Why Economics Matters Farid Abolhassani M.D. بسم الله الرحمن الرحيم

Economics: Definition The study of how individuals and societies choose to Allocate scarce productive resources among competing alternative uses and Distribute the products from these uses among the members of a society

Resources Time and abilities of individuals Land and natural resources Capital Knowledge of production processes Money Money is not defined by economists as a resource in itself

Scarcity Scarcity means that: There are not, and can never be, enough resources to satisfy all human wants and needs

The Cost-benefit Approach To Decisions The major challenge of daily living: Should I do activity x ? Economists’ answer to this question: If B(x) > C(x) Then Do x Otherwise Do not do x End if B(x) and C(x) could always be expressed in monetary terms

Reservation Price: Definition The minimum amount of money one asks to give up something Or The minimum amount of money one is ready to pay to benefit from something

The Role of Economic Theory Many economists believe that: Useful insights into our behavior can be gained by assuming that we act as if governed by the rules of rational decision making.

Common Pitfalls in Decision Making Ignoring implicit costs Failing to ignore sunk costs Focusing on only some of the relevant costs

Common Pitfalls in Decision Making Ignoring implicit costs Failing to ignore sunk costs Focusing on only some of the relevant costs

Cost of Activity x Cost of activity x = Direct costs + Opportunity cost

Opportunity Cost highest valued real The highest valued alternative sacrificed in order to choose an option is called the opportunity ( real ) cost of that option

The Benefit of Activity x Benefit of a pleasant activity = Direct Benefit + Reservation Price Benefit of an unpleasant activity = Direct Benefit – Reservation Price

Common Pitfalls in Decision Making Ignoring implicit costs Failing to ignore sunk costs Focusing on only some of the relevant costs

Sunk Cost: Definition Costs that are beyond recovery at the moment a decision is made

Marginal Analysis Number Tomans / Number Marginal benefit of pizza Marginal cost of pizza - 500

Common Pitfalls in Decision Making Ignoring implicit costs Failing to ignore sunk costs Focusing on only some of the relevant costs

Buick or Toyota CbCb CtCt C b = d C t = d distance Cost

The Invisible Hand Adam Smith Wholly unaware of the effects of their actions, self-interested consumers often act as if driven by what Adam Smith called an invisible hand to produce the greatest social good.

Economic Analysis Evaluating and choosing among alternative courses of action through examining both the costs and consequences of the alternatives.

Efficiency most Get the most from scarce scarce resources

Elements of Efficiency Do not waste resources Technical efficiency Produce each output at least cost Cost-effectiveness efficiency Produce the type and amounts of output which people value most Allocative efficiency

Allocative Efficiency Social Desirability They Are Not the Same

Marginal Conditions for Allocative Efficiency Marginal cost: Marginal cost: The additional cost incurred in producing the last unit of an output Marginal benefit: Marginal benefit: The additional benefit obtained by consuming the last unit of an output Marginal Benefit = Opportunity cost of resources used up to create the last unit of output

Allocative Efficiency: Role of Market Perfect market Marginal Social Cost = Marginal Social Benefit Market Failure

The Last Remaining Points Positive questions and normative questions Microeconomics and macroeconomics