Economics, Philosophy and Politics
I. What is Economics?
A. Keynes "It (economics) is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions."
· A perspective, a way of thinking; not limited to particular social phenomena (e.g. material well being).
B. Some Characteristics and early Preliminaries
1. Science as abstraction: "...knowledge is always gained by the orderly loss of information...." Boulding; "Science may be described as the art of systematic oversimplification." Popper
a. Formal theories as simplifications of the complex real world; from theories, hypotheses are then derived which are then tested (empirically) against the real world. Economics follows the scientific method.
b. Assumptions may not be true; validity of the
model depends on the accuracy of the predictions not on the realism of the
assumptions. Examples: NY Times – 105 models for the skyscrapers in lower
2. Correlation v. causation: A => B vs. A and B appear together (negative or positive). Examples: USC football (1980s) and me; decline in crime rates and expenditures on police (passage of tough crime laws); economic performance and presidents (Reagan, Clinton, G.W. Bush).
3. ceteris paribus: "all other things held constant," when trying to establish a causal relationship between X and Y one needs to control (measure) all of the other variables (other than X) that affect the dependent variable Y.
C. (The sound bite definition) Economics is the study of human choice in the face of scarcity, the interactions of these economizing agents within various institutional settings, and the consequences.
1. Economizing behavior: rational choice in the face of scarcity.
2. Interactions: need for coordinating these diverse interests; institutions, in particular, the marketplace.
3. Consequences: intended and unintended. Examples: every driver intends to reach his/her destination, but the overall flow of traffic is not controlled (unintended consequence); market equilibria have unintended consequences (Adam Smith’ invisible hand).
D. The Basic Economic Postulates or Assumptions
1. Focus is on the individual decision maker; even when analyzing group decisions; it is the individuals who comprise these groups who decide.
- Self interest motivated; altruism (?); do individuals have other interests? [Richard Dawkins, "Selfish Gene."]; Compare Scientific American 2002 “Economics of fair play”
2. Individuals have insatiable wants. Wants are many, not just material. A good is defined as anything which yields positive satisfaction (utility).
3. Resources used to satisfy these wants are limited.
4. Individuals must choose; we assume they choose rationally, make the best choice they can. This is an allocation problem. This problem exists for the individual as well as for organizations of individuals (business, government, society). Although we focus primarily on the market, there are other allocation mechanisms; e.g. COPS – altercation in the emergency room (triage).
a. Weigh expected benefits and expected costs; choose action which is "best" for them; choose the most effective means for a given end.
b. If expected benefits or expected costs are altered, then behavior changes.
5. Consumers are willing to substitute goods in consumption, and the value of any good depends on the relative quantity of current consumption of that good. Example: My first cappuccino vs. the second cappuccino vs. the third cappuccino.
a. Economic thinking is based on marginalism. Choices are made about incremental or additional units rather than about absolute amounts.
b. Utility (benefit) obtained from consumption of additional units of goods decreases as the individual consumes more units of that good - diminishing marginal utility.
6. Cost is measured as the most highly valued alternative foregone.
a. A choice means that alternatives have been foregone; the cost of that choice is the highest valued alternative foregone: opportunity cost.
b. Costs include explicit and implicit costs. Example - costs of education.
E. Illustration – Partying as an economic decision
1. Marginal costs
2. Marginal benefits
3. Rule: MB > MC, do it; MB < MC don't do it; optimal MB = MC stop, optimal.
HW: When is it rational for a consumer to consume zero quantity of beer? Diagram and explain.
HW: How might this model be used to explain abuse of alcohol or drugs?