Chapter 1 Think Like an Economist Flashcards
Economics
The study of how people and businesses make decisions under conditions of scarcity and the implications of those decisions for society
Economic problem
How to allocate scarce resources to multiple alternatives —> tradeoffs
Economic analysis
Positive and normative
Positive analysis
• Looks at reality trying to find the truth
- Try to learn “how the world works” - We want to be able to make predictions like “if we do this, then that will happen”
Normative analysis
• Value judgments
- How should the world be - In answering normative questions, prior positive analysis is often important to form informed opinions
Economic model
- mathematical simplification of reality
- Used to gain analytical power
- Abstraction from less relevant details
- Useful if they have predictive power
The Role of Economic Models
- To Explain and predict economic decisions.
- Understanding how households and firms make decisions we can make predictions about what will happen when the conditions in an economic system change
The Economic Way of Thinking
- We will assume the economic agents (firms and consumers) are self interested
- We will also assume the economic agents are rational
- Self interest in a rational and didn’t respond to incentives and they choose the best available alternative
Rationality
The assumption of rationality implies that agents know their objectives well and they don’t Make mistakes in the pursuit of those objectives
Behavioral Economics
Studies deviations from rationality and how they change the conclusions of classical economic models
Economic surplus
The total benefit of taking an action minus the total cost
The net benefit from the action
Surplus = Benefit - Cost
Explicit costs
Cost for which agents make explicit payment
Tuition, gas, parking, books, etc…
Implicit costs
Cost that are not paid explicitly but come from “foregone alternatives”
(How much you’d make in the best paying job that you are not taking to come to school?)
Opportunity cost
The value of the next best alternative that must be forgone in order to undertake an activity
Includes both explicit and implicit costs
To illustrate how we think about the way that rational agents do cost-benefit analysis we introduce two measures of benefits and costs
Average cost/benefit
Marginal cost/benefit
