Chapter 1, Lesson 2
• How do you define theory?
• Using that definition, what is “economic theory”?
• Economic theory: economic model; simplification of economic reality
used to make predictions about the real world
• For example, what happens to consumption of Pepsi when price
increases?
• Economists make simplifying assumptions
• Other-things-constant assumption: assume nothing else of
importance changes – that other things remain constant
• Example: want to see how change in price of Pepsi affects
amount purchased
• Isolate relationship between two variables (price and
amount purchased) by assuming there are no changes in
other relevant variables like consumer income or price of
Coca-Cola
• Behavior assumption: how people make choices based on selfinterest
• you select alternatives you perceive to be in your best
interests
• Rational self-interest means that you try to maximize the
expected benefit achieved with a given cost or to minimize the
expected cost of achieving a given benefit
• Self-interest often includes welfare of family and friends
• Concern for others is influenced by your personal cost of that concern
• Example: You may volunteer to take the dog out before you leave for
school, but are less likely if you are asked to do so at 4 a.m.
• The lower your personal cost of helping others, the more help you will
offer
• Rationality also implies each firm supplies products expected to
maximize firm’s profit
• Also behavioral assumptions because they specify how economic decision
makers are expected to behave
• Your Turn: Give examples of choosing actions that are
based on your rational self-interest, yet pose some
sort of cost to you in the process
• Four groups of six-to-seven
• Each group will read on individual section of this article
• Groups will summarize respective section using three bullet
points minimum
• Create summary of section using markers and poster board
at front of room
• Be creative, use pictures, and PROVIDE APPLICABLE
EXAMPLES!
• Everyone uses some sort of theory, although they may not even
realize it
• Example: Pounding on vending machine so quarter will go where it needs
to, but not knowing the actual intricacies of how a vending machine
actually works
• Economists explain theories by telling how they think the economy
works based on case studies and personal experience, as well as
supporting data
• Questions: Think of some theories you have
• Write down three questions that would determine whether or not others
hold the same theories
• If so, what is the theory on which you agree?
• If not, why do you disagree?
• Normative: reflects someone’s opinion
• “The U.S. unemployment rate should be lower”
• Cannot be shown true or false by reference to facts
• Positive: statement about economic reality that can be
supported or rejected by reference to facts
• “The U.S. unemployment rate is 9%”
• Need not be true, but can find out if they are or are not by referring to
facts
• Most disagreements among economists center around normative statements
• Think about an argument you have had with your siblings, parents, or
friends
• Write down the situation in your notebooks
• Then share this argument with the person sitting next to you
• Your partner must identify whether the argument was based on a
normative statement or positive statement that can be supported
by facts
• BE PREPARED TO DISCUSS!
• Fist of Five:
1.
2.
3.
4.
5.
No idea
Uncertain and shaky
Comfortable
Would test well and relatable
Can teach to someone else
• What is a common element behind every decision you make?
• Economic choice involves some adjustment to existing situation
• Example: jeans on sale and you must decide whether to buy another pair,
or you have just finished dinner at a restaurant and decide whether to eat
dessert
• All economic choice is based on comparison of expected marginal benefit
and expected marginal cost of action under consideration
• Marginal: incremental, additional, extra
• Change in the status quo
• Rational decision-maker will change status quo as long as
expected marginal benefit from change exceeds expected
marginal cost
• Pair & Share: What are the marginal benefits and marginal
costs of eating dessert?
• What are larger marginal choices that you make that have a
large impact on the economy?
• What about for a corporation?
• Draw examples of both that your classmates must solve
themselves through Pictionary
• After you solve, then identify both the marginal benefit and
marginal cost of each decision
• What is the better option, in your opinion?
• Rational choice takes time and requires information, yet both
are scarce and, thus, valuable
• Often willing to pay others to gather and digest information
for you
• Example: college guides, travel agents, real estate
brokers…what are other examples?
• Rational decision-makers will continue to acquire information as
long as the marginal benefit from that information exceeds the
marginal cost of gathering it
• How many of you have thought about your economic behavior
this in-depth before?
• Microeconomics: focuses on one’s economic behavior and
behavior of other individuals and firms who make choices
involving what to buy and what to sell, how much to work and
how much to play, how much to borrow and how much to save
• Macroeconomics: focuses on performance and economy
as a whole, especially the national economy
• Micro: individual pieces of economic puzzle
• Macro: fits pieces together to look at big picture
• Four types of decision makers in economy:
1. Households
2. Firms
3. Governments
4. Rest of world
• Interaction between all determine how economy’s
resources are allocated
• Households play leading role in economy
• Demand goods and services produced
• Own resources, so therefore supply resources used to produce goods and
services
• Firms, governments, and rest of world demand resources that
households supply
• Use those resources to supply goods and services households demand
• Rest of world includes foreign households, foreign firms, and foreign
governments that supply resources and products to U.S. markets and
demand resources and products from U.S. markets
• Markets: means by which buyers and sellers carry out exchange
• Bring together two sides of exchange, demand and supply,
means price and quantity are determined
• Think, Ink, Pair, Share: Where are marketplaces that you know
of?
• Why is this considered a marketplace?
• Goods and services bought and sold in product markets
• Resources are bought and sold in resource markets
• Most important resource market is labor, or job, market
• Circular flow model: describes flow of resources, products,
income, and revenue among economic decision makers
• Depicts interaction among households and firms in a market
economy
• Households on left, firms on right
Households
• Supply: human resources,
natural resources, and
capital goods to firms
through resource markets
(lower portion of figure)
• Demand: goods and
services from firms through
products markets (upper
portion of figure)
Firms
• Supply: goods and
services to households
through product markets
• Demand: human resources,
natural resources, and
capital goods from
households through
resources markets
• Begin to sketch a circular flow model with a partner by using an
example of a firma and households working together
• You must include the following elements:
•
•
•
•
•
•
Households
Firms
Resource Market
Product Market
Natural, Human, and Capital Resources
Goods and Services
• Keep room for yourselves, as you will be adding to this!
• Flows of resources and products supported by flows of income
and expenditure – the flow of money
• Supply and demand for resources determine what firms pay for
resources
• Resource prices – wages, interest, rent, and profit – flow as income to
households
• Supply and demand for products determine what households
pay for goods and services
• Prices paid for goods and services flow as revenue to firms
• Finish your own circular-flow model with a partner by adding
the following:
• Resource prices (include all)
• Product prices
• Exit Ticket:
• How are your everyday decisions “economic” decisions?
• Will you put more thought into the decisions you make going
forward?
• If so, how?
• If not, why not?