DC Econ Chapter 1 - Textbook

In 1950, the typical woman who married did so at age 20. Now, however, she is waiting until age 27. Furthermore, a larger number of women are choosing not to marry at all. Contributing to delayed marriages and nonmarriages is the fact that fewer women are agreeing to marry non-college-educated men employed by or seeking to work in manufacturing industries. In this chapter, you will learn that diminished prospects for male employment by manufacturing firms and decreased male earnings at these companies have provided women with economic incentives that reduce their willingness to marry these men. Indeed, you will learn that such incentives play significant roles in most decisions made by all individuals, including choices about when and whether to m

The Power of Economic Analysis

Simply knowing that self-interest and incentives are central to any decision-making process is not sufficient for predicting the choices that people will actually make. You also have to develop a framework that will allow you to analyze solutions to each economic problem. You must do so whether you are trying to decide how much to study, which courses to take, or to finish school, or whether you are evaluating if the U.S. government should provide more grants to universities or raise taxes. The framework that you will learn in this text is the economic way of thinking. This framework gives you power—the power to reach informed judgments about what is happening in the world. You can, of course, live your life without the power of economic analysis as part of your analytical framework. Indeed, most people do. Economists believe, though, that economic analysis can help you make better deci-sions concerning your career, your education, financing your home, and other impor-tant matters.

In the business world, the power of economic analysis can help increase your com-petitive edge as an employee or as the owner of a business. As a voter, for the rest of your life you will be asked to make judgments about policies that are advocated by political parties. Many of these policies will deal with questions related to interna-tional economics, such as whether the U.S. government should encourage or discour-age immigration or restrict other countries from selling their goods here.

Economics

The study of how people allocate their limited resources to satisfy their unlimited wants.

Defining Economics Economics is part of the social sciences and, as such, seeks explanations of real events. All social sciences analyze human behavior, as opposed to the physical sciences, which generally analyze the behavior of electrons, atoms, and other nonhuman phenomena.

Resources

Things used to produce goods and services to satisfy people’s wants. Wants

What people would buy if their incomes were unlimited.

Economics is the study of how people allocate their limited resources in an attempt to satisfy their unlimited wants. As such, economics is the study of how people make choices.

To understand this definition fully, two other words need explaining: resources and wants. Resources are things that have value and, more specifically, are used to pro-duce goods and services that satisfy people’s wants. Wants are all of the items that people would purchase if they had unlimited income.

Whenever an individual, a business, or a nation faces alternatives, a choice must be made, and economics helps us study how those choices are made. For example, you have to choose how to spend your limited income. You also have to choose how to spend your limited time. You may have to choose how many of your company’s limited resources to allocate to advertising and how many to allocate to new-product research. In economics, we examine situations in which individuals choose how to do things, when to do things, and with whom to do them. Ultimately, the purpose of economics is to explain choices.

Microeconomics versus Macroeconomics

Economics is typically divided into two types of analysis: microeconomics and macroeconomics.

Microeconomics is the part of economic analysis that studies decision making undertaken by individuals (or households) and by firms. It is like looking through a microscope to focus on the small parts of our economy.

Macroeconomics is the part of economic analysis that studies the behavior of the economy as a whole. It deals with economywide phenomena such as changes in unemployment, in the general price level, and in national income.

Microeconomic analysis, for example, is concerned with the effects of changes in the price of gasoline relative to that of other energy sources. It examines the effects of new taxes on a specific product or industry. If the government establishes new health care regulations, how individual firms and consumers will react to those regulations would be in the realm of microeconomics. The effects of higher wages brought about by an effective union strike would also be analyzed using the tools of microeconomics. In contrast, issues such as the rate of inflation, the amount of economywide unem-ployment, and the yearly growth in the output of goods and services in the nation all fall into the realm of macroeconomic analysis. In other words, macroeconomics deals with aggregates, or totals—such as total output in an economy. Be aware, however, of the blending of microeconomics and macroeconomics in modern economic theory. Modern economists are increasingly using microeconomic analysis—the study of decision making by individuals and by firms—as the basis of macroeconomic analysis. They do this because even though macroeconomic analysis focuses on aggregates, those aggregates are the result of choices made by individuals and firms.

Recent technological developments have contributed further to the theoretical

blending of microeconomics and macroeconomics. Increasingly, businesses, govern-ments, and even individuals are turning to artificial intelligence (AI) technologies, which are digital-app-based or -assisted tools utilized in making and implementing decisions. AI technologies often implement sophisticated and typically automated data-analytics methods for working with very substantial volumes of information, com-monly known as big data, to reveal previously hidden relationships. In the past, people applied their skills in using basic statistical techniques to examine and learn from large sets of data. To a growing extent, however, people now have adopted machine learning, or the application of simple or sophisticated AI-guided programming of digital devices, to search through massive bodies of data that human minds might struggle to compre-hend. Increasingly, AI technologies also entail the use of virtual-reality techniques, which allow people to view or perceive fully artificial environments, or augmented-reality methods, which enable individuals to observe virtual overlays of information alongside real images. With such AI technologies, businesses, governments, and consumers can make more informed decisions. Furthermore, a growing number of economists also are employing AI technologies to examine people’s decision making and choices. Why does the application of big data analytics potentially have microeconomic and macroeconomic implications?

Two Opposing Sets of Answers

In every nation, three fundamental questions must be addressed irrespective of the form of its government or who heads that government, how rich or how poor the nation may be, or what type of economic system—the institutional mechanism through which resources are utilized to satisfy human wants—has been chosen.

The Three Basic Questions

The three fundamental questions of economics concern the problem of how to allo-cate society’s scarce resources:

1. What and how much will be produced? Some mechanism must exist for determining which items will be produced while others remain inventors’ pipe dreams or indi-viduals’ unfulfilled desires.

ECONOMICS IN YOUR LIFE To contemplate a recent example from U.S. housing finance regarding choosing among answers to the three basic economic questions, take a look at Government Involvement Enables a Private U.S. Housing Finance Company to Provide “Cheap” Loans on page 12.

2. How will items be produced? There are many ways to produce a desired item. It is possible to use more labor and fewer machines, or vice versa. It is possible, for instance, to produce an item with an aim to maximize the number of people employed. Alternatively, an item may be produced with an aim to minimize the total expenses that members of society incur. Somehow, a decision must be made about the mix of resources used in production, the way in which they are organized, and how they are brought together at a particular location.

3. For whom will items be produced? Once an item is produced, who should be able to obtain it? People use scarce resources to produce any item, so typically people value access to that item. Thus, determining a mechanism for distributing produced items is a crucial issue for any society.

Now that you know the questions an economic system must answer, how do cur-rent systems actually answer them?

Two Opposing Sets of Answers

At any point in time, every nation has its own economic system. How a nation’s resi-dents go about answering the three basic economic questions depends on that nation’s economic system.

Centralized Command and Control Throughout history, one common type of eco-nomic system has been command and control (also called central planning). Such a system is operated by a centralized authority, such as a king or queen, a dictator, a central government, or some other type of authority. Such an entity assumes responsibility for addressing fundamental economic issues. Under command and control, this authority decides what items to produce and how many, determines how the scarce resources will be organized in the items’ production, and identifies who will be able to obtain the items.

For instance, in a command-and-control economic system, a government might decide that particular types of automobiles ought to be produced in certain numbers. The government might issue specific rules for how to manage the pro-duction of these vehicles, or it might even establish ownership over those resources so that it can make all such resource allocation decisions directly. Finally, the government may then decide who will be authorized to purchase or otherwise utilize the vehicles.

The Price System The alternative to command and control is the price system (also called a market system), which is a shorthand term describing an economic system that answers the three basic economic questions via decentralized decision making. Under a pure price system, individuals and families own all of the scarce resources used in production. Consequently, choices about what and how many items to produce are left to private parties to determine on their own initiative, as are decisions about how to go about producing those items. Furthermore, individuals and families choose how to allocate their own incomes to obtain the produced items at prices established via privately organized mechanisms.

In the price system, which you will learn about in considerable detail in later chapters, prices define the terms under which people agree to make exchanges. Prices signal to everyone within a price system which resources are relatively scarce and which are relatively abundant. This signaling aspect of the price system provides infor-mation to individual buyers and sellers about what and how many items should be produced, how production of items should be organized, and who will choose to buy the produced items.

Thus, in a price system, individuals and families own the facilities used to produce automobiles. They decide which types of automobiles to produce, how many of them to produce, and how to bring labor and machines together within their facilities to generate the desired production. Other individuals and families decide how much of their earnings they wish to spend on automobiles.

Mixed Economic Systems By and large, the economic systems of the world’s nations are mixed economic systems that incorporate aspects of both centralized command and control and a decentralized price system. At any given time, some nations lean toward centralized mechanisms of command and control and allow relatively little scope for decentralized decision making. At the same time, other nations limit the extent to which a central authority dictates answers to the three basic economic ques-tions, leaving people mostly free to utilize a decentralized price system to generate their own answers.

A given country may reach different decisions at different times about how much to rely on command and control versus a price system to answer its three basic economic questions. Until 2008, for instance, U.S. residents preferred to rely mainly on a decen-tralized price system to decide which and how many financial services to produce and

how to produce them. During some years since then, the U.S. government has owned substantial fractions of financial firms and hence has exerted considerable command-and-control authority over production of financial services.

1.3 Evaluate the role that rational self-interest plays in economic analysis

The Economic Approach: Systematic Decisions Economists assume that individuals act as if they systematically pursue self-motivated interests and respond predictably to perceived opportunities to attain those interests. This central insight of economics was first clearly articulated by Adam Smith in 1776. Smith wrote in his most famous book, An Inquiry into the Nature and Causes of the Wealth of Nations, that “it is not from the benevolence [good will] of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” Thus, the typical person about whom economists make behavioral predic-tions is assumed to act as though he or she systematically pursues self-motivated interest.

Rationality assumption The assumption that people do not intentionally make decisions that would leave them worse off.

The Rationality Assumption The rationality assumption of economics, simply stated, is as follows:

We assume that individuals do not intentionally make decisions that would leave them worse off.

The distinction here is between what people may think—the realm of psychology and psychiatry and perhaps sociology—and what they do. Economics does not involve itself in analyzing individual or group thought processes. Economics looks at what people actually do in life with their limited resources. It does little good to criticize the rationality assumption by stating, “Nobody thinks that way” or “I never think that way” or “How unrealistic! That’s as irrational as anyone can get!” In a world in which people can be atypical in countless ways, economists find it useful to concentrate on discovering the baseline. Knowing what happens on average is a good place to start. In this way, we avoid building our thinking on exceptions rather than on reality. Take the example of driving. When you consider passing another car on a two-lane

highway with oncoming traffic, you have to make very quick decisions: You must esti-mate the speed of the car that you are going to pass, the speed of the oncoming cars, the distance between your car and the oncoming cars, and your car’s potential rate of acceleration. If we were to apply a model to your behavior, we would use the rules of calculus. In actual fact, you and most other drivers in such a situation do not actually think of using the rules of calculus, but to predict your behavior, we could make the prediction as if you understood those rules.

Responding to Incentives

If it can be assumed that individuals never intentionally make decisions that would leave them worse off, then they will respond to changes in incentives. Indeed, much of human behavior can be explained in terms of how individuals respond to changing incentives over time.

Schoolchildren are motivated to do better by a variety of incentive systems, rang-ing from gold stars and certificates of achievement when they are young, to better grades with accompanying promises of a “better life” as they get older. Of course, negative incentives affect our behavior, too. Penalties, punishments, and other forms of negative incentives can raise the total cost of engaging in various activities.

How have earnings-based and tuition-expense-related incentives of pursuing a col-lege degree changed in recent years?

Defining Self-Interest Self-interest does not always mean increasing one’s wealth measured in dollars and cents. We assume that individuals seek many goals, not just increased wealth measured in monetary terms. Thus, the self-interest part of our economic-person assumption includes goals relating to prestige, friendship, love, power, helping others, creating works of art, and many other matters. We can also think in terms of enlightened self-interest, whereby individuals, in the pursuit of what makes them better off, also achieve the betterment of others around them. In brief, individuals are assumed to want the ability to further their goals by making decisions about how items around them are used. The head of a charitable organization usually will not turn down an additional contribution, because accepting the funds yields control over how they are used, even though their use is for other people’s benefit.

Does the fact that many people donate to charity necessarily imply that the donors only wish to help others?

Economics as a Science

Economics is a social science that employs the same kinds of methods used in other sciences, such as biology, physics, and chemistry. Like these other sciences, economics uses models, or theories. Economic models, or theories, are simplified representa-tions of the real world that we use to help us understand, explain, and predict eco-nomic phenomena in the real world. There are, of course, differences between sciences. Social scientists, including economists, tend to make less use of laboratory experiments in which changes in variables—human choices or outcomes subject to change—are studied under controlled conditions. Social scientists often test their models, or theories, by examining what has already happened in the real world.

Models and Realism

At the outset it must be emphasized that no model in any science, and therefore no economic model, is complete in the sense that it captures every detail or interrelation-ship that exists. Indeed, a model, by definition, is an abstraction from reality. It is conceptually impossible to construct a perfectly complete realistic model. For exam-ple, in physics we cannot account for every molecule and its position and certainly not for every atom and subatomic particle. Not only is such a model unreasonably expen-sive to build, but working with it would be impossibly complex. The nature of scientific model building is that the model should capture only the

essential relationships that are sufficient to analyze the particular problem or answer the particular question with which we are concerned. An economic model cannot be faulted as unrealistic simply because it does not represent every detail of the real world. A map of a city that shows only major streets is not faulty if, in fact, all you wish to know is how to pass through the city using major streets. As long as a model is able to shed light on the central issue at hand or forces at work, it may be useful. A map is the quintessential model. It is always a simplified representation. It is

always unrealistic. It is, however, also useful in making predictions about the world. If the model—the map—predicts that when you take Campus Avenue to the north, you always run into the campus, that is a prediction. If a simple model can explain observed behavior in repeated settings just as well as a complex model, the simple model has some value and is probably easier to use.

Assumptions

Every model, or theory, must be based on a set of assumptions. Assumptions define the array of circumstances in which our model is most likely to be applicable. When some people predicted that sailing ships would fall off the edge of the earth, they used the assumption that the earth was flat. Columbus did not accept the implications of such a model because he did not accept its assumptions. He assumed that the world was round. The real-world test of his own model refuted the flat-earth model. Indirectly, then, it was a test of the assumption of the flat-earth model. Is it possible to use our knowledge about assumptions to understand why driving directions sometimes contain very few details?

The Ceteris Paribus Assumption: All Other Things Being Equal Everything in the world seems to relate in some way to everything else in the world. It would be impossible to isolate the effects of changes in one variable on another variable if we always had to worry about the many other variables that might also enter the analysis. Similar to other sciences, economics uses the ceteris paribus assumption. Ceteris paribus means “other things constant” or “other things equal.”

Consider an example taken from economics. One of the most important determi-nants of how much of a particular product a family buys is how expensive that product is relative to other products. We know that in addition to relative prices, other factors influence decisions about making purchases. Some of them have to do with income, others with tastes, and yet others with custom and religious beliefs. Whatever these other factors are, we hold them constant when we look at the relationship between changes in prices and changes in how much of a given product people will purchase.

Deciding on the Usefulness of a Model We generally do not attempt to determine the usefulness, or “goodness,” of a model by evaluating how realistic its assumptions are. Rather, we consider a model “good” if it yields usable predictions that are supported by real-world observations. In other words, can we use the model to predict what will happen in the world around us? Does the model provide useful implications about how things happen in our world? Once we have determined that the model may be useful in predicting real-world phe-nomena, the scientific approach to the analysis of the world around us requires that we consider evidence. Evidence is used to test the usefulness of a model. This is why we call economics an empirical science. Empirical means that evidence (data) is looked at to see whether we are right. Economists are often engaged in empirically testing their models.

Models of Behavior, Not Thought Processes Take special note of the fact that economists’ models do not relate to the way people think. Economic models predict how people act and what they do in life with their limited resources. The economist does not attempt to predict how people will think about a particular topic, such as a higher price of oil products, accelerated inflation, or higher taxes. Rather, the task at hand is to predict how people will behave, which may be quite different from what they say they will do (much to the consternation of poll takers and market researchers). Thus, people’s declared preferences are generally of little use in testing economic theories, which aim to explain and predict people’s revealed preferences. The people involved in examine

Behavioral Economics and Bounded Rationality In recent years, some economists have proposed paying more attention to psycholo-gists and psychiatrists. They have suggested an alternative approach to economic anal-ysis. Their approach, known as behavioral economics, examines consumer behavior in the face of psychological limitations and complications that may interfere with rational decision making.

Bounded Rationality Proponents of behavioral economics suggest that traditional economic models assume that people exhibit three “unrealistic” characteristics:

Bounded rationality

The hypothesis that people are nearly, but not fully, rational, so that they cannot examine every possible choice available to them but instead use simple rules of thumb to sort among the alternatives that happen to occur to them.

1. Unbounded selfishness. People are interested only in their own satisfaction. 2. Unbounded willpower. Their choices are always consistent with their long-term goals. 3. Unbounded rationality. They are able to consider every relevant choice. As an alternative, advocates of behavioral economics have proposed replacing the rationality assumption with the assumption of bounded rationality, which assumes that people cannot examine and think through every possible choice they confront. As a consequence, behavioral economists suggest, individuals cannot always pursue, on their own, their best long-term personal interests. They sometimes require help.

Rules of Thumb A key behavioral implication of the bounded rationality assumption is that people should use so-called rules of thumb: Because every possible choice cannot be considered, an individual will tend to fall back on methods of making decisions that are simpler than trying to sort through every possibility. A problem confronting advocates of behavioral economics is that people who appear to use rules of thumb may in fact behave as if they are fully rational. For instance, if a person faces persistently predictable ranges of choices for a while, the individual may rationally settle into repetitive behaviors that an outside observer might conclude to be consistent with a rule of thumb. According to the bounded rationality assumption, the person will continue to rely on a rule of thumb even if there is a major change in the environment that the individual faces. Time and time again, however, economists find that people respond to altered circumstances by fundamentally changing their behaviors. Economists also generally observe that people make decisions that are con-sistent with their own self-interest and long-term objectives.

Behavioral Economics Goes Mainstream The bulk of economic analysis continues to rely on the rationality assumption as the basis for constructing economic models. In most contexts, economists view the rationality assumption as a reasonable foundation for constructing models intended to predict human decision making. Nevertheless, a growing number of economists are exploring ways in which psycho-logical elements might improve analysis of decision making by individual consumers, firm owners and managers, and government officials. These economists are applying the bounded rationality assumption to study effects of limitations on people’s capabilities to pursue self-interest, to assess how choices relate to long-term goals, or to consider all available choices. As you will learn in later chapters, behavioral theories and methods are being applied to the study of both microeconomic and macroeconomic issues.

Distinguishing between Positive and Normative Economics For many problems analyzed in the “hard” sciences such as physics and chemistry, the analyses are considered to be virtually value-free. After all, how can someone’s values enter into a theory of molecular behavior? Economists, however, face a different problem. They deal with the behavior of individuals, not molecules. That makes it more difficult to stick to what we consider to be value-free or positive economics without reference to our feelings. When our values are interjected into the analysis, we enter the realm of normative economics, involving normative analysis. A positive economic statement is “If the price of gas rises, people will buy less.” If we add to that analysis the statement “so we should not allow the price to go up,” we have entered the realm of normative economics—we have expressed a value judgment. In fact, any time you see the word should, you will know that values are entering into the discussion. Just remember that positive state-ments are concerned with what is, whereas normative statements are concerned with what ought to be.

Each of us has a desire for different things. That means we have different values. When we express a value judgment, we are simply saying what we prefer, like, or desire. Because individual values are diverse, we expect—and indeed observe—that people express widely varying value judgments about how the world ought to be.

A Warning: Recognize Normative Analysis

It is easy to define positive economics. It is quite another matter to catch all unla-beled normative statements in a textbook, even though an author goes over the man-uscript many times before it is printed or electronically created. Therefore, do not get the impression that a textbook author will be able to keep all personal values out of the book. They will slip through. In fact, the very choice of which topics to include in an introductory textbook involves normative economics. There is no value-free way to decide which topics to use in her or his textbook. The author’s values ulti-mately make a difference when choices have to be made. From your own standpoint, though, you might want to be able to recognize when you are engaging in normative as opposed to positive economic analysis. Reading this text will help equip you for that task.

Positive economics Analysis that is strictly limited to making either purely descriptive statements or scientific predictions. For example, “If A, then B.” A statement of what is. Normative economics

Analysis involving value judgments about economic policies; relates to whether outcomes are good or bad. A statement of what ought to be.

ECONOMICS AS IT APPLIES TO YOUR EVERYDAY LIFE AND YOUR FUTURE

Throughout this new edition, you will find numerous examples of how to apply eco-nomics to your everyday life and to decision making with respect to your career, your family, and even how you analyze political statements. In other words, you will learn economic skills that are practical. In many of the examples and other features throughout the text, you will find a Real Application question. These questions relate to: • Career choices • Managerial choices if you decide to go into business • Future behavior in your household • Voting choices

Managerial choices if you decide to go into business • Future behavior in your household • Voting choices

The next-to-last chapter-ending feature, called Economics in Your Life, always ends

with a Real Application question. The last feature in each chapter, called Issues & Applications, will also always end with a Real Application question.

The Choice Faced by a Woman Considering Marriage to a Man Working or Seeking Work in Manufacturing

In years past, inflation-adjusted hourly earnings of male manufacturing workers were among the highest available to men not receiving education beyond high school. In

2000, more than 16 million men had these higher-paying manufacturing jobs, but in the years since, the number of men working in manufacturing industries has declined by about 25 percent. If a woman’s behavior is consistent with the rationality assumption, she will recognize that fewer non-college-educated men are now finding manufacturing employment and earning the higher incomes associated with such jobs. This fact reduces the tangible valuation placed on mar-riage to such a man. Her response to this incentive could be either to postpone marriage until her valuation of such a man’s likely economic contribution to a marriage rises or to perhaps not marry at all.

Male Employment and Earnings Losses in Manufacturing and a Decrease in the Number of Married Women

In fact, the prevalence of marriage on the part of women, which has declined steadily over the past several decades, has dropped even further in recent years. More women are marrying at a later age or opting not to marry. Researchers have found evidence that a disproportionate number of women choosing to postpone matrimony or deciding not

to marry are among those who otherwise likely would have married men with jobs or seeking jobs in manufacturing.

FOR CRITICAL THINKING

Why do you think that the prevalence of marriages by women to higher-income-earning men has remained relatively steady in recent years? (Hint: More higher-income-earning men have com-pleted more years of education and have more stable employ-ment prospects than men who work for manufacturing firms.)

REAL APPLICATION

Currently, a larger percentage of women are obtaining advanced degrees than are men. What are some of the real-world implica-tions of this trend with respect to marriage? Sources are listed at the end of this chap

1-1. Define economics. Explain briefly how the eco-nomic way of thinking—in terms of rational, self-interested people responding to incentives—is involved in each of the following situations. a. A student deciding whether to purchase a text-book for a particular class

b. Government officials seeking more funding for mass transit through higher taxes

c. A municipality taxing hotel guests to obtain funding for a new sports stadium

1-2. Some people claim that the “economic way of thinking” does not apply to issues such as health care. Explain how economics does apply to this issue by developing a “model” of an individual’s choices.

1-3. Does the phrase “unlimited wants and limited resources” apply to both a low-income household and a middle-income household? Can the same phrase be applied to a very high-income household?

1-4. In a single sentence, contrast microeconomics and macroeconomics. Next, categorize each of the fol-lowing issues as a microeconomic issue, a macro-economic issue, or not an economic issue. a. The national unemployment rate b. The decision of a worker to work overtime or not

c. A family’s choice to have a baby d. The rate of growth of the money supply e. The national government’s budget deficit f. A student’s allocation of study time across two subjects

1-5. One of your classmates, Sally, is a hardworking student, serious about her classes, and conscien-tious about her grades. Sally is also involved, how-ever, in volunteer activities and an extracurricular sport. Could Sally be displaying rational behav-ior? Based on what you read in this chapter,

construct an argument supporting the conclusion that she is.

1-6. Recently, a bank was trying to decide what fee to charge for “expedited payments”—payments the bank would transmit with extra speed so that cus-tomers could avoid late fees on cable TV bills, electric bills, and the like. To try to determine what fee customers were willing to pay for expe-dited payments, the bank conducted a survey. It was able to determine that many of the people sur-veyed already paid fees for expedited payment ser-vices that exceeded the maximum fees they said they were willing to pay. How does the bank’s finding relate to economists’ traditional focus on what people do, rather than what they say they will do?

1-7. Explain, in your own words, the rationality assumption, and contrast it with the assumption of bounded rationality proposed by adherents of behavioral economics.

1-8. Why does the assumption of bounded rationality suggest that people might use rules of thumb to guide their decision making instead of considering every possible choice available to them?

1-9. Under what circumstances might people appear to use rules of thumb, as suggested by the assumption of bounded rationality, even though they really are behaving in a manner suggested by the rationality assumption?

1-10. For each of the following approaches that an econ-omist might follow in examining a decision-making process, identify whether the approach relies on the rationality assumption or on the assumption of bounded rationality. a. To make predictions about how many apps a per-son will download onto her tablet device, an economist presumes that the individual faces lim-itations that make it impossible for her to exam-ine every possible choice among relevant apps.

b. In evaluating the price that an individual will be willing to pay for a given quantity of a particular type of health care service, a researcher assumes that the person considers all relevant health care options in pursuit of his own long-term satisfac-tion with resulting health outcomes.

c. To determine the amount of time that a person will decide to devote to watching online videos each week, an economist makes the assumption that the individual will feel overwhelmed by the sheer volume of videos available online and will respond by using a rule of thumb.

1-11. For each of the following approaches that an econ-omist might follow in examining a decision-making process, identify whether the approach relies on the rationality assumption or on the assumption of bounded rationality. a. An economic study of the number of online searches that individuals conduct before select-ing a particular item to purchase online pre-sumes that people are interested only in their own satisfaction, pursue their ultimate objec-tives, and consider every relevant option.

b. An economist seeking to predict the effect that an increase in a state’s sales tax rate will have on consumers’ purchases of goods and services presumes that people are limited in their ability to process information about how the sales-tax-rate increase will influence the after-tax prices those consumers will pay.

c. To evaluate the impact of an increase in the range of choices that an individual confronts when deciding among devices for accessing the Internet, an economic researcher makes the assumption that the individual is unable to take into account every new Internet-access option available to her.

1-12. Which of the following predictions appear(s) to follow from a model based on the assumption that rational, self-interested individuals respond to incentives? a. For every ten exam points Myrna must earn in order to pass her economics course and meet her graduation requirements, she will study one additional hour for her economics test next week.

b. A coin toss will best predict Leonardo’s decision about whether to purchase an expensive busi-ness suit or an inexpensive casual outfit to wear next week when he interviews for a high-paying job he is seeking.

c. Celeste, who uses earnings from her regularly scheduled hours of part-time work to pay for her room and board at college, will decide to

purchase and download a newly released video this week only if she is able to work two addi-tional hours.

1-13. Write a sentence contrasting positive and norma-tive economic analysis.

1-14. Based on your answer to Problem 1-13, categorize each of the following conclusions as resulting from positive analysis or normative analysis. a. A higher minimum wage will reduce employ-ment opportunities for minimum wage workers.

b. Increasing the earnings of minimum wage employees is desirable, and raising the mini-mum wage is the best way to accomplish this.

c. Everyone should enjoy open access to health care at no explicit charge.

d. Health care subsidies will increase the consump-tion of health care.

1-15. Consider the following statements, based on a positive economic analysis that assumes all other things remain constant. For each, list one other thing that could independently change in a way that offsets the outcome stated. a. Increased demand for digital devices will drive up their price.

b. Falling gasoline prices will result in additional vacation travel.

c. A reduction of income tax rates will result in more people working.

1-16. Suppose that the U.S. federal government has borrowed $500 billion to expand its total spending on goods and services across the entire economy in an effort to boost by $500 billion the aggregate production by the nation’s firms. Would we apply microeconomic or macroeconomic analysis to analyze this policy action?

1-17. Suppose that the government has raised by $10 a per-carat tax rate it imposes on diamonds in an effort to influence production of this particular good by each of the firms that produce it and pur-chases by individual consumers. Would we apply microeconomic or macroeconomic analysis to analyze this policy action?

1-18. Centralized command and control prevails throughout a certain nation’s economy. What three key economic questions have been addressed in this nation, and what has been the common ele-ment of the nation’s answers to those questions?

1-19. During her years of college, Dominique discov-ered that her three favorite subjects were astron-omy, chemistry, and political science. She chose to major in astronomy because she had seen data indicating that

science majors earn

higher-than-average wages and because she liked astronomy better than both chemistry and politi-cal science. Upon graduation, however, she learned that average wages in chemistry fields were 20 per-cent higher than average wages earned by astrono-mers. Did Dominique’s behavior violate the rationality assumption?

1-20. Sebastian is a financial analyst who is convinced that his clients do not always make choices that are consistent with their long-term objectives. He has also determined that his clients do not consider every relevant choice and often fail to act in their own self-interest. Does Sebastian perceive that his clients’ behavior necessarily accords with the

rationality assumption or the assumption of bounded rationality?

1-21. Maneesha has completed an analysis of the mar-ket for a prescription medication. She concludes that the policymaker should act to prevent an increase in the price of this drug on the grounds that the mainly older consumers of the medica-tion already have spent their lives paying too much for pharmaceuticals. They ought not to have to pay higher prices, Maneesha has con-cluded, so the government should act to halt any further price increases in this market. Has Maneesha applied positive or normative eco-nomic analysis?