1

CHAPTER

EXPLORING ECONOMICS

CHAPTER 1

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Incentives in the Prisoner Transport

Business
Only when the ship
captains began to
be paid per living
convict on arrival
did the death rate
fall from over 33%
to less than 1%

The British prison transport vessel

Success

CHAPTER OBJECTIVES
Explain how economic analysis can be used in
decision making.
Differentiate between microeconomics and
macroeconomics.
Describe how economists use models.
Describe the ceteris paribus assumption.
Discuss the difference between efficiency and
equity.
Describe the key principles in economics.
Apply the key principles in economics to situations
faced in your daily routine.
CHAPTER 1

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ECONOMICS IS
IMPORTANT:
FOR SCHOOL
FOR WORK
FOR LIFE

CHAPTER 1

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ECONOMICS ISSUES ARE ALL AROUND

US

CHAPTER 1

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WHAT IS ECONOMICS ABOUT?

Economics studies how individuals,
firms, and society make decisions to
allocate limited resources to
competing wants.
Economics assumes that people:
Are rational
Are self-interested
Respond to incentives
CHAPTER 1

SLIDE 6

Rational
Rational People
People Think
Think at
at the
the Margin
Margin

A person is rational if she

systematically and purposefully
does the best she can to achieve
her objectives.
Many decisions are not all or
nothing,
but involve marginal changes:
Should I have a Tall latte or a Grande?
In the mornings: should I sleep 10 or 20
more minutes?

Incentives
- After Christmas sales
- Look at a syllabus and see what is
rewarded
Econ 101:
Exams 70%, 20% hwk, 10% attendance
Math 101:
Exams 90%, 10% hwk

Incentives
- Drive a less crowded route:
- Sigalert.com
- Waze app

- Choose engineering vs. becoming a

nurse?
- Aptitude
- Knowledge
- Job opportunities

Incentives: tipples
restaurant
-

18% flat fee is added to each check

-

The Linkery restaurant in San Diego

- Good or bad?
- What does it reward?

Incentives: tipples
restaurant
-

18% flat fee is added to each check

-

The Linkery restaurant in San Diego

- According to CA law, the tips cannot be

distributed to cooks, but the service
charge can
- About 25% of the 18% service charge
was allocated to cooks
- The owner claims the service improved
and the quality of food as well.

11

RATIONAL SELF-INTEREST:
STUDENTS MIGHT CHEAT, BUT IF
CAUGHT, FACE SEVERE
CONSEQUENCES.

CHAPTER 1

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MICROECONOMICS

MICROECONOMICS: STUDIES THE

DECISION MAKING BY INDIVIDUALS,
BUSINESSES, INDUSTRIES, AND
GOVERNMENT.
MACROECONOMICS

MACROECONOMICS: STUDIES THE

BROADER ISSUES IN THE ECONOMY
SUCH AS INFLATION,
UNEMPLOYMENT, AND NATIONAL
OUTPUT.
CHAPTER 1

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QUESTION: IS THE FOLLOWING A

MACROECONOMIC OR A MICROECONOMIC
ISSUE?
LAWMAKERS ARE DISCUSSING HOW
TO KEEP UNEMPLOYMENT FROM
RISING IN THE COMING YEAR.

MACROECONOMICS

MICROECONOMICS

CHAPTER 1

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QUESTION: IS THE FOLLOWING A

MACROECONOMIC OR A MICROECONOMIC
ISSUE?
EXECUTIVES AT GENERAL MOTORS
ARE DISCUSSING WHETHER RAISING
PRICES WILL LEAD TO GREATER
SALES.

MACROECONOMICS

MICROECONOMICS

CHAPTER 1

SLIDE 15

MODEL BUILDING:
ECONOMIC ANALYSIS
USES SIMPLIFIED
MODELS

CHAPTER 1

SLIDE 16

Assumptions & Models

Assumptions simplify the complex world,
make it easier to understand.
International trade:
assume there are only two countries trading with
each other in 2 products

One input: labor

Realistic? Simplifying?
It yields useful insights about the more
complicated real world.
Economists use models to study economic
issues. A model is a highly simplified
representation of a more complicated reality.

CETERIS PARIBUS
Assumption used in economics in
that all other relevant factors or
variables are held constant.
Models are crafted from new ideas,
then tested against real world data.
For examples, will more spending
lead to economic growth?

CHAPTER 1

SLIDE 18

EFFICIENCY VERSUS EQUITY

EFFICIENCY
HOW WELL
RESOURCES
ARE USED AND
ALLOCATED
Do people get the
goods and services they
want at the lowest possible
resource cost?

EQUITY

THE FAIRNESS
OF VARIOUS
ISSUES AND
POLICIES

CHAPTER 1

SLIDE 19

EFFICIENCY VERSUS EQUITY

EFFICIENCY

EQUITY

DOES THE U.S.

USE ITS
RESOURCES TO
MAKE WHAT
PEOPLE WANT
AT THE LOWEST
COST?

IS IT FAIR THAT
HIGH-TECH
FIRMS OFFER
MORE VACATION
AND OTHER
PERKS THAN
LOW-SKILLED
INDUSTRIES?
CHAPTER 1

SLIDE 20

From the news: Corporate buses in SF

SF wants companies who ferry their

employees around in private buses to limit
and pay for their use of city bus stops.

Theres definitely a divide, one city official

told me. People are waiting for their Muni
bus, and they see a fancy Google bus
delaying their bus, so people who dont even
work in San Francisco can get to their highpaid jobs on time.
Picture: Interior of a facebook bus

POSITIVE VERSUS NORMATIVE

POSITIVE
QUESTION

NORMATIVE
QUESTION

ONE THAT CAN

BE ANSWERED
USING
AVAILABLE
INFORMATION
OR FACTS

BASED ON
SOCIETAL
BELIEFS ON
WHAT SHOULD
OR SHOULD
NOT TAKE
PLACE
CHAPTER 1

SLIDE 23

The debate on corporate

buses
In SF, the median onePositive
bedroom apartment
now costs $2,795 per
month, up 27 percent
in just two years.
The shuttles save a
net 28.7 million VMT
(vehicle miles
traveled) and replace
roughly 757,000
single-passenger car
trips.

Normative

Corporate buses
should be banned.

KEY

PRINCIPLES

CHAPTER 1

SLIDE 25

ECONOMICS IS CONCERNED
WITH MAKING CHOICES
WITH LIMITED RESOURCES
CHAPTER 1

SLIDE 26

SCARCITY
UNLIMITED WANTS CLASH
WITH LIMITED RESOURCES.
EVERYONE FACES
SCARCITY. ECONOMICS
FOCUSES ON THE
ALLOCATION OF SCARCE
RESOURCES.
CHAPTER 1

SLIDE 27

WHEN MAKING DECISIONS, ONE

MUST TAKE INTO ACCOUNT
TRADEOFFS AND OPPORTUNTY
COSTS
CHAPTER 1

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Trade-offs are Everywhere

For every choice something is gained,
something lost.

The Opportunity Cost of a choice: the

value of the opportunities lost.
AND people respond to changes in
opportunity costs.
Unemployment rates and college enrollment:
related.

OPPORTUNITY COST: THE NEXT BEST

ALTERNATIVE; WHAT YOU GIVE UP TO DO
SOMETHING OR PURCHASE SOMETHING.
CHAPTER 1

SLIDE 30

SPECIALIZATION LEADS TO
GAINS FOR ALL INVOLVED
CHAPTER 1

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INDIVIDUALS SPECIALIZE IN CAREERS

MOST SUITED TO THEM, SUCH AS
COOKING OR MECHANICS.
CHAPTER 1

SLIDE 32

PEOPLE RESPOND TO
INCENTIVES, BOTH
GOOD AND BAD
CHAPTER 1

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WOULD YOU PICK UP THIS $20 BILL? IS IT

GREED OR SIMPLY RESPONDING TO AN
INCENTIVE, OR BOTH?
CHAPTER 1

SLIDE 34

RATIONAL BEHAVIOR
REQUIRES THINKING ON
THE MARGIN
CHAPTER 1

SLIDE 35

AT AN ALL-YOU-CAN-EAT BUFFET, COMPARE THE

ADDITIONAL BENEFIT OF ONE MORE PLATE OF
FOOD RELATIVE TO THE ADDITIONAL COSTS
(BLOATING; WEIGHT GAIN)
CHAPTER 1

SLIDE 36

Thinking on the Margin

Actual trade-offs are usually
on the margin.
Marginal means additional
Most economic choices are
marginal choices
E.G. Newt Gingrich wanted
mandatory executions for drug
dealers
but the effect was to reduce
Higher
the EXTRA penalty for
punishments for
murdering police offers during
lesser crimes
reduce the
arrest
marginal cost of

Decision at the margin: How many

movie sequels? a typical motion
picture
What famous movie sequels do you know?

What are the relatively recent movies you seen that

are expected to produce a sequel?

Decision at the margin: How many

movie sequels? a typical motion
picture

Movie
sequel

Money
generated,
million$

Typical
costs,
million$

original

300

125

210

150

2
3

147
103

175
200

MARKETS ARE GENERALLY

EFFICIENT; WHEN THEY ARENT,
GOVERNMENT CAN SOMETIMES
CORRECT THE FAILURE
CHAPTER 1

SLIDE 41

PRIVATE MARKETS AND COMPETITION FORCE

BUSINESSES TO BE EFFICIENT OR BE DRIVEN
CHAPTER 1

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New businesses pop-up as

demand picks up
Children birthday
party locations
- Catch Air
- Atlanta Rocks
Environmentally
friendly cleaning
businesses and
products

Restaurants
Entertainment
options
- Bowling alleys

SEE THE INVISIBLE HAND

It is not from the
benevolence of the
butcher, the brewer, or
the baker that we
expect our dinner, but
from their regard to
their own interest.
-Adam Smith,

The Wealth of Nations

Adam Smith saw the invisible

hand

MARKETS SOMETIMES RESULT IN

UNDESIRABLE OUTCOMES, SUCH AS
CHAPTER 1

SLIDE 45

INSTITUTIONS AND HUMAN

CREATIVITY HELP EXPLAIN
THE WEALTH OF NATIONS
CHAPTER 1

SLIDE 46

SEE THE INVISIBLE HAND

World Distribution of Income, 2000. Source:

Penn World Tables

What are the differences btw the more and less developed
countries?

Institutions Matter
Why are some countries rich and
others poor?
Incentives are sometimes lacking.

Strong institutions that support

these incentives foster economic
growth.
E.g. strong property rights foster
investment
Strong intellectual property rights
(patents, trademarks, copyrights)
foster innovation

Zimbabwe land reform

- Expropriation of land from minority
white farmers and black farmers
who did not support Mugabes
regime
- Result:
- Decline in food production
- Decline in investment
- breakdown of infrastructure:
- banks would not lend to agricultural
business, as land cannot be used as a
collateral
51

KEY CONCEPTS

Economics
Scarcity
Incentives
Microeconomics
Macroeconomics
Ceteris paribus
Efficiency
Equity
Positive question
Normative question
Opportunity costs
CHAPTER 1

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QUESTION: WHICH OF THE FOLLOWING IS A

NORMATIVE QUESTION?

WHAT IS THE SPEED LIMIT ON

CAMPUS?

HOW MUCH DO TEXTBOOKS

COST THIS TERM?

SHOULD CHEWING GUM BE

BANNED IN CLASSROOMS?

HOW MUCH DOES STUDYING

IMPROVE YOUR GRADE?

WHEN IS THE NEXT HOME

FOOTBALL GAME?
CHAPTER 1

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PRACTICE
QUESTION

WHAT ARE THE

OPPORTUNITY COSTS OF
GOING TO COLLEGE? IS
IT WORTH IT? WHAT
MIGHT CHANGE YOUR
DECISION?

CHAPTER 1

SLIDE 54

QUESTION: IF YOU PAY $10 TO SEE A MOVIE

AT A MULTISCREEN CINEMA, THEN SNEAK
INTO A SECOND MOVIE WITHOUT PAYING,
THE MARGINAL COST OF THE SECOND
MOVIE IS:

$0

$5

$10

None of the above

CHAPTER 1

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PRACTICE
QUESTION

WHAT ARE THE COSTS OF

ECONOMIC PROGRESS? ARE
WE BETTER OFF TODAY
THAN 50 YEARS AGO? 500
YEARS AGO? WILL WE BE
BETTER OFF IN 100 YEARS?
CHAPTER 1

SLIDE 56