1. Ch. 1 Economic Way of Thinking (Part II) 1-8-2009
Econ 100 Lecture 1.4
Ch. 1 Economic Way of Thinking
(Part II)

2. Overview The economic way of thinking A useful website
Narrow versus broad economics
The CIA and Afghan warlords as an economic incentive problem
Choice under constraint
Summing Up
A useful website

3. Broad versus Narrow Economics
Theory of behavior based on “incentives” is restricted to analysis of human behavior in the marketplace
E.g., impact of the “cow gas” tax
Broad economics
Incentives are not limited to economic incentives, such as prices, taxes or income
Behavior based on incentives is not restricted to only markets
E.g., CIA and Afghan warlords

4. Broad Economics
Afghan warlords and Viagra (
Whatever it takes to make friends and influence people – whether it's building a school or handing out Viagra," one veteran CIA officer told The Washington Post.
According to the newspaper, pills to boost the libidos of Afghan tribal patriarchs are the latest in a long line of inducements including medicine or operations for family, toys and school equipment, tooth extractions and visas
The trick was to identify a means of pleasing the CIA source enough to guarantee his loyalty without making it obvious to others that he's being rewarded.

5. CIA and Economics Essentially this is an economic problem
Goal is to maximize (or increase) the loyalty of the Afghan warlords
Subject to the constraint that they aren’t found out to be collaborating with the US
Need to design an incentive which meets:
The objective function (loyalty), and
The constraint (we don’t kill off our allies)

6. What is Economic Theory Based On?
“all social phenomena emerge from the actions and interactions of individuals who are choosing in response to [maximizing] expected benefits and costs” (Heyne) [under a constraint (e.g., time, money, alternatives available)]
Constraint  scarcity
Scarcity: can’t have all of the things you want
Even if you had unlimited income and no natural resource constraints => time
Without scarcity, there is no economic problem as no one has to tradeoff some of one good for another because of a monetary or income constraint

7. Another Way of Saying This
Consumers
Maximize their utility/satisfaction from consuming a number of goods and services within the constraint of their budget/income
Where U(x,y) is the utility or value from consuming goods x and y
Pi is the price of good i
I is the consumer’s income

8. Follow the Math
We will find that consumer will choose to consume Qx and QY up to the point that:
Where MUi is the marginal utility (or value) of consuming good i
But you knew this already

9. So What is Economics? Economics is the study of the: Choices we make
Constraints that we face
Tradeoffs that are made because of scarcity

10. What is Economics?
“Economic theory originated as a study or markets, of complex exchange processes”
Adam Smith, Wealth of Nations ( )
“… developed to explain how order and cooperation emerged from apparently uncoordinated interactions of individuals pursuing their own interests in substantial ignorance of the interests of those whom they are cooperating”
Adam Smith’s invisible hand

11. A Warning
“Learning the mere techniques of economic analysis is far easier than master the art of applying them sensibly and persuasively to actual social problems” (Heyne, p.16)
“..Economics does not furnish a body of settled conclusions …It a method rather than a doctrine, an apparatus of the mind…” (Keynes)

12. Review/Discussion Questions
Ch. 1
#2, 6, 9, 12

13. A Useful Website for this Material
Overview: Welcome to Economics!
After you finish this unit, you should be able to:
Explain what the term "invisible hand" means and who first used it.
Give at least one common definition of economics.
State what Malthus thought about population growth.
Explain how Popper defines scientific statements.
Distinguish between positive and normative statements.
Explain what scarcity, choice, and self-interest have to do with economics.