Transcript Tools for Analyzing Economic Behavior Indifference Curves and

Introduction
History of Economic Thought
Evolution of Economic Ideas Economic Research
Role of Scientific Researchers
History of Economic Thought
•Aristotle’s condemnation of the use of
money in the exchange of commodities.
1200-1500 •Scholastic writings providing insight
into the functioning of the developing
Western European economy.
1500-1750 •Pamphlets on particular questions of
economic policy written mostly by
business men with practical knowledge
of institutions and operation of the
economy.
1650-1750 •Emerged as a discipline.
1776
•Adam Smith, trained in moral
philosophy, shaped the economic
literature into political economics in his
Wealth of Nations.
300 BC
History of Economic Thought (continued)
1900-30
1930’s
1940-80
1980present
•Political economics became
“economics” and economics became
professionalized.
•The Great Depression increased
government involvement in economic
activity which spurred interest in
economic education.
•Most economists were academics
concerned with with abstract,
theoretical issues, rather than practical
economic issues.
•Methodologies for testing theories
advanced.
•Technology and increased data
availability facilitated the development
and tests of theories in new areas.
Evolution of Economic Ideas Economic Research
•Students and professors present their current
and/or recent research to other economists in
seminars and professional meetings.
•They refine their work, based on feedback about
their presentations, until it is suitable for
publication in economic texts and journals.
•Material in economic text books and journals are
the basis of economists’ education.
•Ideally, open competition among researchers
results in progressive research programs and the
rejection of incorrect ideas.
Role of Scientific Researchers
•Develop and logical theories that lead to
empirically testable propositions.
•Test the propositions.
•The theories become part of economic thought if
the results of the tests support the propositions.
•Tools for analyzing economic behavior are based
on generally accepted economic theories.
Tools for Analyzing
Economic Behavior
Supply and Demand
Indifference Curves and Budget Lines
Aggregate Supply and Demand
Aggregate Savings and Investment
Production Possibility Frontier
Tools for Analyzing Social
Behavior
Correlation Analysis
Regression Analysis
Tools for Analyzing Economic Behavior
Supply and Demand
Supply: the relationship between quantity supplied
and price of a well defined product, when all other
factors that affect quantity supplied are constant.
Quantity Supplied: the quantity that producers are
willing and able to sell at a given price level.
Demand: the relationship between quantity
demanded and price of a well defined product,
when all other factors that affect quantity demanded
are constant.
Quantity Demanded: the quantity that consumers
are willing and able to buy at a given price level.
Tools for Analyzing Economic Behavior
Supply and Demand
Supply Schedule
Price
Quantity
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Demand Schedule
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Tools for Analyzing Economic Behavior
Supply and Demand
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Tools for Analyzing Economic Behavior
Supply and Demand
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Tools for Analyzing Economic Behavior
Supply and Demand
Price $6
Demand
Price
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Supply
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Tools for Analyzing Economic Behavior
Supply and Demand
Price
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Quantity
Tools for Analyzing Economic Behavior
Supply and Demand
Supply: the relationship between quantity supplied
and price of a well defined product, when all other
factors that affect quantity supplied are constant.
Quantity Supplied: the quantity that producers are
willing and able to sell at a given price level.
Demand: the relationship between quantity
demanded and price of a well defined product,
when all other factors that affect quantity demanded
are constant.
Quantity Demanded: the quantity that consumers
are willing and able to buy at a given price level.
Tools for Analyzing Economic Behavior
Indifference Curves and Budget Lines
Indifference Curves: plot the combination of goods
that yield the same level of satisfaction to a
consumer.
Budget Line: Plots the combination of goods the
consumer can buy, given income and prices of the
goods.
Consumer Equilibrium: the combination of goods
on the budget line that that lies on the highest
possible indifference curve.
Tools for Analyzing Economic Behavior
Indifference Curves and Budget Lines
Example of Consumer Equilibrium:
Income = $100
P1 = $1
P2 = $5
The consumer can buy 100 units of good 1 by
spending all income on good 1.
The consumer can buy 20 units of good 1 by
spending all income on good 2.
Tools for Analyzing Economic Behavior
Quantity of Good 2
Indifference Curves and Budget Lines
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5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100
Quantity of Good 1
Tools for Analyzing Economic Behavior
Indifference Curves and Budget Lines
Labor Supply Decision
Leisure is a normal good.
Good 1 is Labor/Leisure.
Good 2 is income.
Income is the value of all goods (other than leisure)
the consumer can buy.
The slope of the budget line is the negative of the
wage rate.
The higher the wage rate, the steeper the budget
line.
Tools for Analyzing Economic Behavior
Indifference Curves and Budget Lines
Labor Supply Decision:Example
The consumer has 16 hours to either work or
consume as leisure.
Wage rate = $10.
Tools for Analyzing Economic Behavior
Income
Indifference Curves and Budget Lines
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Tools for Analyzing Economic Behavior
Income
Indifference Curves
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Budget
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Tools for Analyzing Economic Behavior
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Indifference Curves and Budget Lines
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Economics for the Real World
What is Thaler’s theory of mental accounting?
People estimate gains and losses in a way that can
lead to seemingly odd choices
What behavior of New York cab driver’s does
Thaler use to demonstrate the theory?
On busy days the cab drivers work fewer hours than
on slow days.
According to Thaler, is this behavior consistent
with traditional economic theory?
No. According to Thaler, economic theory dictates
that they should at least work a full day on busy days.
Do you agree with Thaler?
New York Cab Drivers
Income
Budget line on a good day
 Labor/Leisure
New York Cab Drivers
Income
Budget line on a good day
 Labor/Leisure
Economics for the Real World
What is loss aversion?
Greater sensitivity to losses than too gains.
How is this demonstrated in investors behavior?
Investors are more likely to sell a stock when the
price increases than when the price decreases.
Is this consistent with economic theory?
P
Market for a Stock
Supply P 
P2
P1
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Q1
Q2
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Market for a Stock
P
Supply P 
P1
P2
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Q2 Q1
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Utility Function for a Loss Averse Individual
Utility
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Loss/Gain
Utility Function for a Loss Averse Individual
Utility
Utility gained by selling a stock
when the price increases by $10
above purchase price.
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-$10
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Loss/Gain
$10
Utility lost by selling a stock
when the price decreases by
$10 below the purchase price.
Economics for the Real World
How is loss aversion evident in employees behavior
concerning participation in 401k plans provided by
employers?
They are more likely to participate in presumptive
plans than in voluntary plans.
What is another way of explaining this behavior?
Hyperbolic discounting: a person is more likely to
continue participating in the plan than they are to
make the initial decision to participate.
Are these behaviors consistent with economic
theory?
Investment Programs
Presumptive Participation
Gross Income = $1,000
Investment Program Deduction = $50
Net Income w/o Opting Out = $950
Net Income Opting Out = $1,000
Gain from Opting Out = $50
Investment Programs
Voluntary Participation
Gross Income = $1,000
Investment Program Deduction = $50
Net Income w/o Participating = $1,000
Net Income with Participation = $950
Loss from Participating = $50
Utility Function for a Loss Averse Individual
Utility
Utility gained by opting out
of the investment program.
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-$50
.
Loss/Gain
$50
Utility lost by opting into
the investment program.
Utility Function for a Loss Averse Individual
Utility
Utility gained by a $10 wage increase.
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-10
.
10
Utility lost by a $10 wage decrease.
Loss/Gain
Utilit|y Function for a Loss Averse Individual
Utility
Utility gained by a 2% increase in
nominal wage rate when inflation is 5%.
.
-1%
.
% Nominal Wage
2%
Utility lost by a 1% decrease in nominal
wage rate when inflation is 2%.
The change in the real wage
rate is -1% in both cases.
Economics for the Real World
What are the implications for employers’ cost
cutting strategies?
Employees are less likely to complain about wage
increases that are are below inflation, than to complain
about nominal wage decreases that result in the same
change in the real wage rate.