Overview: Welcome to Economics!
• http://ingrimayne.com/econ/Introduction/Overview1.html
• After you finish this unit, you should be able to:
– Explain what the term "invisible hand" means and who first used
it.
– Give at least one common definition of economics.
– State what Malthus thought about population growth.
– Explain how Popper defines scientific statements.
– Distinguish between positive and normative statements.
– Explain what scarcity, choice, and self-interest have to do with
economics.