1. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter 1 The Economic Way of Thinking

2. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 35 Chapter 1 Outline Introduction Recognizing Order The Importance of Social Cooperation How Does it Happen An Apparatus of the Mind

3. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 35 Chapter 1 Outline Cooperation Through Mutual Adjustment Rules of the Game Property Rights as Rules of the Game The Biases of Economic Theory Biases or Conclusions? No Theory Means Poor Theory

4. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 35 Introduction Is order prevalent in society? –How does an economic system work when it is functioning properly? –What mechanisms of social cooperation do we depend upon?

5. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 35 Recognizing Order Rush hour traffic is an example of social cooperation. –There are general rules that everyone is expected to obey. We tend to notice failures. –We take successes for granted so much so that we aren’t even aware of them.

6. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 35 Recognizing Order Thousands of diverse commuters travel to work each day Each is expected to follow a set of rules Traffic flows smoothly

7. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 35 The Importance of Social Cooperation Civilization depends upon cooperation. Thomas Hobbes (1588-1679) –Contended that people’s commitment to self- satisfaction required force to keep them from attacking one another.

8. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 35 How Does It Happen How does society determine the course of actions necessary to produce the goods and services we enjoy?

9. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 35 How Does It Happen Adam Smith (1723-1790) –Most people believed political rulers’ attention was necessary to sustain society. Smith disagreed. –In 1776 published An Inquiry into the Nature and Causes of the Wealth of Nations. –Founder of Economics

10. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 35 An Apparatus of the Mind What is The Economic Way of Thinking? –John Maynard Keynes The Theory of Economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions.

11. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 35 An Apparatus of the Mind Summary –All social phenomena from the actions and interactions of individuals who are choosing in response to expected additional benefits and costs to them.

12. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 35 An Apparatus of the Mind Question –Does this assume people are selfish, materialistic, and shortsighted?

13. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 35 An Apparatus of the Mind Focus is on actions, interactions, and consequences. Actions emphasize economizing. Economizing - –Allocate resources in a way that allows the economizer to derive whatever he/she wants –Results from scarcity –Involves trade-offs

14. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 35 An Apparatus of the Mind Expected Benefits and Expected Cost Economic theory assumes that : People make choices under scarcity based on People make choices under scarcity based on

15. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 35 An Apparatus of the Mind The core problem for economic interactions is a multiplicity of diverse and even incommensurable individual projects.

16. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 35 An Apparatus of the Mind Specialization (Division of Labor) –Results from people’s economizing actions. –Is necessary to increase production. Question –Will specialization without coordination work?

17. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 35 An Apparatus of the Mind Adam Smith referred to the Commercial Society in his “Wealth of Nations” and said… “It is but a very small part of man’s wants which the produce of his own labour can supply.”

18. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 35 An Apparatus of the Mind Adam Smith and the Commercial Society… “He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for.”

19. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 35 An Apparatus of the Mind Adam Smith and the Commercial Society… “Every man thus lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.”

20. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 35 An Apparatus of the Mind Social coordination is highly complex Question –How are the parties involved in producing goods and services motivated to coordinate their activities?

21. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 35 Cooperation Through Mutual Adjustment Economizing actions create alternatives available to others. Social coordination is a process of continuing mutual adjustment.

22. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 35 Cooperation Through Mutual Adjustment Example –Why don’t drivers on a freeway drive in one lane?

23. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 35 Cooperation Through Mutual Adjustment The net advantage determines people’s actions –Costs versus Benefits Money persuades!

24. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 35 Rules of the Game Economic systems and social interaction are directed and coordinated by the rules participants know and follow. Disputed – inconsistent – unclear rules cause the game to break down.

25. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 35 Property Rights as Rules of the Game Property rights are an example of rules of the game of social interaction. A market exchange economy is based upon private property rights. Socialist economies – private & public property rights. Change away from socialism may be chaotic – i.e. Soviet bloc.

26. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 35 Property Rights as Rules of the Game Clearly defined and enforced property rights… –Encourage the effective use of already existing scarce resources –Spark efforts to discover new resources –Innovate new cost-cutting technologies –Develop new talents and skills

27. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 35 The Biases of Economic Theory Economics focuses on choice. –Events result from people’s choices Only individuals choose.

28. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 35 The Biases of Economic Theory Individuals choose after weighing benefits and costs Interactions assume some “rules of the game.”

29. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 35 Biases or Conclusions? Question –Are the biases inherent in the economic way of thinking really prejudices instead? We must begin somewhere.

30. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 35 Biases or Conclusions We are always wrong to some extent. –Every “true” statement leaves out a great deal that is also true and thus errs by omission.

31. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 35 No Theory Means Poor Theory Discovery of causal relationships depends upon theory. We observe only a small fraction of what we “know.”

32. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 35 No Theory Means Poor Theory Economic theory by itself cannot answer any interesting or important social questions. It must be supplemented with knowledge from other sources –History –Culture –Politics –Psychology –Social Institutions

33. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 35 Once Over Lightly Economics is a theory of choice and its unintended consequences. All social phenomena emerge from –Individuals’ actions and interactions –In response to expected benefits and costs

34. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 35 Once Over Lightly Economizing –Individuals continually comparing Expected additional benefits Expected additional costs Rules of the game are important as they influence our choices Property Rights

35. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 35 of 35 END OF CHAPTER 1