Chapter 1, Lesson 2

How do you define theory? Using that definition, what is “economic theory”?

Economic theory: economic model; simplification of economic reality used to make predictions about the real world For example, what happens to consumption of Pepsi when price increases?

Economists make simplifying assumptions Other-things-constant assumption: assume nothing else of importance changes – that other things remain constant Example: want to see how change in price of Pepsi affects amount purchased Isolate relationship between two variables (price and amount purchased) by assuming there are no changes in other relevant variables like consumer income or price of Coca-Cola

Behavior assumption: how people make choices based on self- interest you select alternatives you perceive to be in your best interests Rational self-interest means that you try to maximize the expected benefit achieved with a given cost or to minimize the expected cost of achieving a given benefit

Self-interest often includes welfare of family and friends Concern for others is influenced by your personal cost of that concern Example: You may volunteer to take the dog out before you leave for school, but are less likely if you are asked to do so at 4 a.m. The lower your personal cost of helping others, the more help you will offer Rationality also implies each firm supplies products expected to maximize firm’s profit Also behavioral assumptions because they specify how economic decision makers are expected to behave

Your Turn: Give examples of choosing actions that are based on your rational self-interest, yet pose some sort of cost to you in the process

Four groups of six-to-seven Each group will read on individual section of this article Groups will summarize respective section using three bullet points minimum Create summary of section using markers and poster board at front of room Be creative, use pictures, and PROVIDE APPLICABLE EXAMPLES!

Everyone uses some sort of theory, although they may not even realize it Example: Pounding on vending machine so quarter will go where it needs to, but not knowing the actual intricacies of how a vending machine actually works Economists explain theories by telling how they think the economy works based on case studies and personal experience, as well as supporting data Questions: Think of some theories you have Write down three questions that would determine whether or not others hold the same theories If so, what is the theory on which you agree? If not, why do you disagree?

Normative: reflects someone’s opinion “The U.S. unemployment rate should be lower” Cannot be shown true or false by reference to facts Positive: statement about economic reality that can be supported or rejected by reference to facts “The U.S. unemployment rate is 9%” Need not be true, but can find out if they are or are not by referring to facts Most disagreements among economists center around normative statements

Think about an argument you have had with your siblings, parents, or friends Write down the situation in your notebooks Then share this argument with the person sitting next to you Your partner must identify whether the argument was based on a normative statement or positive statement that can be supported by facts BE PREPARED TO DISCUSS!

Fist of Five: 1.No idea 2.Uncertain and shaky 3.Comfortable 4.Would test well and relatable 5.Can teach to someone else

What is a common element behind every decision you make?

Economic choice involves some adjustment to existing situation Example: jeans on sale and you must decide whether to buy another pair, or you have just finished dinner at a restaurant and decide whether to eat dessert All economic choice is based on comparison of expected marginal benefit and expected marginal cost of action under consideration

Marginal: incremental, additional, extra Change in the status quo Rational decision-maker will change status quo as long as expected marginal benefit from change exceeds expected marginal cost

Pair & Share: What are the marginal benefits and marginal costs of eating dessert? What are larger marginal choices that you make that have a large impact on the economy? What about for a corporation? Draw examples of both that your classmates must solve themselves through Pictionary After you solve, then identify both the marginal benefit and marginal cost of each decision What is the better option, in your opinion?

Rational choice takes time and requires information, yet both are scarce and, thus, valuable Often willing to pay others to gather and digest information for you Example: college guides, travel agents, real estate brokers…what are other examples? Rational decision-makers will continue to acquire information as long as the marginal benefit from that information exceeds the marginal cost of gathering it

How many of you have thought about your economic behavior this in-depth before? Microeconomics: focuses on one’s economic behavior and behavior of other individuals and firms who make choices involving what to buy and what to sell, how much to work and how much to play, how much to borrow and how much to save

Macroeconomics: focuses on performance and economy as a whole, especially the national economy Micro: individual pieces of economic puzzle Macro: fits pieces together to look at big picture

Four types of decision makers in economy: 1.Households 2.Firms 3.Governments 4.Rest of world Interaction between all determine how economy’s resources are allocated

Households play leading role in economy Demand goods and services produced Own resources, so therefore supply resources used to produce goods and services Firms, governments, and rest of world demand resources that households supply Use those resources to supply goods and services households demand Rest of world includes foreign households, foreign firms, and foreign governments that supply resources and products to U.S. markets and demand resources and products from U.S. markets

Markets: means by which buyers and sellers carry out exchange Bring together two sides of exchange, demand and supply, means price and quantity are determined Think, Ink, Pair, Share: Where are marketplaces that you know of? Why is this considered a marketplace?

Goods and services bought and sold in product markets Resources are bought and sold in resource markets Most important resource market is labor, or job, market

Circular flow model: describes flow of resources, products, income, and revenue among economic decision makers Depicts interaction among households and firms in a market economy Households on left, firms on right

Households Supply: human resources, natural resources, and capital goods to firms through resource markets (lower portion of figure) Demand: goods and services from firms through products markets (upper portion of figure) Firms Supply: goods and services to households through product markets Demand: human resources, natural resources, and capital goods from households through resources markets

Begin to sketch a circular flow model with a partner by using an example of a firma and households working together You must include the following elements: Households Firms Resource Market Product Market Natural, Human, and Capital Resources Goods and Services Keep room for yourselves, as you will be adding to this!

Flows of resources and products supported by flows of income and expenditure – the flow of money Supply and demand for resources determine what firms pay for resources Resource prices – wages, interest, rent, and profit – flow as income to households Supply and demand for products determine what households pay for goods and services Prices paid for goods and services flow as revenue to firms

Finish your own circular-flow model with a partner by adding the following: Resource prices (include all) Product prices Exit Ticket: How are your everyday decisions “economic” decisions? Will you put more thought into the decisions you make going forward? If so, how? If not, why not?