Chapter 1
The Economic Approach
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Overview
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Basic terms and definitions
Eight guideposts to economic thinking
Positive and normative economics
Four pitfalls to avoid in economic thinking
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What is Economics?
Economics is the study of how we make
choices under scarcity.
1. Choice – The act of selecting among
alternatives
2. Scarcity – The concept that there is less
of a good freely available from nature
than people would like.
ex. time, money, cars, etc.
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Scarcity
A. Scarcity is not the same thing as poverty
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Scarcity
B. Scarcity necessitates rationing
a. Rationing – Allocating scarce goods
to those who want them.
b. In a market economy, price is used
to ration goods
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Scarcity
C. Scarcity leads to competitive behavior
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What do we do in the face of
scarcity?
When will the world run out of oil?
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Resources
Resources: An input used to produce an
economic good
1. Human resources (human capital)
2. Physical resources (physical capital)
3. Natural resources
Capital: Human-made resources used to
produce other goods and services.
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Example of Human Capital
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The Economic Way of Thinking
Things are not always as they appear:
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8 Guideposts to Economic Thinking
1. Resources are scarce so trade-offs must
be made (No such thing as a free lunch).
Opportunity Cost: The highest valued
alternative that must be sacrificed when
choosing an option
ex. An hour of your time
ex. how you spend your next $15
ex. Airbags vs. AIDS research
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8 Guideposts to Economic Thinking
2. Individuals are rational: they try to get
the most from their limited resources.
“greatest benefit at least possible cost”
ex. Beer or liquor
Note: What is rational for one person
may not be rational for everyone
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8 Guideposts to Economic Thinking
3. Incentives matter: choice is influenced in
a predictable way by changing incentives
ex. Money game
ex. Killer seatbelts
ex. Prices
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8 Guideposts to Economic Thinking
4. Individuals make decisions at the margin
Marginal: Describes the effect of a change in
the current situation
ex. Ponderosa Buffet
ex. Supersizing your extra value meal
ex. Drive or Fly
*Cost-benefit analysis: one will undergo an
action when the marginal benefits outweigh the
marginal costs*
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8 Guideposts to Economic Thinking
5. Information helps us make better choices,
but is costly.
ex. New car vs. New pencil
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8 Guideposts to Economic Thinking
6. Beware of secondary effects: economic
actions generate both direct and indirect
effects
Secondary effect: the indirect impact of
an event or policy that may not be easily
and immediately observable.
ex. Yacht tax
ex. Trade restrictions
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8 Guideposts to Economic Thinking
7. The value of a good or service is subjective:
ex. FSU Football Tickets
ex. How much would you pay for a bottle of
water right now?
Moving goods and services to those who value
them most is a primary source of economic
progress.
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8 Guideposts to Economic Thinking
8. The test of a theory is its ability to predict
If real world events are consistent with a
theory, then that theory is valid
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Testing Theories
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Positive vs. Normative Economics
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Positive economics: the scientific study
of what is (testable)
Normative economics: Judgments
about what ought to be (not testable)
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4 pitfalls to avoid in economic
thinking
1. Violation of ceteris paribus principle
ceteris paribus: other things constant
ex. Buying Roses
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4 pitfalls to avoid in economic
thinking
2. The belief that good intentions guarantee
desirable outcomes
ex. Endangered species act
ex. Child resistant safety caps
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4 Pitfalls to avoid in economic
thinking
3. The belief that association is causation
ex. Superstitions
ex. Initials and performance
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4 Pitfalls to avoid in economic
thinking
4. Fallacy of composition: belief that what is
true for one might be true for all
ex. Standing at a football game
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The Economic Way of Thinking
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Microeconomics vs.
Macroeconomics
Microeconomics: focuses on how human
behavior affects the conduct of affairs
within individually defined units such as
households or firms (the trees)
Macroeconomics: focuses on how human
behavior affects outcomes in highly
aggregated markets such as the nations
market for labor (the forest).
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Review
1. What is scarcity
2. What are the 8 guideposts to economic
thinking
3. Positive vs. Normative economics
4. What are the 4 pitfalls to avoid in
economic thinking
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