Economic Thinking andEconomic Tools

Chapter 2

Economic Thinking

Normative vs. Positive Statements Normative: What Should be Positive: What is

In Principles of Economics we stated: Economics uses positive statements

In this Course we state: Economics attempts to be about

Positive Statements

Economic Thinking

Problem In Analyzing Economic Problems is that Perceptions may confuse issues Personal Bias Cultural Bias Other Issues

Conventional Wisdom

Economic Thinking

Example: In May of 2003, Jayson Blair a

reported for the New York Times is fired because of numerous false information in his articles.

He was discovered because he plagiarized an article from the San Antonio Express

Mr. Blair is an African American

Economic Thinking

Example (cont): The fact that Mr. Blair is an African

American is to some proof that affirmative action leads firms to promote based on race or ethnicity and not on merit

Economic Thinking

Example (cont): Columnists Howard Kurtz (CNN),

William Safire (New York Times), and Tim Rutten (Los Angeles Times), among others conclude that race was a factor in the continuation of Mr. Blair as a reporter even after internal memos indicated there was grave problems with his reporting

Economic Thinking

Example (cont): To those opposing affirmative action

this is clear evidence of the problem it creates

The evidence is clear, he was only promoted because of the “race thing”

Economic Thinking

Example (cont): Those who support affirmative action,

on the other hand, indicate this is an example of how only when minorities are involved in the same mistakes committed by non-minorities is race become an issue.

For instance, Terry Neal (Washington Post) and Seth Mnookin (Newsweek) argue that race was not an issue

Economic Thinking

Example (cont): Terry Neal relates the example of Stephen

Glass (New Republic) who not only fabricated stories as Mr. Blair has done but went as far as creating Web sites and voice mails to support his fabrications

Also, R. Foster Winans (Wall Street Journal) who in 1985 was convicted for writing false articles for the purpose of making money in the stock market

Economic Thinking

Example (cont): In none of these cases was there a

condemnation that a system that is not minority friendly results in lower quality white reporters not being fired earlier

Who is right? Both arguments are probably

right and wrong at the same time

Economic Thinking

In the Summer of 2003 the Supreme Court upheld the University of Michigan’s Law school admission policy but not that of its undergraduate program Difference in the policies

Economic Thinking

In writing for the majority, Justice O’Connor indicate that “American businesses have made clear that the skills needed in today’s increasingly global marketplace can only be developed through exposure to widely diverse people, cultures, ideas, and viewpoints.” She went on to say that she expected that in 25 years these type of procedures would not be needed

Economic Thinking

On the other hand, writing a dissenting opinion Justice Thomas states: “these programs [affirmative action] stamp minorities with a badge of inferiority and may cause them to develop dependencies or to adopt an attitude that they are ‘entitled’ to preferences.”

Economic Thinking

Economics of the science of how individuals go about the business of satisfying their wants given scarce resourcesThe word Scarcity is crucialScarcity leads to Opportunity Cost

MicroeconomicsThe Basic Approach

Choices Opportunity Cost

Maximization Constraint Maximization Example

Choose X to maximize V(X) subject to the constraint involving X and Z

Max U(X1,X2) s.t. I = P1* X1 + P2* X2

MicroeconomicsThe Basic Approach (Cont)

We have two sets of variables: Endogenous (solved by the system) In this case X1 and X2 Exogenous (values given outside the

system) In this case I, P1, and P2

MicroeconomicsThe Basic Approach (Cont)

From the utility maximization we derive the demand curve. In this case, D1 =F(P1, P2, M)

Next, we are interested on how the the solutions change when an exogenous variable changes

MicroeconomicsThe Basic Approach (Cont)

The Law of DemandΔD1/ΔP1 <0

Substitutes vs. ComplimentsΔD1/ΔP2 < or > 0?

Normal vs. Inferior GoodsΔD1/ΔI < or > 0?

Demand and Supply

Law of DemandRelative PriceIncome and Substitution EffectThings that may impact demand Price of own good, Price of substitute and compliment

goods Income

Demand and Supply

Things that may impact demand (Cont.) Preferences Number of buyers Etc.

Demand

D

Q

P

Decrease in

quantity demanded

Increase in quantity

demanded

Demand

D

Q

P Exogenous variable increases demand

Demand

D

Q

P Exogenous variable decreases demand

Demand and Supply

Law of Supply Relative PriceIncome and Substitution Effect for LaborThings that may impact supply Price of own good, Price of substitute and compliment

goods Cost of Inputs

Demand and Supply

Things that may impact supply (Cont.) technology Number of sellers Etc.

Supply

Q

P S

Supply

Q

P SIncrease in supply

Supply

Q

PS Decrease in supply

Demand and Supply

D

Q

P S

P*

Q*

Demand and Supply(Increase in Demand)

D

Q

P S

P

P*

Q Q*

Equilibrium Price increases and equilibrium quantity also increases

Demand and Supply(Increase in Supply)

D

Q

P S

P*

P

Q* Q

Equilibrium Price decreases and equilibrium quantity increases

Demand and Supply(Decrease in Demand)

D

Q

P S

P*P

Q*Q

Equilibrium Price decreases and equilibrium quantity also decreases

Demand and Supply(Decrease in Supply)

D

Q

P S

P*

Q*

P

Q

Equilibrium Price increases and equilibrium quantity

decreases

Demand and Supply

D

Q

P S

Excess Demand

Demand and Supply

D

Q

P SExcess Supply

Demand and Supply of Labor

D

L

wS

Demand for Labor

Reasons why it slopes downward: Law of Diminishing Marginal Returns Substitution Effect Scale Effects

Supply of Labor and Equilibrium

Why Supply Slopes Upwards then downwards Income and Substitution Effect

Stable Equilibrium

Equilibrium

If w > we then there is an Excess Supply which implies there is unemployment

If w < we then there is an Excess Demand which implies there is an tight labor market

Shocks to Equilibrium:Demand

DEMAND Output becomes more or less

“popular” Shift to more efficient capital Competitiveness in output market

changes Technology

Shocks to Equilibrium:Supply

Supply Change in Labor size

Women enter the market place Immigration Taxes

Change in Quality of Labor Education Cultural Change

Draft vs. No Draft

Assume that the military in this economy is deciding whether to ask civilian government whether to institute a draft or not.Clearly wages will be lower with the draft and will not cause an excess demand (since there is a draft)

Draft vs. No Draft

w

L

wND

wD

LND LD

D

S

Draft vs. No Draft

Is Draft Cheaper? Government:

Yes if Yellow box is larger than brown box No if the opposite is true

Society No, since the opportunity cost of some of

those drafted are likely to have higher

How Would Arm Forces Differ Under the Draft

Draft: Larger, could have soldiers with

higher opportunity cost. May not be better due to the

possibility of low moral.

How Would Arm Forces Differ Under No Draft

No Draft: Smaller Maybe Lower Opportunity Cost

Low Education “taste” for soldiering Perhaps Racial Component

Equity vs. Efficiency

No Draft: Efficient In other words Draft is inefficient

Draft: Could be more equitable

Economic Thinking andEconomic Tools

More about regression analysis later

More about experimental economics later