Macro 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
Do you think Americans are better
off today than they were 100 years
ago?
How would you determine or measure
this? What’s the criteria?
Watch Video: Stossel Macro 01-Is life
getting worse?
Some criteria to consider:
Life expectancy (years)
1900-1920
2007-2011
47
78
Infant mortality (deaths per 1,000 live births) 100
6.7
Real Per capita GDP
$4,800
$46,350
High school completion (percent of adults)
22
90
Electrification (percent of US households)
8
99
Here’s someone who thinks we’re
much better off today
Watch Video: Louis CK- technology
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
In his Nobel address, [Gary] Becker suggested that the
economic approach is not a subject matter, nor is it a
mathematical means of explaining “the economy.”
Rather it is a decision to examine the world a bit
differently. It is a systematic means of describing how
people make decisions and how they change their
minds; how they choose someone to love and marry,
someone perhaps to hate and even kill; whether, coming
upon a pile of money, they will steal from it, leave it
alone, or even add to it; why they may fear one thing and
yearn for something only slightly different; why they’ll
punish one sort of behavior while rewarding a similar
one.”
Optional Video: RSAnimate-Freakonomics
Alfred Marshall:
Political Economy or Economics
is a study of mankind in the
ordinary business of life; it
examines that part of individual
and social action which is most
closely connected with the
attainment and with the use of
the material requisites of
wellbeing.
What does the term “scarcity” or
“scarce” mean to you?
Can we eliminate scarcity?
If we can’t, what must we do?
Scarcity and Tradeoffs
Scarcity leads to tradeoffs which result in
making choices
Scarcity and Tradeoffs
Thomas Sowell: “We cannot opt out of
economic issues and decisions. Our only
options are to be informed, uninformed, or
misinformed, when making our choices.”
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.
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
Reading: Robert Frost-The road not taken
(1) There are always tradeoffs.
There is no such thing as a free lunch!
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-Incentives
for real estate agents
Optional Video: RSAnimate-surprising
truth about what motivates
(4) Think on the margin, not in total
or on average
Marginal means additional or incremental
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
(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
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.
(8) Economic thinking is scientific
thinking
Class Activity: Do you believe that students who
regularly attend class earn higher grades? How
could you prove (or disprove) that?
Reading: David Romer- “Do students go to
class? Should they?”
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”
Steven Levitt & Stephen Dubner
Super Freakonomics
In the United States especially, politics
and economics don’t mix well. Politicians
have all sorts of reasons to pass all sorts
of laws that, as well-meaning as they may
be, fail to account for the way real people
respond to real-world incentives.
Errors:
(3) Association is NOT causation
Watch Video: Freakonomics- parenting
causation vs correlation
Errors:
(4) Fallacy of Composition
Assumption: what’s good for the individual
is good for the group.
Making this assumption is the fallacy.