Economics and Economic Reasoning pptx

© 2003 McGraw-Hill Ryerson LimitedWhat Economics Is ◆ The following are the five important things to learn in economics cont’d: ● Information about economic institutions ● Information ab

Economic Reasoning

© 2003 McGraw-Hill Ryerson Limited

What Economics Is

◆ Economics is the study of how human beings coordinate their wants and

desires, given the decision-making

mechanisms, social customs, and

political realities of the society

What Economics Is

◆ One of the key words in the definition of the term “economics” is coordination

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What Economics Is

◆ Three central coordination problems

any economic system must solve are:

● What, and how much, to produce.

● How to produce it.

● For whom to produce it.

What Economics Is

◆ Scarcity ensues because individuals

want more than can be produced

● Scarcity – the goods available are too few

to satisfy individuals’ desires.

● Wants are unlimited, but resources are

limited

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What Economics Is

◆ The following are the five important

things to learn in economics:

● Economic reasoning.

● Economic terminology.

● Economic insights economists have about

issues, and theories that lead to those insights.

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What Economics Is

◆ The following are the five important

things to learn in economics (cont’d):

● Information about economic institutions

● Information about the economic policy options facing society today.

A Guide to Economic

Reasoning

◆ Economic reasoning is making

decisions by comparing costs and

benefits

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Marginal Costs and

Marginal Benefits

◆ The relevant costs and benefits to

economic reasoning are the expected

incremental or additional costs incurred

and the expected incremental or

additional benefits of a decision.

Marginal Costs and

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Marginal Costs and

Marginal Benefits

◆ Marginal cost = the additional cost to you over and above the costs you have already incurred

● This means eliminating sunk costs – costs that have already been incurred and cannot be recovered.

Marginal Costs and

Marginal Benefits

◆ Marginal benefit = the additional

benefit above and beyond what you’ve already accrued

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Marginal Costs and

● If the marginal costs of doing something

exceed the marginal benefits, don’t do it.

Economics and Passion

◆ Economic reasoning is based on the

premise that everything has a cost

◆ Reasonable economic solutions are

often not the most popular, as economic reasoning may take some passion out

of life

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Opportunity Cost

◆ Opportunity cost – the basis of

cost/benefit economic reasoning; it is a cost of the activity you have chosen

measured by the benefit foregone of the next-best alternative

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Opportunity Cost

◆ Opportunity costs are not limited to

individual decisions but to government decisions as well

Opportunity Cost

◆ The opportunity cost concept applies to all aspects of life and is fundamental to understanding how society reacts to

scarcity

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Economics and Market Forces

◆ When goods are scarce, they must be rationed

● Rationing is a mechanism chosen to determine who gets what.

Economic and Market

Forces

◆ One of the important choices that a

society must make is to what extent

economic forces are allowed to function freely

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Economic and Market

Forces

◆ A market force is an economic

circumstance that is given relatively free

rein by society to work through the market.

● Market forces ration by changing

prices.

Economic and Market

Forces

◆ Economic reality is controlled by three forces:

● Economic forces (the invisible hand).

● Social and cultural forces.

● Political and legal forces.

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Economic and Market

Forces

◆ Economic forces:

● The invisible hand is the price mechanism—the rise and fall of prices—that guides our actions in a market.

● When there is a shortage, the price goes up.

● When there is a surplus, the price goes down.

Economic and Market

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Economic Insights

◆ General insights into how economies

work are often based on economic

theory

● Economic theory – generalizations about the workings of an abstract

economy.

Economic Insights

◆ Theory ties together economists’

terminology and knowledge about

economic institutions and leads to

economic insights

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Economic Insights

◆ Because theories are too abstract to

apply to specific cases, a theory is often embodied in an economic model or an economic principle

● Economic model – a framework that places the generalized insights of the theory in a

more specific contextual setting.

Economic Insights

◆ Because theories are too abstract to

apply to specific cases, a theory is often embodied in an economic model or an economic principle

● Economic principle – a commonly held insight stated as a law or general

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Economic Insights

◆ Theories, and the models and principles used to represent them, are abstract but efficient, means of conveying

information

Economic Insights

◆ In order to understand the theory you

must understand the assumptions

underlying the theory

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The Invisible Hand

The Invisible Hand

Theory

◆ This insight is called the invisible hand theory – a market economy through the price mechanism will allocate resources efficiently

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Economic Theory and

Microeconomics and

Macroeconomics

◆ Economic theory is divided into two

parts: microeconomics and

macroeconomics

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Microeconomics

◆ Microeconomics is the study of

individual choice, and how that choice is influenced by economic forces

◆ Microeconomic theory considers

economic reasoning from the viewpoint

of individuals and firms and builds up

from there to an analysis of the entire

economy

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Microeconomics

◆ Microeconomics studies such things as: pricing policy of firms, households’

decisions on what to buy, and how

markets allocate resources among

alternative ends

◆ Microeconomics analyses from the

parts to the whole

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Macroeconomics

◆ Macroeconomics is the study of

inflation, unemployment, business

cycles, and economic growth

◆ Macroeconomics analyzes from the

whole to the parts

Economic Institutions

◆ Corporations, governments, and cultural norms are all economic institutions

They differ significantly among nations

◆ Economic institutions sometimes seem

to operate in ways quite different than

economic theory predicts

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Economic Institutions

◆ In applying economic theory to reality, you must know about economic

institutions

Economic Policy

Options

◆ Economic policies are actions taken

by government to influence economic

actions

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Economic Policy

Options

◆ Those who wish to carry out economic policy effectively must understand how institutions might change as a result of the economic policy

Objective Policy

Analysis

◆ Good objective policy analysis keeps

the value judgments separate from the analysis

◆ Subjective policy analysis is that which reflects the analyst’s view of how things should be

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Objective Policy

Analysis

◆ In order to make the distinction between objective and subjective analysis clear, economists have divided economics

into three categories

● Positive economics

● Normative economics

● Art of economics

Objective Policy

Analysis

◆ Positive economics is the study of

what is, and how the economy works

work, what are the consequences of rent control

on the market for housing, and are the costs of having children related to family income?

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Objective Policy

Analysis

◆ Normative economics is the study of what the goals of the economy should be

Objective Policy

Analysis

◆ Normative economics is the study of what the goals of the economy should be

● Examples include: people on welfare should work in order to get benefits, inherited wealth should be

taxed more heavily, and corporations should not be allowed to move their facilities overseas unless it is agreed to by labor unions.

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Objective Policy

Analysis

◆ Art of economics is the application of the knowledge learned in positive

economics to the achievement of the

goals determined in normative

economics

Objective Policy

Analysis

◆ Maintaining objectivity is easier in

positive economics – harder in

normative economics

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Objective Policy

Analysis

◆ It is hardest to maintain objectivity in the art of economics since it embodies the problems of both positive and normative economics

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Policy and Social and

Political Forces

◆ The choice of policy options depends

on more than economic theory

◆ Political and social forces must be taken into account when applying economic

theory to reality

Economic Reasoning