ECON 200: Chapter 1 (Economics and Life)
So because this is my first chapter I thought I would lead with a little introduction. We are going to get through this class…together. Yes all 750 of us. Hopefully you guys enjoy my style of note taking and get some good information out of these along with a few laughs. Basic Insights of Economics
Economics: the study of how people manage resources - Keep in mind that this is far more than the shiny stuff like gold and cash, it’s also intangible products like devoting time or innovative ideas
Microeconomics: the study of how individuals and firms manage the resources
Macroeconomics: looking at the economy on a broader scale (regionally, nationally, or internationally)
- Just to be clear we are in microeconomics so if you are expecting Macro notes you will be thoroughly disappointed if you keep reading. If you want to learn more check out What is the corpus callosum?
Rational Behavior: making choices to achieve goals in the most effective way possible
- Economists will ask themselves four questions to solve a problem ∙ What are the wants and constraints of those involved? ∙ What are the trade-offs?
∙ How will others respond?
∙ Why isn’t everyone already doing it?
Scarcity: the condition of wanting more than we can get with available resources
- An example that is all too familiar to all of us is maybe we’ve got our heart set on buying an expensive item (the new Tesla, a gold bracelet, or the iphone 7), but our college student budget just won’t allow for it. This would be scarcity of money (within reason…I know someone is going to comment on my extremely 1st world problem example)
- The wants are the expensive items, but the constraint is the money. This just tackled that first question
Opportunity Cost and Marginal Decision Making
- Time to answer questions two “What are the trade-offs?” - Every thing has benefits (the positives) and costs (the negatives) - A good example would be in your college search you might have
made a list of possible universities complete with pros and cons for all of them. Let’s take Maryland because I’m guessing you’re familiar with it. A benefit could be that it had a great reputation
for your major but it was a little too close to home (a cost). You had to make a trade-off, but you decided the benefit outweighed the cost.
Opportunity Cost: the value of what you have to give up in order to get something: the value of your next best alternative - I don’t know about you guys but I had to replay that definition in my head a couple times to get it Don't forget about the age old question of What were the very earliest uses of radio technology?
- So look at it this way, the more you like your second choice the higher the opportunity cost
- Back to the college example, let’s say you were choosing between Maryland and Stanford and you chose Maryland. The opportunity cost would be high because you passed up a great school, but nonetheless you made a trade-off because you valued one aspect more than another.
- It would be unfair to leave you guys without a quantitative example, so here is one with some money. You just won the lottery. A check for one million dollars is being placed into your hands, but then the government tells you if you take the check they will kill your father. You immediately refuse the check because you’re an empathetic and loving human being. The opportunity cost of saving your father’s life is missing out on 1 million dollars.
Marginal Decision Making: comparison of additional benefits with additional costs, without looking at the related costs and benefits of past choices Don't forget about the age old question of what is regime?
- To explore this, I think of a waterpark. You pay your 80 dollars then you enter the water park. Every time you ride the slide it costs a dollar. In your decision making as to whether or not you want to keep going on the slide, you should evaluate your enjoyment, rather than going on the slide just to feel like you got your 80 dollars worth.
Sunk Costs: costs that have already been incurred and cannot be recovered or refunded
- You can’t return than lotion that promised no more acne, even though it was false advertising. That’s a sunk cost
- Question 3 stated, “How will others respond?”
- So if any of you are business majors this is all about the customer, if you want to make a change or any sort you have to think how that will affect your audience
Incentives: something that causes people to behave in a certain way by changing the trade-offs they face
- Positive incentive will encourage…for example if your mom says she’ll pay you to do the dishes, you are more likely to do them. Money is the incentive
- Negative or disincentive discourages someone from doing something. Let’s say Giant starts charging 20 dollars a loaf for bread, you might check out Safeway
- No matter what you do there will always be a response, maybe not always an angry mob with pitchforks, but there is always an effect of actions
*Collateral: a possession pledged by a borrower to a lender (a car, a house, a small child), basically if you don’t pay back your loan the lender keeps the collateral
- Last question, “Why isn’t everyone else doing it?” then we’re done (with the questions…sorry still only halfway through the chapter) Don't forget about the age old question of What is the definition of marginal benefit?
- It’s not rocket science that every business wants to provide what people want to make a profit, which leads us too…
Efficiency: use of resources in the most productive way possible to produce the good and services to add the greatest economic value - Quick clarification, something is valuable if people want it and a resource produces that thing of value
- So let’s go back to that question…why isn’t everyone else doing it? There are a few possible reasons
1. Innovation: Maybe no one has thought about it yet. Somebody out there is the proud mastermind behind the pool noodle.
2. Market failure: For whatever reason, your product is inefficient. Maybe Starbucks can easily copy your extra vanilla macchiato latte or Amazon has cornered the market on books.
3. Intervention: Maybe you have an incredible new idea for a drug that cure Alzheimer’s, but the side effects are very dangerous. The government might halt your ability to distribute it
4. Goals other than profit: Maybe you’re a humanitarian that has an idea called Water for People. You have great
intentions, but it is just not profitable enough to make it in the market that you have to shut it down.
An Economists Problem Solving Toolbox
Well we’re done with asking ourselves questions, but now we have to put our answers to good use, let’s keep going to figure out some tools we can apply to our problem solving process. If you want to learn more check out what is Bilateral contract?
Correlation and Causation
- I still remember my psychology teacher drilling into me that correlation does not prove causation. If you get nothing from this, that one line could be helpful.
Correlation: a consistently observed relationship between two variables
- Babies that are given lots of affection tend to be more secure in their family life (I just pulled that out of the air, I didn’t go looking at babies and how many hugs they get and what they turn into)
- Two types of correlations, well three
1. Positive correlation- the more siblings you have, the more fights you have
2. Negative correlation- the more sleep you get, the less caffeine you need to function
3. No correlation- Number of tattoos and ability to cook Causation: a relationship between two events in which one brings about the other
- Typically they can be lumped together more or less. People who touch fire tend to pull their hand away. Well yeah, because torching off skin causes pain and causes people to pull their hand away. That’s not just a correlation; it’s a proven fact. If you want to learn more check out What is disruptive innoavation?
- Sometimes it’s not so clear, here are three times is gets a little murky
1. Correlation without causation: Long blizzards tend to lead to a baby boom. Sure there are reasons as to why that may be, but the blizzard itself does not lead to more baby
2. Omitted variables: If I say towns with more police officers have more crime, you’ll look at me kind of weirdly. Yes they are related but I needed to mention that socio-economic status of the residents is in the picture too. The police presence isn’t causing the crime. (Well with recent events, I’m not too sure, but that’s a discussion for a different day)
3. Reverse causation: So your parents try and convince you that success will cause your happiness. But what the true causation is is that your happiness will cause success, because if you love what you do you’ll be more successful. Models
So in econ, there are some really attractive girls…nah I’m playing Model: a simplified representation of the important parts of a complicated situation
- Tangible models include toy trains or terrariums that represent the ecosystem, but in Econ it’s a little different
- It describes complex situations or ideas in simple terms, specifically…the economy
Circular flow model: a representation of how the economy’s transactions work together
- In this model there are only two players, the households and the firms
- Households supply land and labor (your backyard and your aunt that wants a life purpose). It also buys the goods and services (a new TV and a housekeeper).
- Firms buy or rent the land and produce the goods and services. - But if you’ve ever tried to draw a circle, using only two points is a sure fire way to get you in the oval zone.
- So also in the circle we have two markets
- The market for goods and services: All the activity that is involved exchanges (buying and selling)
- Market for the factors or production: All the activities used to produce the good or service
- The inputs are land, labor and capital, output is goods and services
- So there are two loops going around the circle, one is the goods like we’ve mentioned, but the other is the flow of money or dollars.
- Pg. 16 has a nice visual of this model but because I don’t want you guys getting mad that you have to walk across your dorm room and grab the five-pound thing, I’ll put a similar image on the next page.
- Just to drive this model home I’m going to do an example. Your mom decides she wants to be a hairdresser. Your household is providing labor (your mom). That goes to the production market where she hones her skills by going to beauty school. She is now part of the firm, which is providing a service. Then she uses the exchange market and cuts her best friends hair at a new salon. Her friend is another household and the cycle repeats.
Three things all good models should do…
1. Predicts Cause and Effect: the circular flow model is a good one because it shows how every player affects the market in multiple ways.
2. A good model makes clear assumptions: your teachers may tell you to be skeptical and never assume, but if you want to go into model making you need to take a stand and own your generalizations
3. Should describe the real world accurately: If your model isn’t accurate then what’s the point. It’s not helping anybody Positive and Normative Analysis
- Have you ever confused a fact and opinion? Sure some are obvious like French fries are the best food in the world is obviously a fact . But, some aren’t as clear-cut. Women are safer drivers. It sounds like an opinion, but statistics clearly show that it’s a fact. Just look at the difference in insurance plans for teenage boys and girls.
Positive Statement: a factual claim about how the world actually works
Normative Statement: a claim about how the world should be - A good way to think about this, is using facts is a positive way of delivering your message while using opinions is a negative way of giving a message. Normative and negative both start with “N”.
And that’s all, you did it! Now go draw the circular flow model and stick it on your dorm fridge while having a little study party with some French fries. Actually scratch that, go for some sweet potato fries, those things can even make econ studying a positive experience.