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Economic Thinking and Economic Tools

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Title: Economic Thinking and Economic Tools


1
Economic Thinking andEconomic Tools
  • Chapter 2

2
Economic Thinking
  • Normative vs. Positive Statements
  • Normative What Should be
  • Positive What is
  • In Principles of Economics we stated
  • Economics uses positive statements
  • In this Course we state
  • Economics attempts to be about Positive
    Statements

3
Economic Thinking
  • Problem In Analyzing Economic Problems is that
  • Perceptions may confuse issues
  • Personal Bias
  • Cultural Bias
  • Other Issues
  • Conventional Wisdom

4
Economic Thinking
  • Example
  • In May of 2003, Jayson Blair a reported for the
    New York Times is fired because of numerous false
    information in his articles.
  • He was discovered because he plagiarized an
    article from the San Antonio Express
  • Mr. Blair is an African American

5
Economic Thinking
  • Example (cont)
  • The fact that Mr. Blair is an African American is
    to some proof that affirmative action leads firms
    to promote based on race or ethnicity and not on
    merit

6
Economic Thinking
  • Example (cont)
  • Columnists Howard Kurtz (CNN), William Safire
    (New York Times), and Tim Rutten (Los Angeles
    Times), among others conclude that race was a
    factor in the continuation of Mr. Blair as a
    reporter even after internal memos indicated
    there was grave problems with his reporting

7
Economic Thinking
  • Example (cont)
  • To those opposing affirmative action this is
    clear evidence of the problem it creates
  • The evidence is clear, he was only promoted
    because of the race thing

8
Economic Thinking
  • Example (cont)
  • Those who support affirmative action, on the
    other hand, indicate this is an example of how
    only when minorities are involved in the same
    mistakes committed by non-minorities is race
    become an issue.
  • For instance, Terry Neal (Washington Post) and
    Seth Mnookin (Newsweek) argue that race was not
    an issue

9
Economic Thinking
  • Example (cont)
  • Terry Neal relates the example of Stephen Glass
    (New Republic) who not only fabricated stories as
    Mr. Blair has done but went as far as creating
    Web sites and voice mails to support his
    fabrications
  • Also, R. Foster Winans (Wall Street Journal) who
    in 1985 was convicted for writing false articles
    for the purpose of making money in the stock
    market

10
Economic Thinking
  • Example (cont)
  • In none of these cases was there a condemnation
    that a system that is not minority friendly
    results in lower quality white reporters not
    being fired earlier
  • Who is right?
  • Both arguments are probably right and wrong at
    the same time

11
Economic Thinking
  • In the Summer of 2003 the Supreme Court upheld
    the University of Michigans Law school admission
    policy but not that of its undergraduate program
  • Difference in the policies

12
Economic Thinking
  • In writing for the majority, Justice OConnor
    indicate that American businesses have made
    clear that the skills needed in todays
    increasingly global marketplace can only be
    developed through exposure to widely diverse
    people, cultures, ideas, and viewpoints. She
    went on to say that she expected that in 25 years
    these type of procedures would not be needed

13
Economic Thinking
  • On the other hand, writing a dissenting opinion
    Justice Thomas states these programs
    affirmative action stamp minorities with a
    badge of inferiority and may cause them to
    develop dependencies or to adopt an attitude that
    they are entitled to preferences.

14
Economic Thinking
  • Economics of the science of how individuals go
    about the business of satisfying their wants
    given scarce resources
  • The word Scarcity is crucial
  • Scarcity leads to Opportunity Cost

15
MicroeconomicsThe Basic Approach
  • Choices
  • Opportunity Cost
  • Maximization
  • Constraint Maximization
  • Example
  • Choose X to maximize V(X) subject to the
    constraint involving X and Z
  • Max U(X1,X2) s.t. I P1 X1 P2 X2

16
MicroeconomicsThe Basic Approach (Cont)
  • We have two sets of variables
  • Endogenous (solved by the system)
  • In this case X1 and X2
  • Exogenous (values given outside the system)
  • In this case I, P1, and P2

17
MicroeconomicsThe Basic Approach (Cont)
  • From the utility maximization we derive the
    demand curve.
  • In this case,
  • D1 F(P1, P2, M)
  • Next, we are interested on how the the solutions
    change when an exogenous variable changes

18
MicroeconomicsThe Basic Approach (Cont)
  • The Law of Demand
  • ?D1/?P1 lt0
  • Substitutes vs. Compliments
  • ?D1/?P2 lt or gt 0?
  • Normal vs. Inferior Goods
  • ?D1/?I lt or gt 0?

19
Demand and Supply
  • Law of Demand
  • Relative Price
  • Income and Substitution Effect
  • Things that may impact demand
  • Price of own good,
  • Price of substitute and compliment goods
  • Income

20
Demand and Supply
  • Things that may impact demand (Cont.)
  • Preferences
  • Number of buyers
  • Etc.

21
Demand
P
Increase in quantity demanded
Decrease in quantity demanded
D
Q
22
Demand
P
Exogenous variable increases demand
D
Q
23
Demand
P
Exogenous variable decreases demand
D
Q
24
Demand and Supply
  • Law of Supply
  • Relative Price
  • Income and Substitution Effect for Labor
  • Things that may impact supply
  • Price of own good,
  • Price of substitute and compliment goods
  • Cost of Inputs

25
Demand and Supply
  • Things that may impact supply (Cont.)
  • technology
  • Number of sellers
  • Etc.

26
Supply
P
S
Q
27
Supply
P
S
Increase in supply
Q
28
Supply
P
S
Decrease in supply
Q
29
Demand and Supply
P
S
P
D
Q
Q
30
Demand and Supply (Increase in Demand)
P
S
Equilibrium Price increases and equilibrium
quantity also increases
P
P
D
Q
Q
Q
31
Demand and Supply (Increase in Supply)
P
S
Equilibrium Price decreases and equilibrium
quantity increases
P
P
D
Q
Q
Q
32
Demand and Supply (Decrease in Demand)
P
S
Equilibrium Price decreases and equilibrium
quantity also decreases
P
P
D
Q
Q
Q
33
Demand and Supply (Decrease in Supply)
P
S
Equilibrium Price increases and equilibrium
quantity decreases
P
P
D
Q
Q
Q
34
Demand and Supply
P
S
Excess Demand
D
Q
35
Demand and Supply
P
S
Excess Supply
D
Q
36
Demand and Supply of Labor
S
w
D
L
37
Demand for Labor
  • Reasons why it slopes downward
  • Law of Diminishing Marginal Returns
  • Substitution Effect
  • Scale Effects

38
Supply of Labor and Equilibrium
  • Why Supply Slopes Upwards then downwards
  • Income and Substitution Effect
  • Stable Equilibrium

39
Equilibrium
  • If w gt we then there is an Excess Supply which
    implies there is unemployment
  • If w lt we then there is an Excess Demand which
    implies there is an tight labor market

40
Shocks to EquilibriumDemand
  • DEMAND
  • Output becomes more or less popular
  • Shift to more efficient capital
  • Competitiveness in output market changes
  • Technology

41
Shocks to EquilibriumSupply
  • Supply
  • Change in Labor size
  • Women enter the market place
  • Immigration
  • Taxes
  • Change in Quality of Labor
  • Education
  • Cultural Change

42
Draft vs. No Draft
  • Assume that the military in this economy is
    deciding whether to ask civilian government
    whether to institute a draft or not.
  • Clearly wages will be lower with the draft and
    will not cause an excess demand (since there is a
    draft)

43
Draft vs. No Draft
S
w
wND
wD
D
L
LND
LD
44
Draft vs. No Draft
  • Is Draft Cheaper?
  • Government
  • Yes if Yellow box is larger than brown box
  • No if the opposite is true
  • Society
  • No, since the opportunity cost of some of those
    drafted are likely to have higher

45
How Would Arm Forces Differ Under the Draft
  • Draft
  • Larger, could have soldiers with higher
    opportunity cost.
  • May not be better due to the possibility of low
    moral.

46
How Would Arm Forces Differ Under No Draft
  • No Draft
  • Smaller
  • Maybe Lower Opportunity Cost
  • Low Education
  • taste for soldiering
  • Perhaps Racial Component

47
Equity vs. Efficiency
  • No Draft
  • Efficient
  • In other words Draft is inefficient
  • Draft
  • Could be more equitable

48
Economic Thinking andEconomic Tools
  • More about regression analysis later
  • More about experimental economics later
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