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EYE on the BENEFIT and COST of SCHOOL
- 2. © 2013 Pearson 1You’re in school! Did you make the right decision?
- 3. © 2013 Pearson Getting Started 1 When you have completed your study of this chapter, you will be able to 1 Define economics and explain the questions that economists try to answer. 2 Explain the kinds of questions that define the economic way of thinking. CHAPTER CHECKLIST
- 4. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS All economic questions and problems arise because human wants exceed the resources available to satisfy them. Scarcity Scarcity is the condition that arises because wants exceeds the ability of resources to satisfy them. Faced with scarcity, we must make choices—we must choose among the available alternatives. The choices we make depend on the incentives we face.
- 5. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS Economics Defined Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity, the incentives that influence those choices, and the arrangements that coordinate them.
- 6. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS Economics divides into two parts: Microeconomics: The study of the choices that individuals and businesses make and the way these choices interact and are influenced by governments. Macroeconomics: The study of the aggregate (or total) effects on the national economy and the global economy of the choices that individuals, businesses, and governments make.
- 7. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS Two big economic questions: • How do choices determine what, how, and for whom goods and services get produced? • When do choices made in self-interest also promote the social interest?
- 8. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS What, How, and For Whom? Goods and services are the objects (goods) and actions (services) that people value and produce to satisfy human wants. What goods and services get produced and in what quantities? How are goods and services produced? For Whom are the various goods and services produced?
- 9. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS When Is the Pursuit of Self-Interest in the Social Interest? The choices that are best for the individual who makes them are choices made in the pursuit of self-interest. The choices that are best for society as a whole are choices made in the social interest.
- 10. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS Can choices made in self-interest also serve the social interest? Let’s illustrate with four topics: 1 Globalization Globalization—the expansion of international trade and the production of components and services by firms in other countries—has been going on for centuries.
- 11. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS But in recent years, its pace accelerated. Microchips, satellites, and fiber-optic cables have lowered the cost of communication. This explosion of communication has globalized production decisions. For example, Nike produces shoes in Malaysia; Toyota produces cars in the United States. Globalization is in the interest of the owners of multinational firms that profit, but is it in the social interest?
- 12. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS 2 The Information Age Makers of computer chips and programs developed products in their self-interest, but did they develop their products in the social interest? 3 Climate Change The choices we make concerning how to produce and use energy are made in our self- interest, but do they serve the social interest?
- 13. © 2013 Pearson 1.1 DEFINITION AND QUESTIONS 4 A Social Security Time Bomb As baby boomers reach retirement age, Social Security payments will increase faster than the taxes used to pay them. The United States will have to borrow from foreigners, but someone will have to pay off these debts. Each voter’s choice about who will pay is made in the self-interest, but is it in the social interest?
- 14. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Economic Ideas: • Choice is a tradeoff • People make rational choices • Benefit is what you gain from something • Cost is what you must give up to get something • Most choices are made at the margin • Choices respond to incentives
- 15. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING A Choice Is a Tradeoff Because we face scarcity we must make choices. To make a choice we select from alternatives. Whatever choice you make, you could have chosen something else. You can think about your choices as tradeoffs. A tradeoff is an exchange—giving up one thing to get something else.
- 16. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Rational Choice A rational choice is a choice that uses the available resources to best achieve the objective of the person making the choice. We make rational choices by comparing costs and benefits.
- 17. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Benefit: What You Gain Benefit is the gain or pleasure that something brings. Benefit is measured by what you are willing to give up. Cost: What You Must Give Up Opportunity cost is the best thing that you must give up to get something—the highest-valued alternative forgone.
- 18. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING How Much? Choosing at the Margin A choice made at the margin is a choice made by comparing all the relevant alternatives systematically and incrementally.
- 19. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Marginal Cost Marginal cost is the opportunity cost of a one-unit increase in an activity. The marginal cost of something is what you must give up to get one additional unit of it. Marginal Benefit Marginal benefit is the what you gain when you get one more unit of something. The marginal benefit of something is measured by what you are willing to give up to get one additional unit of it.
- 20. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Making a Rational Choice You make a rational choice when you take those actions for which marginal benefit exceeds or equals marginal cost. Choices Respond to Incentives An incentive is a reward or a penalty—a “carrot” or a “stick”—that encourages or discourages an action.
- 21. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Economics as a Social Science Economists try to understand and predict the effects of economic forces by using the scientific method first developed by physicists. The scientific method is a common sense way of systematically checking what works and what doesn’t work. An economist begins with a question or a puzzle about cause and effect arising from some observed facts.
- 22. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Economic Models An economist’s second step is to build a model that provides a possible answer to the question of interest. An economic model is a description of some feature of the economic world that includes only those features assumed necessary to explain the observed facts. Check Models Against Facts An economist’s third step is to check the proposed model against the facts.
- 23. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING To check an economic model against the facts, economists use • Natural experiments • Statistical investigations • Economic experiments Natural experiments: A situation that arises in the ordinary course of economic life in which the one factor of interest is different and other things are equal.
- 24. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING A statistical investigation looks for a correlation. Correlation is the tendency for the values of two variables to move together in a predictable and related way. An economic experiment puts people in a decision- making situation and varies the influence of one factor at a time to discover how they respond.
- 25. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Disagreement: Normative versus Positive Economists sometimes disagree about assumptions and models and also about what policy to use. Some disagreements can be settled by appealing to further facts, but others cannot. Disagreements that can’t be settled by facts are normative statements—statements about what ought to be. Disagreements that can be settled by facts are positive statements—statements about what is.
- 26. © 2013 Pearson 1.2 THE ECONOMIC WAY OF THINKING Economics as Policy Tool Economics provides a way of approaching problems in all aspects of our lives: personal, business, and government.
- 27. © 2013 Pearson Does school provide a big enough benefit to justify its cost? The benefits of being in school include the present enjoyment of student life and a higher future income. The costs of being in school for a full-time student include tuition, books, other study costs, and forgone earnings. Is school always best? The costs are incurred now, but the benefits accrue over a working lifetime. For most people, the net benefit is big! Did You Make the Right Decision? EYE on the BENEFIT and COST of SCHOOL
- 28. © 2013 Pearson Is school always best? Bill Gates quit Harvard; Mick Jagger quit the London School of Economics; Alex Rodriguez turned down a scholarship at the University of Miami! All three expected the benefit from school to be less than the opportunity cost of being in school. Did You Make the Right Decision? EYE on the BENEFIT and COST of SCHOOL
Editor's Notes
- Notes and teaching tips: 4, 5, 8, 9, 10, 15, 19, 20, 21, 22, 24, and 25. To enhance your lecture, check out the Lecture Launchers, Land Mines, and Class Activities in the Instructor’s Manual.
- Scarcity Versus Poverty Ask the students why they haven’t yet attained all of their personal goals. One reason will be that they lack sufficient money. Ask them if they could attain all of their goals if they were as rich as Bill Gates. They quickly realize that time is a big constraint. They have stumbled on the fact that scarcity, which even Bill Gates faces, is not poverty. You can emphasize this distinction.
- No definition of economics can adequately capture the subject. For that reason, some teachers don’t like definitions and skip right over them. If you are one of these teachers, go ahead. Not much is lost. Other teachers regard a basic definition as essential, and the textbook takes this view. The definition in the text…“the social science that studies the choices that individuals, businesses, and governments, and entire societies make as they cope with scarcity,” is a modern language version of Lionel Robbins famous definition, “Economics is the science which studies human behavior as a relationship between ends and scarce means that have alternative uses.” Some teachers like to play with definitions a bit more elaborately. If you are one of these, here are four more, all of which add some useful insight and the last one a bit of fun: John Maynard Keynes: “The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps it possessors to draw correct conclusions.” Alfred Marshall: “Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing.” Jacob Viner: “Economics is what economists do.” Jim Duesenberry: “Economics is all about how people make choices. Sociology is about why there isn’t any choice to be made.”
- Don’t skip the questions in a rush to get to the economic way of thinking. Open your students’ eyes to economic in the world around them. Ask them to bring a newspaper to class and to identify headlines that deal with stories about What, How, and For Whom. Use Economics in the News Today on MyEconLab for a current news item and for an archive of past items (with questions). Pose questions and be sure that the students appreciate that they will have a much better handle on questions like these when they’ve completed their economics course.
- Talk about Adam Smith and the Wealth of Nations. Note that this book was the first systematic attempt to address this big question and that economists have been trying to answer it ever since. You might like to mention that several Nobel Prizes have been awarded to economists who have worked on the question including Ken Arrow, John Hicks, and Gerard Debreu, as well as John Nash of “Beautiful Mind” fame.
- There is not much that we can say to our students at this early point in the course about the way we try to answer this big question. But we can raise the interest level and excitement about the economics course by talking about issues like those in the textbook. Talk about some of these and any others that you happen to know a decent amount about. Try very hard to turn your students on! Get them debating these issues and try to steer the discussion toward benefits, costs, and who receives and bears them.
- Begin by encouraging the students to use the economic way of thinking to reflect on their own lives. Why are you here in college? Ask the students why they are pursuing a university degree. Most of them will say that they want a good paying job. Tell them about jobs such as postal workers, long haul truck drivers or grocery clerks that require relatively little training and offer up to $30,000 a year plus benefits. Ask the students to calculate the opportunity cost of being in school. Most students are shaken when they realize that the opportunity cost of a college degree approaches $150,000 to $200,000. Don’t leave them hanging here though. Note that a college education does yield a high rate of return.
- Issues of Life and Death Moving from personal to social decisions, use a “no-win” situation that is of major social importance. Such situations show with stark clarity that scarcity is just as important an issue as poverty. A good example comes from the development of new medical treatments. Every society—even the richest—faces a tradeoff between making new, promising medicines available quickly while assuring that they are also safe. That is why the Food and Drug Administration (FDA) is charged with assessing both the efficacy as well as the safety of each new drug before it is released to the market. Patients who are HIV positive, or who have Alzheimer’s disease or suffer from many types of cancer all require immediate access to the latest, promising medicines in order to have a chance for survival. But without thorough and time-consuming testing procedures, the safety of new drugs is not known. So we must choose between two bad outcomes: 1) lives lost because people take promising drugs that turn out to have unforeseen deadly side-effects, or 2) lives lost because people are denied access to promising drugs until sufficient testing can be performed to check that they are both effective and safe. Regardless of which drug distribution policy we adopt, many people will die. Although depressing, this realty check illustrates drives home the deadly seriousness of the phrase: “There is no such thing as a free lunch.”
- Will your tradeoffs improve? You can do your students a further favor by helping them to realize that the tradeoffs they face today are as favorable as they will ever be. It’s an old cliché, but effective, to remind them that they are not going to be any more attractive than they are now, nor are they going to gain any additional physical prowess or have any greater capacity to learn than they have at this very moment in their lives. Right now they could do almost anything they set their minds to do. Encourage the students to figure out and be utterly convinced that the benefits they receive from being in college exceed the large opportunity cost that scarcity forces them to bear. Remind them of the relevance of this cost benefit calculation to their decisions to skip classes, not studying for exams, or retake core courses and delay graduation.
- Students sometimes have difficulty sorting out economic facts from economic opinions. One way to cure this problem is to have them cut out articles from a newspaper (possibly The Wall Street Journal, or the New York Times) or copy sections of articles from reliable sources from the Internet. Ask the students to label the headlines as either positive or normative economic statements. Tell them to distinguish the headlines is by asking whether a statement is testable. If it can’t be tested, then it’s normative (a value judgment). Explain that some of the common buzzwords that are tip-offs to a normative statement are: should, must, or ought. The value of models. Help the students to appreciate the power of models as tools for understanding reality. The analogy of a model as a map is easy and convincing. Jim Peach, a fine economics teacher at the University of New Mexico, gets his students to make paper airplanes on the first day of class. After flying their paper planes around the classroom (and picking up the debris!) he gets them to talk about what they can learn about real airplanes from experimenting with paper (and other model) planes.
- The success of a model is judged by its ability to predict. Help your student’s appreciate that no matter how appealing or “realistic looking” a model appears to be, it is useless if it fails to predict. And the converse, no matter how abstract or far removed from reality a model appears to be, if it predicts well, it is valuable. Milton Friedman’s pool hall example illustrates the point nicely. Imagine a physicist’s model that predicts where a carefully placed shot of a pool shark would go as he tries to sink the eight ball into the corner pocket. The model would be a complex, trigonometric equation involving tangents, cosigns and a plethora of Greek symbols that no ordinary person would even recognize as representing a pool shot. It wouldn’t depict what we see—a pool stick striking a pool cue on a rectangular patch of green felt. It wouldn’t even reflect the thought processes of the pool shark, who relies on years of experience and the right “touch.” But constructed correctly, this mathematical model would predict exactly where the cue ball would strike the eight ball, hit opposite the bank, and fall into the corner pocket. (You can invent analogous examples from any sport.)
- Suppose economists find a positive correlation between education and income. Does this correlation tell us that more education causes a higher income? Or do people with a high income choose to undertake more education?
- Students sometimes have difficulty sorting out economic facts from economic opinions. One way to cure this problem is to have them cut out articles from a newspaper (possibly The Wall Street Journal, or the New York Times) or copy sections of articles from reliable sources from the Internet. Ask the students to label the headlines as either positive or normative economic statements. Tell them to distinguish the headlines is by asking whether a statement is testable. If it can’t be tested, then it’s normative (a value judgment). Explain that some of the common buzzwords that are tip-offs to a normative statement are: should, must, or ought. The value of models. Help the students to appreciate the power of models as tools for understanding reality. The analogy of a model as a map is easy and convincing. Jim Peach, a fine economics teacher at the University of New Mexico, gets his students to make paper airplanes on the first day of class. After flying their paper planes around the classroom (and picking up the debris!) he gets them to talk about what they can learn about real airplanes from experimenting with paper (and other model) planes.