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Frank & BernankeFrank & Bernanke44thth edition, 2009 edition, 2009

Ch. 1: Thinking Like an EconomistCh. 1: Thinking Like an Economisthttp://www.youtube.com/watch?v=YmwwrGV_aiE

http://www.onthemedia.org/transcripts/2010/05/14/05

http://www.cnn.com/video/#/video/us/2010/08/29/gps.fareeds.take.innovate.cnn

http://opinionator.blogs.nytimes.com/2011/08/07/education-needs-a-digital-age-upgrade/?ref=opinion&nl=opinion&emc=tya2

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http://www.robert-h-frank.com/http://www.robert-h-frank.com/

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http://www.federalreserve.gov/http://www.federalreserve.gov/aboutthefed/bios/board/bernanke.htmaboutthefed/bios/board/bernanke.htm

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http://prezi.com/j4kfnr40vvui/thinking-like-an-economist/

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Economics Is the Science of Economics Is the Science of Rational ChoiceRational Choice

The best choice is the The best choice is the rational decision that rational decision that includes all the costs includes all the costs and benefits of an and benefits of an action.action.

The rule-of-thumb is The rule-of-thumb is to compare the extra to compare the extra benefits of an action benefits of an action with extra costs.with extra costs.

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Scarcity PrincipleScarcity PrincipleResources are scarce, therefore, Resources are scarce, therefore,

costly.costly. If resources were infinite, there would If resources were infinite, there would

have been no cost and decision-making have been no cost and decision-making (choosing) would have been simpler.(choosing) would have been simpler.

TANSTAAFL: There-Ain’t-No-Such-TANSTAAFL: There-Ain’t-No-Such-Thing-As-A-Free-Lunch.Thing-As-A-Free-Lunch.

What is scarce about Bill Gates? What is scarce about Bill Gates?

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Measuring BenefitsMeasuring Benefits

The amount of money you are willing to The amount of money you are willing to spend to obtain the item is the value you spend to obtain the item is the value you attach to it.attach to it.

If you get the item for less than your “benefit” If you get the item for less than your “benefit” then you have an economic surplus.then you have an economic surplus.

Suppose you are willing to pay at most $4 for Suppose you are willing to pay at most $4 for breakfast and if someone else wanted you to breakfast and if someone else wanted you to prepare breakfast, you would charge $6.prepare breakfast, you would charge $6.

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Opportunity CostOpportunity CostOpportunity cost includes all explicit and Opportunity cost includes all explicit and

implicit costs.implicit costs.The opportunity cost of preparing breakfast The opportunity cost of preparing breakfast

for you is the $6 you would charge.for you is the $6 you would charge. If the opportunity cost exceeds the benefit, If the opportunity cost exceeds the benefit,

the rational decision is not to undertake the the rational decision is not to undertake the activity: find a place where they will give activity: find a place where they will give you breakfast for $4 or less.you breakfast for $4 or less.

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Reservation PriceReservation Price

The highest amount you are willing to pay The highest amount you are willing to pay for something.for something.

It measures the benefit you will get from It measures the benefit you will get from this activity.this activity.

If reservation price is greater than what If reservation price is greater than what you have to pay, your benefit exceeds you have to pay, your benefit exceeds your cost.your cost.

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Example 1Example 1

If you have an hour before your economics If you have an hour before your economics midterm but in order to study during that midterm but in order to study during that hour you have to skip your biology class, hour you have to skip your biology class, what is the rational thing to do?what is the rational thing to do?

If the loss of biology grade is less than the If the loss of biology grade is less than the gain in economics grade, skip class.gain in economics grade, skip class.

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Example 2Example 2

Bill has invited Joe to lunch and offered to Bill has invited Joe to lunch and offered to pay. Should Joe accept?pay. Should Joe accept?

Not if the opportunity cost of lost time is Not if the opportunity cost of lost time is greater than the benefit of having a “free greater than the benefit of having a “free lunch.”lunch.”

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Example 3Example 3

Why do you speed when you know the Why do you speed when you know the speeding ticket is costly?speeding ticket is costly?

The probability of getting caught times the The probability of getting caught times the cost of the ticket is less than the perceived cost of the ticket is less than the perceived benefit of getting to the place earlier.benefit of getting to the place earlier.

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Economic SurplusEconomic Surplus

The difference between the value of The difference between the value of benefit and the cost.benefit and the cost.

If there is an economic surplus, then it is If there is an economic surplus, then it is rational to consider the action.rational to consider the action.

Why is it to the advantage of the seller to Why is it to the advantage of the seller to have an auction?have an auction?

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People are Not Always RationalPeople are Not Always Rational Which would you rather have?Which would you rather have?

A discount of $100 on a $2000 plane ticket?A discount of $100 on a $2000 plane ticket?A discount of $90 on a $200 plane ticket?A discount of $90 on a $200 plane ticket?

You bought a $30 ticket to a concert. You bought a $30 ticket to a concert. Because you bought it, the benefit must Because you bought it, the benefit must be worth more than $30.be worth more than $30.Would you buy another ticket if you lose Would you buy another ticket if you lose

your original ticket?your original ticket?Would you go to the concert if you lose $30 Would you go to the concert if you lose $30

from your wallet?from your wallet?

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Importance of MarginalImportance of Marginal

Decisions need to be made on the basis of Decisions need to be made on the basis of what you expect to get and what you have what you expect to get and what you have to pay: MB vs. MC.to pay: MB vs. MC.

What is spent before is immaterial for your What is spent before is immaterial for your immediate decision.immediate decision.