Topic #2: Thinking Like an Economist Dr David Penn Associate Professor of Economics and Director of the Business and Economic Research Center

Thinking Like an Economist  Economics – the study of how a society allocates scarce resources.  With limited resources and unlimited wants, we must make choices.  There is no free lunch (there is always a cost)

Thinking Like an Economist  Positive economics – deals with ‘what is’  Normative economics – has to do with ‘what should be’

Thinking Like an Economist  Normative or Positive?  The unemployment rate is 5.5 percent.  The price of gasoline is too high.  Sales taxes are worse than income taxes.  Wages are the largest component of income.  When gasoline prices rise, consumption drops.  The government should be more involved in health care.

Thinking Like an Economist  Microeconomics – focuses on individual markets and industries; ‘little picture’  Competition  Efficiency  Trade  Market failures

Thinking Like an Economist  Macroeconomics – issues for the whole economy; ‘big picture’  Unemployment  Economic growth  Inflation  Trade  Business cycles

Thinking Like an Economist  Macroeconomics or microeconomics?  Standard Oil once was the prime example of monopoly.  Unemployment is still a major problem for the economy.  Inflation is less of a problem than it has been in years.  A tax on imported oil will increase the price of gasoline.  Anti-trust laws are needed to prevent the concentration of market power in a particular industry.  Households benefit when they can purchase a good for a price that is less than they are willing to pay.

Market economy  Most of the economies in the world are market economies to at least some degree.  Market economies are characterized by individuals and businesses making decisions based on incentives.  Example: price is a powerful incentive  When the price of gasoline rises:  Consumers use less  Refiners make more  Did society or government have to require consumers to use less gasoline or refiners to make more?

Command economy  Very few economies rely on government direction to determine what goods are produced and in what quantities.  North Korea  Cuba  In many economies, however, government rules govern the prices of some goods and services.  Example: the price of gasoline is subsidized in Iran  Result: consumers use too much and local refiners do not make enough gasoline  The degree of government intervention varies from nation to nation.  Not all government intervention in the economy is bad.

Thinking Like an Economist  Economics is a social science  It is difficult to use experiments to test economic theories (but the field of experimental economics is growing rapidly)  Consequently, economists use economic models to test theories

Thinking Like an Economist  Three important economic models:  Production possibilities frontier  Circular flow diagram  Gains from trade analysis  These models will be examined in the next three presentations.