Economic Thinking • Economics as a social Science • The scientific method – Observation, Theory, and Testing – Assumptions and ceteris paribus – Avoiding flaws in logical thinking • Ergo hoc post proper hoc • Fallacy of Composition/Division • Microeconomics vs. Macroeconomics
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Economic Thinking Economics as a social Science The scientific method –Observation, Theory, and Testing –Assumptions and ceteris paribus –Avoiding flaws.
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Economic Thinking
• Economics as a social Science• The scientific method
– Observation, Theory, and Testing– Assumptions and ceteris paribus– Avoiding flaws in logical thinking
• Ergo hoc post proper hoc• Fallacy of Composition/Division
• Microeconomics vs. Macroeconomics
Economics Models
• The art of making: simple and effective
• Example: circular flow– overall economy, role of economic agents,
output and income, product and factor markets
• Example: production possibilities frontier (PPF) -efficiency, tradeoffs, opportunity costs,
economic growth, law of increasing costs
Economics and Economists
• Positive versus normative
• Avoiding unintended consequences
• Scientist, advisor and citizen
• Scientific judgment, values, perception versus reality
The Power of Trade
• Voluntary versus involuntary exchange
• An intuitive approach to gains in trade
• Using an economic model to demonstrate the gains from trade
Voluntary Exchange
• All parties to a voluntary exchange must be made better off
• Allow for specialization and division of labor
• Increase interdependence
• Promote cooperation rather than conflict
An intuitive Approach to Gains From Trade
• Self-sufficiency – Pros: independence– Cons: loss of efficiency, variety in consumption
and production
• Trade with Yakima?
• Trade with other states?
• Trade with other nations?
Gains from Trade: An Economic Model
• Good model building: prove the point and make it simple
• Assumptions = things held true during the analysis = simplification
• Assumptions can be changed later to explore their implications
The Model
• Assumptions:– Two individuals – rancher and a farmer– Two goods – meat and potatoes– Each work eight hours a day– Farmer takes 60min/oz meat and 15min/oz
potatoes– Rancher takes 20min/oz of meat and 10min/oz
of potatoes
• Absolute advantage– Rancher than farmer is more efficient and producing both meat and
potatoes
• Comparative advantage– The farmer is comparatively better at producing potatoes than the
rancher.
• Comparative advantage and opportunity cost– The person with the lower opportunity cost has a comparative
advantage– Someone always has a comparative advantage in the production of
a least one thing
PPF and Production in a Simple Economy
• How much can be produced?
• Need to know:– Total time divided by time/output = total
output, or– output/time multiplied by total time = total
output
Table 1 The Production Opportunities of the Farmer and Rancher
• Voluntary exchange results in gains to trade, but who gets the gains?
• Positive analysis = gains exist so efficiency improvements can occur
• Normative analysis = who should get the gains• Normative analysis involves value judgments and
therefore must be made by others
History of Trade
• Tribal to feudal times• Adam Smith (1776) and David Ricardo (1817)• The costs of not trading (e.g. lamb example)• Distribution impacts: consumers win but some
producers and workers lose• The cost of protectionism• http://www.dallasfed.org/fed/annual/2002/ar02f.html• http://www.economist.com/displaystory.cfm?