Thinking like an economist

Thinking Like An Economist Chapter Frank/Bernanke, Principles of Microeconomics “I’d like to introduce you to Marty Thorndecker He’s an economist but he’s really very nice.” Hi, I am Marty… Hi, I am Marty… Can we express yourself?  Suppose you had the chance to meet the Chief Executive in a cocktail party You were asked to express your opinion on minimum wage legislation in Hong Kong  How you express your views and convince him/her in five minutes? Can you express yourself?  Most students who take introductory economics leave the course without really having learned even the most important basic economic principles  Their ability to answer simple economic questions several months after leaving the course is not measurably different from that of people who never took a principles course.* *Hansen, W L., M K Salemi, and J J Siegfried (2002) “Use it or lose it: teaching economic literacy,” American Economic Review (Papers and Proceedings), 92 (May): 463-72 How we learn a new language Start simple Repetition and drill Active learning Have fun “How much is this?” Should there be 12 separate sections of Econ 101, with 25 students each? Or should there be only one section, with 300 students? What is the Optimal Class Size?  To maximize learning without consideration of cost?  How would considering costs change our answer?  A personal tutorial course in economics might cost $40,000  A class of 300 students might cost $200/student  Extreme case: a class of infinite students might cost less than $0.1/student  What trade-offs must university administrators and students consider when choosing class size? 10 Example 1.16 Should you move one of your boats from the east end to the west end? Average output per boat Number of boats East end West end 100 lbs/boat 130 lbs/boat 100 lbs/boat 120 lbs/boat 100 lbs/boat 110 lbs/boat 100 lbs/boat 100 lbs/boat Number of boats East end West end Total output 2 440 lbs 430 lbs 430 lbs 400 lbs 400 lbs 71 Example 1.16 Should you move one of your boats from the east end to the west end? Average output per boat Number of boats East end West end 100 lbs/boat 130 lbs/boat 100 lbs/boat 120 lbs/boat 100 lbs/boat 110 lbs/boat 100 lbs/boat 100 lbs/boat Marginal output per boat The n-th boat East end West end 100 lbs 130 lbs 100 lbs 110 lbs (= 240-130) 100 lbs 90 lbs (=330-240) 100 lbs 70 lbs (400-330) 72 Rules for allocating resources  The general rule for allocating a resource efficiently across different production activities is:  Allocate each unit of the resource to the production activity where its marginal benefit is highest  For a resource that is perfectly divisible, and for activities for which the marginal product of the resource is not always higher in one than in the others, the rule is:  Allocate the resource so that its marginal benefit is the same in every activity 73 Normative Economics vs Positive Economics  Normative Economic Principle  One that says how people should behave Example: Cost-benefit principle  Positive Economic Principle  One that predicts how people will behave Example: The incentives matter principle A person (or a firm or society) is more likely to take an action if its benefit rises and less likely if its cost rises 74 Economics: Micro and Macro  Microeconomics  The study of individual choice under scarcity and its implications for the behavior of prices and quantities in individual markets  Macroeconomics  The study of the performance of national economies, and of the policies that governments use to try to improve that performance 75 Economic Naturalism  Applications  Use cost-benefit analysis to explain some pattern of events or behavior you have observed in your own environment Start simple Repetition and drill Active learning – apply to real life phenomena 76 Economic Naturalism Observe things happening around us Ask interesting questions Provide plausible answers 77 Ask an interesting question  Why so many computer hardware manufacturers include more than $1,000 worth of “free” software with a computer selling for only slightly more than that? 78 Ask an interesting question  Why don’t automobile manufacturers make cars without heaters? 79 Ask an interesting question  Why the keypad buttons on drive-up automatic teller machines have Braille dots? 80 Ask an interesting question …  Why are round-trip fares from Hawaii to the mainland US higher than the corresponding fares from the mainland US to Hawaii? 81 Ask an interesting question …  Why is airline food so bad? 82 Ask an interesting question …  Why does a telecommunications equipment manufacturer offer “free” BMW sedans to employees with more than one year of service? BMW lease price was $9000/year Why not give employees $9000/year in extra salary instead? 83 Ask an interesting question … Why are foreign films so good? Criteria for choosing a film to see: Is it by a well-known director? Does it feature a favorite actor or actress? Has it gotten rave reviews in the media? Word of mouth? The only foreign films with a chance to make it in the HK market are really good ones—those able to generate strong reviews and word of mouth 84 End 85 [...]... scarcity and of the results of those choices for society  In a market system, allocation of resources occur via the price system, incomes and preferences 14 Rationality assumption and The Incentive Principle  People have goals and try to fulfill them as best as they can  The Incentive Principle: An agent (person, firm or society) is more likely to take an action if its benefit rises, and less likely... your ticket and discover that you have lost a $100 bill from your wallet Do you buy a ticket and see the play anyway? 34 Example 1.7 A lost theater ticket You have just arrived at the theater and discover that you have lost the $100 ticket you purchased earlier that day Do you buy another ticket and see the play anyway? 35 Example 1.6 vs Example 1.7  In both cases, you are $100 poorer than before ... action if, and only if, the extra benefits from taking the action are at least as great as the extra costs  Critics of the cost-benefit approach often object that people don’t really calculate costs and benefits when deciding what to do 24 People often behave as if they were comparing the relevant costs and benefits 25 People often make bad decisions because they fail to compare the relevant costs and benefits... 1/3, and save zero lives with probability 2/3 Which program would you choose? A or B? 30 Can cost-benefit analysis help you make better decisions? Example 1.5 Choosing a public health program A rare disease will claim 600 lives if we do nothing We must choose between the following two programs: Program C: 400 people will die with certainty Program D: 1/3 chance that no one will die, and 2/3 chance... Boundless wants cannot be satisfied with limited resources  Therefore, having more of one thing usually means having less of another  Because of scarcity we must make choices  Even Bill Gates (once valued as having US$100 billion) still faces scarcity  There are only 24 hours 11 Selling Seats Through An English Auction    In the classroom, the teacher owns the seats As usual, the teacher can assign... in the economics way -the teacher will sell seats through an English auction In an English auction, bidders cry out their bid for a good item until no one is willing to submit a higher bid The highest bidder will get the item This kind of auction has been used in Hong Kong’s land auction There is no restriction on how many seats a student can buy or resale activity Bidders suggest a seat for auction... is more likely to take an action if its benefit rises, and less likely to take it if its cost rises Incentives matter in our analysis of behavior and in designing economic policies 15 The Cost-Benefit Principle  An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs Should I do activity x? C(x)... and universities may also be subsidized 21 Example 1.1 Should I turn down my stereo?  You have settled into a comfortable chair and are listening to your stereo when you realize that the next two tracks on the album are ones you dislike  If you had a programmable disc player or a remote control, you would have programmed them not to play  But you don't, and so you must decide whether to get up and... decisions because they fail to compare the relevant costs and benefits 26 Can cost-benefit analysis help you make better decisions? Example 1.2 You are about to buy a $20 alarm clock at the campus store when a friend tells you that Fortress has the same alarm clock on sale for $10 Do you travel to Fortress? 27 Can cost-benefit analysis help you make better decisions? Example 1.3 You are about to buy... has the same computer on sale for $6500 Do you travel to Fortress? 28 Example 1.2 and 1.3 Should you travel to Fortress?  B(x) = benefit of traveling to Fortress = $10 in both cases  C(x) = cost of traveling to Fortress = the same amount in both cases  So your answer should be the same in both cases 29 Can cost-benefit analysis help you make better decisions? Example 1.4 Choosing a public health program