Study Notes on Economic Thinking
How to Think Like an Economist
Overview
Discussions on the role of economists and the methodologies they employ in their work, with emphasis on fundamental concepts in economics.
Chapter 2: How to Think Like an Economist
Introduction to thinking like an economist and the methods used by economists.
The chapter skips the circular flow diagram which is commonly found in economics textbooks.
Central questions include: What do economists do? How do they operate?
The Role of Economists
Yale Psychologist Paul Bloom
Discusses the market for organ transplants and critiques ethical implications.
Arguments regarding the monetary value of human organs, notably kidneys.
Paul Bloom argues that economists' willingness to quantify such values showcases a moral disconnection, coining the phrase:
“The problem is not that economists are unreasonable people, it’s that they’re evil people. They work in a different moral universe.”
The discussion raises ethical implications around economics and moral reasoning.
Encouraging students to adopt this different perspective raises moral concerns about economics as a discipline.
The Economist as Scientist
Economists play dual roles:
Scientists: who aim to explain how the world operates.
Policy Advisors: who seek to improve societal conditions.
The Scientific Method in Economics
Economists employ the scientific method, which encompasses:
Model/Theory Development: Formulating initial theories about economic behaviors.
Data Collection: Gathering relevant data to inform and validate these theories.
Analysis: Analyzing the collected data to interpret results and draw conclusions.
Model Reformulation: Revising theories based on findings to enhance accuracy.
Economic Models
Economists develop models based on assumptions regarding human behavior.
The term Homo economicus (commonly referred to as “Econs”) is crucial here.
Assumptions about 'Econs':
Rationality: Decisions are made logically.
Self-interest: Individuals seek to optimize their outcomes.
Preference for more resources: Individuals are assumed to always prefer more goods.
The realism of these assumptions is debated among economists.
Acknowledgement of tradeoffs inherent in creating simplified models.
Are You Homo Economicus?
Presenting a hypothetical scenario regarding birthday wishes to explore personal preferences and reveal economic reasoning:
A) Surprise me, I love surprises!
B) Money, obviously.
C) Questioning the significance of arbitrary celebration, eventually opting for money.
The Value of Economic Models
Models are constructed to predict economic phenomena; if successful, they hold value.
Complexity in modeling arises rapidly; economists may achieve accuracy but also face failures.
Emphasis on the necessity of data to verify or falsify theoretical predictions.
Challenges in Economic Experiments
A distinct challenge faced by economists is the ethical implications of conducting randomized experiments on humans.
Performing experiments on large scale societies or nations is deemed impractical.
Example Case: Cares Act of 2020, estimating a fiscal response of $2.2 trillion, creating significant debate:
Arguments for increased support versus critiques of the relief measures.
This underlies the challenges in resolving many economic queries definitively.
Natural Experiments
Acknowledging natural experiments as a viable alternative to randomized controlled trials.
Examples include:
The impact of minimum wage laws on employment.
Effects of military drafts on the earnings of those who served in the Vietnam War.
Medicare eligibility at the age of 65.
Limitations include the inability to address all economic queries and issues around generalizability.
Obstacles in Economic Scientific Practice
Economists face unique obstacles, including:
B) Difficulty and sometimes impossibility of conducting experiments.
C) Question of whether economics can be approached subjectively versus objectively.
The Production Possibilities Frontier
Definition
Production Possibilities Frontier (PPF): A graphical representation showing the potential combinations of two goods that an economy can produce, given its resource limits and technology level.
Resources include: land, labor, and capital.
The level of economic well-being correlates to how much production occurs.
Illustrative Example
PPF illustrates production choices, highlighting trade-offs, such as the trade-off between producing computers versus butter:
**Analytical Points: **
Efficient production versus inefficient.
Feasibility of production combinations.
Implications of Technology on PPF
Technological advances can lead to an outward shift on the PPF, indicating economic growth allowing for increased production of goods.
Production capacity for both goods is expected to improve with technological progress.
Biased Technological Advances
Biased advances affect one area of the economy’s production curve, e.g.,
Introduction of superior fertilizer leading to increased agricultural output while neglecting production elsewhere.
Factors Impacting PPF's Position
Expanding resources such as additional land, labor, or capital also contribute to outward shifts in the PPF.
Opportunity Cost and PPF
Critical concept: opportunity costs arise when allocating resources for production:
In moving from producing computers to butter, how much of one good must sacrifice to increase production of another?
Mathematical representation of Opportunity Cost:
Meaning: For each unit of good A (e.g., a computer), resource allocation can cause measurable detriment in good B (e.g., butter).
Example Calculation
In a two-good economy, opportunity costs are articulated verbally:
“You give up x of good B to get y of good A.”
Calculation methodology to illustrate moves across PPF.
Calculating Opportunity Cost From PPF
Reference changes in production from point A to B; the opportunity cost is determined by:
Example calculation, from point A (200 cars and 100 computers) results in:
Further shift from B to maximum cars (300 cars without computers) results in:
The Shape of the PPF
The PPF can take on varied geometric forms (linear or bow-shaped).
The shape impacts opportunity costs encountered when reallocating resources.
Bow-Shaped PPF
A bow-shaped PPF indicates increasing opportunity costs as production escalates for a specific good.
Linear PPF suggests constant opportunity costs across production.
Rationale Behind Bow-Shaped PPF
Bowed PPF arises when differing workers have specialized skills impacting production; costs vary as one good replaces another.
Example: Skills related to constructing computers versus farming for butter; not all production methods yield equal benefits.
Discussion: Recognizing Economic Concepts
Engage in partner discussions to articulate theoretical applications:
Consider scenarios creating unbiased growth where both goods improve in production.
Instances that create biased growth favoring one good over another are explored.
Normative Versus Positive Economic Statements
Definitions
Positive Statements: Factual, descriptive claims that can be validated. Example statement:
“Minimum-wage laws cause unemployment.”
Normative Statements: Prescriptive assertions about what should happen or be. Example statement:
“The government should raise the minimum wage.”
Notable Examples in Economic Discourse
When discussing carbon taxes, an economist notes,
“Economists (some with caveats), Exxon, and Elon Musk have all stated that a specific version of the carbon tax is the best way to encourage cleaner consumer choices.” This aligns as a positive statement.
Contrarily, Presidents’ remarks regarding resource allocations represent normative statements rooted in opinion. “I don’t think we should **.”
Reasons for Economic Disagreements
Economists may offer differing policies due to:
Conflicting positive theories about economic realities.
The absence of experimental evidences.
Variability in values shaping what policies ought to pursue or prescribe.
Consensus on Economic Principles
Existing Agreement Among Economists:
General consensus on numerous economic statements, e.g.:
93% affirm the impact of rent control reducing housing quality.
90% believe in unrestricted outsourcing.
85% support the elimination of agricultural subsidies.