The Economic Way of

Thinking

What is Economics?

• Terminology and jargon

• Common sense

• Way of looking at the world

• Way of explaining human behavior

What is economics? From a famous

economics student:

“You Can’t Always Get What You Want” ♫

1. Due to scarcity, people have to make

choices; or there’s not enough for

everyone to have everything they want

2. Choices involve tradeoffs

and costs

Opportunity costs: The cost of anything is

the next best alternative

Free Ice Cream Day at Ben and

Jerry’s: Too expensive for me

3. People make decisions by

comparing expected costs and

expected benefits

• Should I study one more hour or play

games on my IPAD?

4. People make decisions by

thinking at the margin.

Decisions are made by dividing them up

into incremental choices and weighing the

expected costs and expected benefits of

each increment. Few choices are all or

nothing.

5. People respond to incentives

in predictable ways, and price is

a powerful incentive

6. Voluntary trade makes

people better off and creates

wealth

People can produce more in less time

by specializing and concentrating on

what they do best. Their excess

production can be traded to others to

obtain valuable goods or services. By

voluntarily giving up things that we

value less for things we value more,

both parties to a trade are made better

off.

7. Competitive markets are a

good way to organize economic

activity and increase individual

freedom, the quality of life, and

trust

8. People create economic systems

and institutions that influence their

choices and outcomes

9. Governments can sometimes improve market outcomes.

Markets don’t solve all problems. Externalities, defining and enforcing property rights, free-rider problems, and social goals such as equity bring the government into the economy. The key question to ask is “do the expected benefits of government actions outweigh their expected costs?”

10. The standard of living of a nation and its citizens is based on their ability to produce goods and services.

The more we can produce from a given

amount of resources, the higher will be our

living standards. The story of economic

growth and our rising standard of living is the

story of productivity growth, which is based on

improvements in education and technology.

Chuck Noland: Same person,

different income

Spot the rich nations

http://apod.nasa.gov/apod/image/0011/earthlights2_dmsp_big.jpg

Some Long Thoughts About

Economic Growth in the Long

Run

Harvesting Wheat 1500

Peter Breughel the Elder, Wheat Harvest, Metropolitan Museum of Art

Harvesting Wheat 1860

Jean Millet, The Gleaners, Musée d’Orsay, Paris

Harvesting Wheat in U.S. 2010

Rice Harvest in India 2010

US Real GDP Per Capita Growth in Long Run

Note: Log scale so a straight line means same rate of growth.

Average annual growth rate over past 190 years is 1.8%/year..

Commodity

Work Hours

Need to Earn

in 1895

Work

Hours

Need to

Earn in

1997

Productivity

Multiple

(How Much

Cheaper

Today?)

Horatio Alger books (6 vols.) 21 0.6 35.0

One-speed bicycle 260 7.2 36.1

Cushioned office chair 24 2.0 12.0

100-piece stoneware dinner set 44 3.6 12.2

Hair brush 16 2.0 8.0

Cane rocking chair 8 1.6 5.0

Solid gold locket 28 6.0 4.7

Encyclopedia Britannica 140 33.8 4.1

Steinway piano 2400 1107.6 2.2

Sterling silver teaspoon 26 34.0 0.8

The Good Old Days?

Fun, and Interesting, Books About Economics

(all with no graphs!)

• Charles Wheelan, Naked Economics: Undressing the Dismal Science

• Tim Harford: The Undercover Economist: Exposing Why the Rich are Rich, the Poor are Poor—and Why You can Never Buy a Decent Used Car

• Steven Landsburg, The Armchair Economist: Economics and Everyday Life

• P.J. O’Rourke, Eat the Rich: A Treatise on Economics

• James Surowiecki, The Wisdom of Crowds: Why the Many are Smarter than the Few and How Collective Wisdom Shapes Business, Economies, Societies, and Nations

• Russell Roberts, The Choice: A Fable of Free Trade and Protectionism

• Russell Roberts, The Price of Everything: A Parable of Possibility and Prosperity

• James Gwartney, Richard Stroup, and Dwight Lee, Common Sense Economics: What Everyone Should Know About Wealth and Prosperity