Thinking Like an Economist

Chapter 1

Week 1

Hurricane Katrina

Can a major disaster be good for the economy??

Broken Window Fallacy Ce qu'on voit et ce qu'on ne voit pas

I am sorry to disturb these ingenious calculations, as far as their spirit has been introduced into our legislation; but I beg him to begin them again, by taking into the account that which is not seen, and placing it alongside of that which is seen. The reader must take care to remember that there are not two persons only, but three concerned in the little scene which I have submitted to his attention. One of them, James B., represents the consumer, reduced, by an act of destruction, to one enjoyment instead of two. Another under the title of the glazier, shows us the producer, whose trade is encouraged by the accident. The third is the shoemaker (or some other tradesman), whose labour suffers proportionably by the same cause. It is this third person who is always kept in the shade, and who, personating that which is not seen, is a necessary element of the problem. It is he who shows us how absurd it is to think we see a profit in an act of destruction. It is he who will soon teach us that it is not less absurd to see a profit in a restriction, which is, after all, nothing else than a partial destruction. Therefore, if you will only go to the root of all the arguments which are adduced in its favour, all you will find will be the paraphrase of this vulgar saying - What would become of the glaziers, if nobody ever broke windows?

--Frédéric Bastiat 1850

Rationality Assumption

People have well-defined goals and try to fulfill them the best they can.

Scarcity Principle

No free lunch.

Boundless needs and wants.

Concept of Cost

• Dollar costs (seen)

• Opportunity costs (unseen)

• Sunk costs (out of sight—forget about them!)

Cost Benefit Principle

An action is taken if marginal benefit exceeds marginal cost.

Space Shuttle Example

Number of launches

Total cost

($ billions)

Total benefit

($ billions)

Average cost

($ billions)

Marginal cost

($ billions)

0 0 0

1 3 6

2 7 12

3 12 18

4 20 24

5 32 30

Space Shuttle Example

Number of launches

Total cost

($ billions)

Total benefit

($ billions)

Average cost

($ billions)

Marginal cost

($ billions)

0 0 0 0 0

1 3 6 3 3

2 7 12 3.5 4

3 12 18 4 5

4 20 24 5 8

5 32 30 6.4 12

Decision Pitfalls

1. Measuring costs or benefits proportionally.

2. Ignoring opportunity costs.

3. Ignoring sunk costs.

4. Using average instead of marginal costs and benefits.

Ten Propositions about Which Most Economists Agree

Current Statistics

U.S. GDP 08/31 3.3%

Unemployment 08/05 5.0%

Inflation 06/05 3.2%

Types of Graphs

Figure A-2 Using the Coordinate System

Novels Purchased by Emma

Copyright©2003 Southwestern/Thomson Learning

Demand Curve

Shifting Demand Curves

Calculating the Slope of a Line

Graph with an Omitted Variable

Graph Suggesting Reverse Causality