Transcript (1)

Introduction
Rhesus monkeys are willing to forgo 10% of their
“income” of cherry juice to examine photos of leading
and attractive members of their group.
This behavior mirrors our willingness to purchase
celebrity magazines.
Nevertheless, economists who study making choices in
response to rewards or inducements, propose some are
willing to pay to be viewed by others as leading and
attractive members of our society.
What can economists tell us about why people purchase
items that attract attention such as flashy sports cars or
designer clothing?
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Learning Objectives
• Discuss the difference between
microeconomics and macroeconomics
• Evaluate the role that rational selfinterest plays in economic analysis
• Explain why the study of economics
is a science
• Distinguish between positive and
normative economics
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Chapter Outline
• The Power of Economic Analysis
• Defining Economics
• Microeconomics versus Macroeconomics
• The Economic Person: Rational Self-Interest
• Economics as a Science
• Positive versus Normative Economics
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Did You Know That ...
• Six of seven main U.S. railroad lines
meet in Chicago?
• The bottlenecks these lines caused
created incentives to lay more track?
• Incentives are the underpinnings for all
the decisions you and others make?
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The Power of Economic Analysis
• Incentives
 Rewards for engaging in a
particular activity
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The Power of Economic
Analysis (cont'd)
• The economic way of thinking is a
framework to analyze solutions to
economic problems.
 How much time to study
 Choosing which courses to take
 Whether troops should be sent abroad
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The Power of Economic
Analysis (cont'd)
• The economic way of thinking gives you
the power—the power to reach
informed conclusions about what is
happening in the world.
• Economic analysis helps you make
better decisions, and increases your
understanding when watching or
reading the news on the Web.
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The Power of Economic
Analysis (cont'd)
• Economic analysis is a way of thinking
about all decisions.
 Your education, career, financing your
home, family
 Your involvement in the business world, or
in politics as a voter
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Defining Economics
• Economics
 The study of how people allocate
their limited resources to satisfy their
unlimited wants
 The study of how people make choices
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Defining Economics (cont'd)
• Resources
 Things used to produce other things to
satisfy people’s wants
• Wants
 What people would buy if their incomes
were unlimited
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Defining Economics (cont'd)
• With limited income (resources),
people must make choices to satisfy
their wants.
• We never have enough of everything,
including time, to satisfy our
every desire.
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Defining Economics (cont'd)
• Individuals, businesses, and nations
face alternatives, and choices must
be made.
• Economics studies how these choices
are made.
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Microeconomics
versus Macroeconomics
• Microeconomics
 The study of decision making undertaken
by individuals (or households) and by firms
 Like looking though a microscope to focus
on the smaller parts of the economy
 Decision
A
of a worker to work overtime or not
family’s choice of having a baby
 An
individual firm advertising
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Microeconomics
versus Macroeconomics (cont'd)
• Macroeconomics
 The study of the behavior of the economy
as a whole
 Deals with economywide phenomena
 The
national unemployment rate
 The
rate of growth in the money supply
 The
national government’s budget deficit
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Microeconomics
versus Macroeconomics (cont'd)
• Macroeconomics deals with
aggregates, or totals—such as total
output in an economy.
• Modern economic theory blends micro
and macro concepts.
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The Economic Person:
Rational Self-Interest
• Economists assume that individuals
act as if motivated by self-interest and
respond predictably to opportunities
for gain.
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The Economic Person:
Rational Self-Interest (cont'd)
“It is not from the benevolence of the
butcher, the brewer, or the baker that we
expect our dinner, but from their regard to
their own interest.”
—Adam Smith, An Inquiry into the Nature
and Causes of the Wealth of Nations, 1776
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The Economic Person:
Rational Self-Interest (cont'd)
• Rationality Assumption
 The assumption that people do not
intentionally make decisions that would
leave them worse off
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Example: “Neuroeconomics”
Explores the Rationality Assumption
• Economists want to know which parts of the
brain play the greatest role in determining an
individual’s choices.
• Brain scans reveal considerable coordination
between the limbic system (governing emotions)
and the prefrontal cortex (associated with reason
and calculation).
• There is evidence the brain attempts to factor in
reasoned calculations aimed at making a choice
consistent with the “best” overall outcome.
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The Economic Person:
Rational Self-Interest (cont'd)
• Questions
 Does the fact that some people make
apparently irrational choices invalidate the
rationality assumption in economics?
 Can economic models be applied to
situations in which behavior is at odds with
what we expect from rational people?
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The Economic Person:
Rational Self-Interest (cont'd)
• Responding to incentives
 Rationality and the use of incentives
 Positive
incentives
 Negative
incentives
 Making choices
 Balancing
cost and benefits
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The Economic Person:
Rational Self-Interest (cont'd)
• Some examples of incentives
 Responding to positive incentives
 Schoolchildren
getting gold stars, working to
have a “better life” for yourself
 Responding to negative incentives
 Penalties,
punishments, using credit cards to
avoid check overdrafts
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E-Commerce Example: Playing the Float
with Plastic Instead of Checks
• Checks used to take up to several days to clear.
• People would rush to make deposits to avoid
overdraft charges.
• Technological developments enhanced digital
imaging, and banks have reduced check float.
• This has provided incentives for more credit card
purchases—as they allow for deferred payment.
• How might high interest rates influence incentives to
use credit cards?
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The Economic Person:
Rational Self-Interest (cont'd)
• Defining self-interest
 The pursuit of one’s goals, does not
always mean increasing one’s wealth
 Prestige
 Friendship
 Love
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Example:
The Perceived Value of Gifts
• The perceived value of gifts
 Often, the recipient of the gift places a
value on it far less than the market value.
 Should we substitute gift certificates for
physical gifts?
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Economics as a Science
• Models or Theories
 Simplified representations of the real
world used as the basis for predictions
or explanations
A
map is the quintessential model
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Economics as a Science (cont'd)
• Assumptions
 The set of circumstances in which a model
is applicable
 Every model, or theory, must be based on
a set of assumptions.
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Example: Getting Directions
• A map is a simplifying model of reality.
• The degree of simplification varies
across maps; some contain more detail
than others.
• Economic models attempt to focus on
what is relevant to the problem at hand
and omit what is not.
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Economics as a Science (cont'd)
• Ceteris Paribus Assumption
[KAY-ter-us PEAR-uh-bus]
 Nothing changes except the factor or
factors being studied.
 “Other things constant”
 “Other things equal”
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Economics as a Science (cont'd)
• Economics is an empirical science.
 Real-world data is used to evaluate the
usefulness of a model.
 Models are useful if they predict economic
phenomena.
 Economic models predict how people
react, not how they think.
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Economics as a Science (cont'd)
• Behavioral Economics
 Approach to the study of
consumer behavior
 Emphasizes
psychological limitations
and complications which may interfere
with rational decision making
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Economics as a Science (cont'd)
• Bounded Rationality
 Hypothesis that people are nearly, not
fully, rational
 They
cannot examine every choice available
to them
 Use
simple rules of thumb to sort alternatives
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Positive versus
Normative Economics
• Positive Economics
 Purely descriptive statements or scientific
predictions; “If A, then B,” a statement
of what is
• Normative Economics
 Analysis involving value judgments; relates
to whether things are good or bad, a
statement of what ought to be
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Issues and Applications: Do People
Engage in Conspicuous Consumption?
• In 1902, economist Thorstein Veblin coined
the phrase conspicuous consumption.
• Ori Heffetz of Princeton University looked for
empirical evidence to support Veblin’s idea.
• Evidence showed higher-income people buy
visible items.
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Issues and Applications:
Do People Engage in
Conspicuous Consumption? (cont'd)
• Is conspicuous consumption for
real or just a rational response to
higher income?
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Summary Discussion
of Learning Objectives
• Microeconomics versus macroeconomics
 Economics is the study of how individuals make
choices to satisfy wants.
 Microeconomics is the study of decision making
by individual households and individual firms.
 Macroeconomics is the study of nationwide
phenomena, such as inflation and
unemployment levels.
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Summary Discussion
of Learning Objectives (cont'd)
• Self-interest in economic analysis
 Rational self-interest is the assumption
that individuals behave in a reasonable
(rational) way in making choices to further
their interests.
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Summary Discussion
of Learning Objectives (cont'd)
• Economics as a science
 Economists use models, or theories, that
are simplified representations of the real
world to analyze and make predictions
about the real world.
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Summary Discussion
of Learning Objectives (cont'd)
• The difference between positive and
normative economics
 Positive economics deals with what is,
whereas normative economics deals with
what ought to be.
 Positive statements are of the “if…then”
variety, while normative ask what “should,
or could” be.
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