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Economics:
Scarcity and Choice
Economics:
Scarcity and Choice Economic Models
Regan
Whitworth, Bring to class in separate boxes an elaborate plastic model airplane and a balsa glider. Display the plastic model to the class, pointing out all the "realistic" features of the model: its color, rivets, visible seams between plates, markings, etc. Then point out that it's really NOT realistic: it's made of plastic, not metal; has no seats; is not big enough to get into; and moreover, it won't do the one thing which airplanes must do: FLY!!! Remove the balsa model from its box. Point out that this model, which many people would regard as much less realistic, will fly. A demonstration is sometimes a useful diversion.
It can then be pointed out that no model
is realistic, in the sense that it can't do everything the original does, or
it wouldn't be a model. The kind of model one chooses depends on what one is
trying to find out. Both models have their uses, but neither is
"realistic" if put to the wrong use.
Joe A. Garwood, Valencia Community College Early in the Principles course we all usually deal with the concept of abstracting and its importance to economics. We need to do this to show why it's necessary to abstract, and to allay student apprehensions about our simplified examples and heavy use of models, theories, principles, etc. I ask a student whom I know to be single
whether or not he or she ever intends to marry. If the answer is yes, I point
out that there are roughly three billion people of the opposite sex to choose
from and that finding "Mr. or Ms. Right" could be quite a chore. I
then ask how the student intends to go about finding the ideal mate. In
response, the student will indicate that certain criteria are used to reduce
the sample to manageable proportions, e.g., appearance, education, location,
personality, religion, or special interests. After going through this process I point
out that the student has been abstracting and emphasize how necessary it is
to the final outcome. I also point out that the criteria used represent
theories about what will make the ideal mate for that student. Conclusion ‑
abstractions and theories are absolutely essential if we are to make any
sense out of the real world. This is a real interest grabber and it develops
an appreciation for the need to abstract. Economic Models and Paper Planes Rose M. Rubin, University of North Texas Students often have difficulty initially grasping the concepts of modeling and of economic models as representations of theory. I find that this idea can be presented in a readily comprehensible way by using what is probably the most instantly recognized "model" a paper airplane. I follow a standard discussion of
"What is Economics?," by discussing the methodology of economics.
As I proceed, I very ostentatiously pick up a large piece of paper
(preferably colored, which is easily visible to the entire class) and start
folding what the students quickly recognize to be a simple paper airplane. At
the proper point in the discussion to introduce the concept of a
"model," I hold it up and ask, "What is this?" Someone in
the class inevitably responds, "A paper airplane," so that I can
then ask, "How do you know it is an airplane?" The usual response
is in terms of, "It looks like an airplane." or "It has
wings." (Sometimes, a member of the class will come up with the word
"model"). Then, I introduce the idea that there are certain,
specific variables or factors which indicate that this is a "model"
of a plane. While it is clearly a "plane," it does not include all
the details of an actual plane, i.e. no motor, no propeller or jets, no
wheels, etc. Nonetheless, it has been clearly recognized as a paper airplane
or model of an airplane. Then I draw the analogy between the
"plane" and economic models or theories as abstractions from
reality, which are nonetheless representations and which describe the entire
economy (macro) or specific areas of the economy, such as markets (micro).
Further, these abstractions may contain only key variables, (give examples)
and still represent a complex economy, just as the paper airplane is recognizable
by its wings. The second stage of this demonstration
is to ask, "Will it fly?" Of course, the students know that it
potentially will and usually respond, "Try it" or "Test
it." This leads into a discussion of the use and usefulness of models
not only for initial description of the economy, but also to show that change
in the variables permits analysis of resulting changes which occur in the
system. At this point, add ailerons on the wings or a paper-clip ballast to
the paper airplane and see what happens to the direction of flight to
demonstrate changing or adding variables to the system. Logical Fallacies Illustrating the Fallacy of
Composition Steven T. Call, Metropolitan State College of Denver Failure to avoid the fallacy of composition accounts for many errors in economic analysis, both by professional economists and by laymen. I use variants of the following two examples to illustrate the fallacy. They are particularly effective in large classes. (a) Place your class notes where they are difficult to see from the rear of the room. Ask a student somewhere near the middle or rear of the class if he can see your notes. If done properly, the student will say no. Ask him to stand. He should now be able to see the notes. Since the class is simply the sum of individual students, it should follow that if everyone stands up, everyone should be able to see your notes better. Ask the class to rise. In large classes, no one can see anything. This is a powerful demonstration. (b) Ask a student to quietly drop his or her desk top (where feasible). This can be done with very little disturbance to the class. Again, since any one student can do it, and since the class is just the sum of students, everyone should be able to lower their desk tops simultaneously without disturbance. In a large class, the sound is deafening and very effective. This technique sets up the class for a wide variety of policy and theoretical issues where aggregation and externalities are important. Ralph Byrns, University of North Carolina
at Chapel Hill One way to enrich a discussion of scientific methods and the process of theorizing is to discuss some of the more common logical fallacies. Among these are: (a) Appeals to authority, or ad hominem arguments. Albert Einstein (or the Bible, or the president, or my Mother) said that "...". Therefore, it must be true that "...". Alternatively, communists (or the devil) believe that "...". Therefore, "..." is obviously wrong. Or, Keynes was a communist and therefore, his suggestion that "..." must be wrong. Such appeals are, of course, not compatible with logical or scientific approaches to solving problems. (b) Post hoc ergo propter hoc. Precedence does not imply causation. To make this point, suggest that if the idea that anything that follows another is necessarily caused by the first, then roosters would be justified in believing that early morning crowing causes the sun to rise. Similarly, union wage hikes or big government deficits, or growth in the money supply do not necessarily cause price inflation simply because they precede it. Nor does victory by the National Football Conference team in the Super Bowl necessarily portend an increase in the Dow Jones index, etc. These are simply statistical artifacts until more scientific causal explanations are developed and tested. (c) Composition and Decomposition. The whole may be either greater than (synergy) or less than the sum of its parts. If you buy all of a cow's components at your local butcher shop, you will still be unable to assemble a cow. Similarly, a crowd of people may behave very differently than any of the individuals that comprise it would alone (e.g., a lynch mob). A basketball player who tries to play against a five member team is unlikely to score one‑fifth as many points as any team composed of five individuals, even if they are less talented on average. Nor would two teams of 50 players each be likely to score 10 times as many baskets as two standard 5‑member teams. Logical Errors in Rain Dancing Gary M. Galles, Pepperdine University and University of California, Los Angeles It is often difficult to impress students with the necessity to consistently apply the logic of opportunity cost thinking to reach correct conclusions. To drive this point home, I ask how accurate the results of a string of implications AàBà...-->Z would be if an error were made somewhere in the chain. They see that the conclusion can be way off, and farther off the earlier in the chain the error comes (even if all the other links are logically correct), which I use to emphasize the special importance of examining the beginning assumptions of a chain of logic as well as each implication step. I then illustrate the point with the example of rain dancing. I ask the students why rain dancing
could arise and persist for over a century when it does not affect whether
rain falls. All it takes is a view of God as one who needs appeasement and a
post hoc, ergo propter hoc fallacy. Once I get the idea of dancing to appease
the rain god (whose anger is shown by the fact that it hasn't rained when it
should have), and it rains after such a dance, the post hoc ergo propter hoc
conclusion that the dancing caused the rain could easily be reached. Once
this is established as a theory, there is no natural tendency to correct the
error. If the tribe dances long enough, it will rain; if it doesn't rain,
they didn't dance well enough, or long enough, or their hearts weren't in it
or it wasn't enough like the ancestors did it. Further steps in logic are
taken, starting from the error rather than examining the initial error. Bienvenido S. Cortes, Pittsburg State University, Kansas Much has been said about the common fallacy in economic methodology that association is causation. Simply because two variables are found to be statistically correlated does not necessarily imply that they are causally related. A high correlation may reflect a spurious or nonsensical relationship. Some classic examples include the "Super Bowl Predictor" (Stovall, 1988) which contends that when the NFC team wins the Super Bowl, the stock market goes up, and Jevons' theory that sunspots cause the business cycle. In beginning principles and more so in advanced economics courses which require students to formulate and test cause-and-effect relationships, it is also very important to emphasize the causality must be based on sound economic theory. Even if the movements of tow variables are causally related, the direction of causation may be altogether different from what was expected. It is possible that the direction of causality may be reverse or even two-way. With or without getting into a discussion of Granger (1969) causality tests, the instructor will be able to demonstrate the significance as well as the difficulty of inferring causal relationship by asking the class: What variable causes what? (Or alternatively, which one comes first?) (a) advertising and consumption? (b) government spending and income? (c) sunspots and economic activity? (d) the chicken and the egg Possible answers: (a) consumption causes advertising (Ashley, et al, 1980) (b) government spending causes national income (Holmes & Hutton, 1990) (c) economic activity causes sunspots (Sheehan & Grieves, 1982) (d) the egg causes the chicken (Thurman & Fisher, 1988) Graphics Michael
Kuehlwein, Graphs can be very informative and we draw heavily on them in
introductory courses. But I try to warn my students graphical evidence can
only suggest, not prove, the existence of a relationship between two
variables. Take the relationship between the number of guns distributed
annually in the
Figure 1-2 The graph appears to imply that reducing the number of guns sold in our society reduces the murder rate. That may be true, but there are alternative interpretations of these data as well. First, the causation may to the other way: lower murder rates may reduce incentives or citizens to buy guns to protect themselves. That would be an example of reverse causation. Second, these two variables may not be directly related to each other, but may both be influenced by an omitted third variable. One possibility is the aging of the population, which might naturally reduce both gun-related homicides and the number of guns sold in the US. The rate of decrease in our two series appears too high to be completely explained by population aging, but other factors could be involved as well. Perhaps “political correctness” or reduced exposure to guns in our society has increased apprehensions about both owning and using them. Finally, our two variables may be
unrelated to each other, but chance has created the appearance of a
significant correlation. Perhaps the real reason homicides have fallen is
because of increased use of such drugs as Prozac, or better drugs to deal
with other mental illnesses. And reduced danger may cause fewer people to buy
guns. This would be an example of spurious correlation between two variables.
The watchword is caution in interpreting graphical evidence. Introducing Graphical Analysis Ralph Byrns At the start of a course, students want to hear about class requirements, grading standards, etc. This discussion can be used to show mathephobic students that graphs are not intrinsically difficult, and can be very useful in portraying relationships among variables. The following lecture can be extended to show that economics is concerned with how people respond to incentives, and how incentives can be structured to alter human behavior in a desired fashion. (This discussion works best if you are a bit of a ham, and act as though negotiating the grade scale with students.)
Regardless of student response, offer Figure 1‑6 (or something you devise) as another alternative. You can accompany Figure 1‑6 with the suggestion that very good students who normally get As will work hard even if standards are easy, but that you know that many D students will work just hard enough to pass the course no matter how hard or easy standards are. Indicate that you are considering altering the structure of your grade system (curve), but not the average (mean) grade awarded, to make it relatively easy to get a good grade (an A or B) so that students who would normally get a B+ can earn an A with a little extra work, but that you intend for anyone who gets a D to consider it the most demanding D they've ever received.
Figure 1-6 Any number of other possible
relationships between grade means/structures and student effort/understanding
can also be graphed, depending on how much you want to review graphs before launching
into economics, per se. When you begin winding this part of your lecture
down, indicate that economics is concerned with: (a) how people respond to incentive structures (such as grades). (b) trade-offs between goals. (c) coordination and resolution of conflicts, etc. Now point out that economic reasoning is at the center of things you have discussed for the past few minutes. Thus, the preceding exercise reviews graphs for your students and can be used to emphasize just how inescapable the economic way of thinking is. Positive vs. Normative Economics Are You Positive that’s not Normative? Brian
Eggleston, Most principles texts attempt to define clear distinctions between POSITIVE and NORMATIVE economics. Positive economics purportedly concerns what is ("the facts") while normative economics pertains to what should be ("value judgments"). Institutionalists, in the tradition of
Gunnar Myrdal (Nobel Laureate, 1974), have long viewed this as largely a
false dichotomy. They argue that facts and value judgments are not so easily
separated. For example, one's beliefs (ideology) impact the choice of
problems undertaken and consequently which "facts" are discovered.
Students generally fail to see the importance of this issue and for many
years I found it difficult to illustrate the point. The passage cited below captures the
interdependence (circularity) between fact (reality) and value (belief) quite
nicely. I read it to my classes, pausing at the end of each sentence to ask
if there is any disagreement. (I have never encountered any.) When finished,
I then reiterate the first and last sentence. I find that students very much
get the point. "Reality"
is what we take to be true. What we take to be true is what we believe. What
we believe is based upon our perceptions. What we perceive depends on what we
look for. What we look for depends upon what we think. What we think depends
upon what we perceive. What we perceive determines what we believe. What we
believe determines what we take to be true. What we take to be true is our
reality. Gary Zukav, The Dancing Wu Li Masters: An Overview of the New Physics (New York: Bantam Books, 1980), p. 310 Editor: See “Semi-Positive” Economics and Pareto Optimality" at this link for an elaboration of Dr. Eggleston’s point. Distinguishing Positive from
Normative Stephen Teney, The Franciscan University of the Prairies From a purely definitional perspective, the distinction seems clear-cut between a normative view of an issue and a positive analysis of that same issue. However, students seem to have difficulty in distinguishing between a normative view and positive analysis. The following example relates the
concept of normative-positive representations to the government's provision
of goods and services. Suppose that in year one the government
allocates its resources per Figure 1-7. (I always stress to the students that
representation of the federal government's budget allocation is a positive
issue - as Casey Stengel would say, "you could look it up.")
.Now suppose in year two the budget allocation
is revised to look like Figure 1-8: At this point, I always ask the students
- "How do we evolve from year one to year two?" Some student
usually mentions something about voting and then I emphasize the point that,
"yes, we voted as a society, through our elected representatives, to
change the allocation of government services." The budget allocation in
year two is also a positive representation of the government resource
allocation. However, the process by which we evolve from year one to year two,
is a normative one - we vote to increase spending in areas we feel should
receive more financial support. You can always adjust the percentages in
the two samples pies to reflect personal taste, but education spending is always
a component worth including. It is relevant for the student (and therefore
the faculty), and it usually leads to some lively discussion. Ideological Conditioning and
Economic Analysis Robert D. Simonson, Minnesota State University-Mankato The ideological nature of much economics often confuses students and leads many to question it as a "science." One standard procedure is to familiarize students with the positive‑normative dichotomy ("what is" vs. "what ought to be"). Many economists attempt to remove themselves from normative "value judgments" and practice value‑free science. This dichotomization leaves most of the public with the unfortunate impression that economists, like auto mechanics, should agree when diagnosing problems and prescribing policy. But if economics is value‑free, why does unrest in the profession and disagreement among economists seem to be the norm? The answer is that ideology underpins
economic paradigms and colors our policy prescriptions. Some excellent books
have been written to explain the concept of ideology, how it shapes our
thinking, and how it may pass for science to the casual observer. Ambitious
students might read George C. Lodge, The
New American Ideology (Alfred A. Knopf, Inc., 1976) or Gould and Truitt, Political Ideologies (Macmillan
Publishing Co., Inc., 1973). A less time‑consuming explanation is
condensed in the introduction to Robert B. Carson's Economic Issues Today (St. Martin's Press, 1990). These sources
tend to conclude that ideology is: (1) a synthetic (man‑made); (2) a
framework people use to define and apply values to the "real
world"; (3) a collection of ideas which define the nature of the good
community; and (4) controversial. Students persist, however, in seeking a
tangible example of how ideology influences our reasoning and resultant
policy formulation. This request poses a unique problem. The example must be
of a nature such that ideology itself is not relied upon to explain
ideological conditioning. Although economics cannot be as mechanical as physics,
after years of searching, I finally arrived at the following concrete
example: Directions: Connect these nine dots with four straight lines, but do not retrace any lines or pick up your pencil.
After a few futile attempts, most
students view the puzzle as unsolvable. This is expected; psychologists
inform us that most people cannot solve this puzzle even if given unlimited
time. Why? We think in certain ways and tend to follow established patterns
of thought. We resist violating established boundaries. The eye senses a
boundary established by the dots at the outer edges of the puzzle and the
mind seeks a solution within these boundaries. Such attempts will be futile.
Only people who are not restricted by perceived boundaries can easily solve
the puzzle. Students are amazed at how simple
solving the puzzle is when it previously seemed impossible. Now ask students
to compare the puzzle to real world problems. The connection is quickly made
that ideologies, by their very nature, establish the boundaries of accepted
thought and beliefs. They may be asked if the puzzle could have been solved
had the directions instructed them to stay within the boundaries established
by the eight dots on the outer edges. The obvious answer is "no."
They may then be asked the extent to which economic problem‑solving is
constrained by ideological conditioning. Students again quickly make the
connection between their earlier objections and ideological conditioning.
They often respond with examples of their own (news articles, advertising,
political campaigns, etc.) which illustrate ideology masquerading as science.
Ideologies are universal and pervasive. Some ideologies are not
"better" or "worse" than others from a scientific
perspective. Science and human values are intertwined at the base of economic
analysis and all inquiry. Economists are not architects of ideology, but
their analyses are performed in the real world laboratory. Resultant
prescriptions are consequently influenced and ultimately judged by a public
who are, in general, products of ideological conditioning. All Economic Goals are Normative Ralph Byrns Emphasize that all goals are intrinsically normative. There is a broad consensus about the desirability of the first micro goal listed in my text (efficiency), but students are often astonished if you point out that many government policies are inefficient: (a)
import quotas
and tariffs. laws requiring government contractors to pay union wages (the
Davis‑Bacon Act), or (b)
that government
agencies "Buy American." (c)
state and local
licensing of barbers, dog groomers, etc. Other examples abound. You probably have favorites of your own. After introducing equity and freedom as
additional micro goals, stimulating discussions can be generated by examples
of trade-offs among these goals. For example, your freedom to be alone may
deny me freedom to associate with you; my desire for greater equality may
deny you freedom to spend your money as you choose if I persuade others to
vote for taxes to support the impoverished (or mug you to secure an
involuntary transfer payment); efficiently importing goods produced at low
costs by foreigners may (inequitably?) deprive some of the poorest among us
of their jobs. Moreover, efficiency may be in conflict with other social
goals; Constitutional denials of the right to sell oneself into slavery, or
of bribing others to vote our way are examples cited by Arthur Okun in Efficiency vs. Equity (Washington,
D.C.: Brookings, 1971). In discussing positive versus normative
economics, emphasize that policy making tends to be far more publicized than
theory and involves huge doses of value judgments. This is a major reason for
the erroneous perception that economists seldom agree. Macroeconomics vs. Microeconomics Using a Watch to Distinguish
Micro/Macro Jerry McElroy, Saint Mary's College‑Notre Dame
Distinguishing Macro from Micro Ralph Byrns Indicate that the differences between macro and micro are more of degree than kind. For example, unemployment can be addressed as an issue for macropolicy, but much of unemployment is best explained at the micro level (search unemployment, efficiency wages, seasonality, structural, frictional, minimum wage effects, etc.). Thus, unemployment is addressed in both macro and micro. Similarly, money and banking are commonly treated in macro principles, but many issues in banking are microeconomic in nature. Scarcity and Resources Rational Decision Making and
Economics Eric K. Steger,
Quite often near the beginning of each semester, I tell all students in my principles of economics classes that I'm glad that I'm able to fit into their life plans. I tell them that knowingly or unknowingly, they have decided that they would rather be taking economics now than doing anything else. Generally, several students protest and indicate that they'd rather be doing many other things than being in any economics class. I simply say if that is true, they should drop the class immediately because they're acting irrationally. However, I then explain that economics is crucial to each one of them. In fact, when their goals are carefully considered, taking economics is what they would rather be doing than anything else. This usually makes it clear how their behavior is consistent with their life plans rather than acting irrationally. R. Michael Brown, Metropolitan State College of Denver A meaningful existence unavoidably involves choices in the face of scarcity. There is a passage in Homer's Odyssey in which Ulysses meets Calypso, a sea princess and child of the goods. The divine and immortal Calypso is fascinated by Ulysses, never previously having encountered a mere mortal. Curiously, Calypso envies Ulysses his mortality. Most readers find Calypso's envy strange‑‑most of us have occasionally fantasized that we would like to live forever. (Indeed, most religions promise everlasting lives to their true believers.) It would seem that Ulysses should envy Calypso her immortality, but not vice versa. Why would an immortal ever want to be mortal? An appreciation of scarcity is the key
to understanding their different perspectives. Calypso views Ulysses' limited
life as much more meaningful than her immortal one because he may be
significantly affected by even decisions that seem, at first glance face, to
be trivial. Every choice Ulysses makes involves a REAL decision. Calypso, on
the other hand, will live regardless of her decisions; she will never truly
choose in a life or death situation. Thus, she views her life as less
meaningful than his. A Date with Scarcity, Choice and
Income Distribution Don C. Jackson,
To illuminate the fundamental ideas of scarcity, choice and distribution of income, I use the following classroom exercise. A girl and boy are selected from the class. The boy is told he has just discovered the girl and is greatly attracted to her. To make a grand impression he has invited her to dinner at one of the better restaurants in town. I display on the board a menu which has appetizers from $4 to $12, entrees from $8 to $25, drinks from $1 to $5 and desserts from $3 to $10. I ask the girl to order. The boy is then told he has the following additional wants and needs this week: ...Gasoline for the car..$15 ...Fraternity Dues..$20 ...TV set rental...$10 ...An Economics text..$40 He
is told he has only $50 to spend this week and no credit. I then ask him to
order from the menu and decide on a tip for the waiter. After determining his
choice and his financial dilemma, the class discusses scarcity (of the boy's
money and as reflected in relative prices on the menu), choice (why the girl
chose what she did, why the boy chose what he did, including foregoing the
Economics text) and distribution of income (money to wealthy Scarcity and the Speed of Light Seymour Patterson, Truman State University, Missouri Students often have trouble with the idea that one human imperative is to make choices. I persuade them that only in Heaven, a place of eternal bliss, is scarcity not encountered, and thus, is decision making unnecessary. I have found it instructive to extend scarcity into a world where neither time nor income is a constraint, yet scarcity remains a problem. Have students imagine a world in which
any distance can be traveled at the speed of light. Suppose a student in such
a world had to study English and Mathematics for an examination. It would be
possible for the student to go to the movies, have a drink at a local bar,
and study English and Math at home before time advanced one second.
Similarly, an instructor could simultaneously teach different courses in
different classrooms without worrying about time conflicts. Intertemporal
considerations would become irrelevant; i.e., the opportunity cost of time
would become zero. With zero opportunity cost, people would become unaware of
time, as though it had been suspended‑‑it would in fact not even
exist. Since time is not the only cost of any activity, however, opportunity
costs would still exist for activities involving incomes and prices. Now suppose that, in addition to the
absence of time, income in our hypothetical world were unlimited. Such a
state of affairs would, ipso facto, mean that its inhabitants could
conceivably produce all the guns and butter they desired. The consequences
would be awesome. There would be no reason for enemies to attack each other
because any attack could be evaded by fleeing at the speed of light. Thus, no
one would bother to invent or try to use weapons of mass destruction. The
inhabitants of our imaginary world would have all their needs met. They could
simultaneously be in excellent physical shape and gluttons, because they
could simultaneously eat and exercise. Nevertheless, scarcity would still
exist. People could still die from cirrhosis of the liver caused by alcohol
abuse, or lung cancer from inhaling excessive nicotine, or their bodies might
shut down because of excessive cholesterol. After all, the people in our
imaginary world would still be heir to all human vices, and they would still
obtain physical and psychic utility from some things that would cause them
great distress. Thus, even in an unlimited‑income, light‑speed
world, scarcity is unavoidable. People would still be forced to choose, and
nothing guarantees that their choices will be prudent, even when these
choices maximize some subjective utility function. Distinguishing Economic Capital
from Financial Capital Marvin L.
Larson, It can be a real task to convince students (especially accounting majors) that financial capital may be a surrogate for economic capital, but that economists are correct in insisting that it is not a factor of production. I have developed a thirty second demonstration that can be quite convincing. One student volunteer is given a pencil
and a sheet of paper, while another (hopefully, a business major) is provided
with a dollar bill. (You can readily get volunteers by first offering to pay
$1 to whomever produces the most.) Each has a half minute to produce
something. The first student (labor) can quickly produce a graph with the pen
(capital) and paper (representing land). The second student is normally at a
loss about what to do with the dollar or tries to buy land and capital from a
classmate. (Be ready for the student who tries to make a paper airplane out
of the dollar; if this occurs, specify that it violates the rules by
converting money into physical capital. When the second student is forced to
surrender the dollar to the first student (entrepreneur), conclude this
example by commenting that money, often thought a factor of production by
principles students, does not directly produce anything. An Alternative Taxonomy of
Resources Ralph T. Byrns The traditional taxonomy of resources is: labor, land, capital, and entrepreneurship. Kenneth Boulding's alternative grouping can be illuminating: technology (or knowledge), materials, and energy. His categories lead to a useful definition of production as requiring "the use of knowledge to apply energy to some material in a manner that makes it more valuable." Many students quickly forget the distinctions between economic (physical) capital and financial capital, so it may be worthwhile to spend a few moments emphasizing the differences between them. Opportunity Costs Dennis C.
McCornac, During the first few weeks of class when the syllabus and course requirements are being discussed, I set the price of an A. If the student is unable to achieve an A by fulfilling requirements, he or she is able to buy one. The going rate, however, is one million dollars. The payment must be made in unmarked bills and slipped under the professor's door late at night. Though the students initially are somewhat bewildered by the offer, I find this offer is an excellent example of: (1) the concept of opportunity cost, (2) a perfectly elastic supply curve, (3) the idea that everything (or almost everything) has a price, and (4) the concept of value. Note: To date every student who received an A has done so through hard work and scholarly achievement. I am also still teaching, and not retired. William L.
Weber, Many students in principles classes are reluctant to place values on a life. At the beginning of each semester I like to divide the class into groups of three or four in order to discuss how lives are valued and to introduce the notions of scarcity, opportunity cost, and positive vs. normative economics. Each group is asked to imagine that they are on the executive committee of a hospital with the job of allocating a scarce piece of medical equipment, say a kidney dialysis machine. A handout is given to each group describing the profile of each patient and the number of hours that they need to use the machine. The total number of hours demanded by all patients will need to exceed the number of hours available on the machine so that the students will be forced to make choices between patients. The patient profile can include the age of the patient, their occupation and income, whether or not they have insurance, their marital status, and the number of their dependents. The students are then asked to decide which patients get to use the machine and which do not. After each group decides how to allocate
the scarce kidney dialysis machine we have a class discussion where the
concepts of scarcity and opportunity cost can easily be introduced and
developed. A distinction between positive and normative economics can also be
made at this time. To do this, we walk about the choice of objective that
each group made in their allocation of the machine. For example, did the
group choose to save the maximum number of lives, or, did they choose to save
the maximum number of lives of those that had insurance, or, did they choose
to maximize the life span of those who needed treatment. The patient profiles
can be readily developed to examine the implicit choice of objectives. Each
of the objectives has positive consequences, while the choice among the
objectives is essentially normative. Later on during the semester we often
talk about the opportunity costs of raising the speed limit on interstate
highways and how to value the loss of life that occurs because of higher
speeds. There is always at least one student who argues that we cannot place
a value on life. At this point one can quickly remind the student that when
they were choosing how to allocate the scarce kidney dialysis machine, they
were implicitly placing values on lives. The discussion can later be guided
into how individuals place values on their own lives by purchasing life
insurance policies or through their choice of occupation and housing, and how
individuals are sometimes forced to place values on the lives of others when
they serve on juries in wrongful death cases. What Makes Something a Free
Good? Carole E. Scott, State University of West Georgia Suppose that someone stopped you on your way to class and offered to sell you a week's worth of air to breathe for $5. You would laugh. The story would be different if you were in a space ship hit by a meteor and all the air in the ship leaked out the hole. For the moment you save yourself by jumping in a space suit, but it doesn't have enough air to enable you to get back to Earth or survive until a rescue ship arrives. Fortunately, however, you are near a space station, and you radio it for help. They radio back that they will be happy to send you over a day's supply of air for $5,000. Why would you pay nothing for air in the
first case and $5,000 in the second case? Is it because the supply of air is
greater on Earth than in the space station? Does Everything Have a Price? Ralph Byrns Some instructors may view the perspective of all human action as self interested as imperialism by economists. This exercise may not be to their liking, but we find that arguing that all behavior of homo economicus is perfectly explicable as optimization given relative prices (opportunity costs) and budget constraints causes students to focus in on economic reasoning early in the course. After arguing
that everyone always pursues the opportunities that they perceive to the best
(lowest cost for a given desirable outcome), we turn the argument around and
ask if anyone in the class can conceive of any action that they would not do
regardless of price. Most students respond that there are things they would
not do for any price. (They are still thinking of monetary prices.) Then ask,
e.g., "How many of you would NOT kill your mothers for any price?"
Most students will raise their hands. Select a young, innocent looking
student and conspiratorially swear the rest of the class to secrecy about
what your student is about to reveal. Then introduce yourself as Vlad the
Impaler (a Transylvanian monarch who inspired the Dracula of fiction), and
suggest that the alternative to their killing their mothers painlessly by
injection is that you will, but by torture and only after slaughtering the
student's entire family (including the student). Faced with such blood‑curdling
alternatives, most students will confess that for the right price (in this
case, a worse alternative), they would kill their mothers. Admit that
this may seem a contrived example, but that many who dearly love their
mothers would commit euthanasia if extended torment by an inevitably fatal
disease were the alternative. Similar choices are frequently made when
enormous medical costs must be incurred to keep a loved one alive for, at
best, some short period. The point of
this exercise is that any action, regardless of how unpleasant, may be chosen
if the alternative is even less pleasant. In Tragic Choices (Norton
Publishing, 1978), Calabresi and Bobbitt detail numerous tradeoffs between
painful alternatives and suggest that such choices are often made using
disguised decision mechanisms. Student Expressions and Opportunity Cost Ralph Byrns Many students use expressions that conform to economic concepts of costs (e.g., "That's going to cost you") but then have difficulty in class in seeing that cost is not synonymous with a monetary price. When introducing the concept of opportunity cost, try to use as many nonmonetary examples as you can. (See, e.g., Hugh Macaulay's contribution in Chapter 6.) Then concede that monetary prices are a handy proxy for opportunity costs, but seldom reflect all costs. You might also want to talk about monetary prices as typically coming closer to reflecting costs in a market economy than under socialism or other systems, or mention that psychologists attempt "behavior modification" for their patients merely by altering opportunity costs. Efficiency Gary Galles, Pepperdine University and University of California, Los Angeles Students often have trouble mastering the concept of economic efficiency (the relevant mastery entailing the ability to consistently and accurately apply the concept to real life). I believe that this, in large part, is due to the difference between what economists mean by efficiency (the value of what is produced exceeds the opportunity costs of all the inputs used to produce it) and the preconceived engineering or energy‑efficiency notions they usually bring to class. To drive home the idea of economic efficiency in class, I use several examples of engineering or energy inefficiency that are (or may be) economically efficient. Included are the following: (a) I ask whether it is more efficient to insulate a house in a temperate climate or a cabin in a cold mountain resort. Students usually favor the cabin by their replies, but I respond with an important maxim: the right approach to answering almost any policy question is it depends on whether the value of output exceeds the value of the inputs. I then ask what the answer to the insulation question depends on. We discover that the value of the insulation (which must be compared to its cost) is an increasing function of the amount of energy saved, the price of energy and the amount of use. For an infrequently used cabin, the energy dollar savings may be outweighed by the infrequency of use, and hence it may be inefficient to insulate the cabin, despite its energy inefficiency. I also ask whether time share condos were more or less likely to be insulated than other cabins, to get them to see that increased frequency of use makes insulating more economically efficient. (b) For a similar example, I ask whether a California law requiring at least a certain level of thermal efficiency for all air conditioners sold in the state is economically efficient. This again focuses on the trade-off between the costs of increasing thermal efficiency (that shows up in the purchase price) versus the benefits of cheaper cooling, which is a function of how much the air conditioner is used. It is easily conceivable that an infrequently used air conditioner would be most economically efficient by violating thermal efficiency standards, because the lower purchase price more than compensates for the higher stream of energy costs. This example can also serve as an introduction to present values (by asking how to discount the future energy cost savings to compare it to the higher purchase price of the "higher quality" air conditioner investment) and to the issue of requiring certain standards to be met versus providing the information for consumers to make their own choices (e.g., the legally mandated sticker affixed to new refrigerators revealing the expected energy costs of yearly operations. (c) I ask when it would be economically efficient to continue to use an older technology manufacturing plant rather than invest in a new one to lower "costs." Here I get them to focus on the fact that the existing plant represents a "sunk" cost, so that the relevant choice is between the marginal cost of the old plant and the expected average cost of the new one (for which none of the costs are yet sunk). This clearly means that "state of the art" engineering or technically efficient plants may easily be economically inefficient for an existing producer. This can be elaborated to discuss when it becomes efficient to switch (when the marginal cost of the existing plant exceeds the average cost of the new, usually due to required repairs or renovation necessary to continue production at the old plant or to cost reducing new techniques for a new one) or to talk about what type of factory a new entrant should build (because for him there are no sunk costs). (d) Related to the above, I ask whether it is more efficient for established firms to be leaders or laggards in adopting the latest technology. We find that this, in part, depends on the type of technological change involved. If it was a "scrap it" change requiring the abandonment of existing equipment, new entrants would tend to be the leaders, because they have no existing equipment whose value would fall with the introduction of the new process. If it was a "bolt‑on" change which enhances the efficiency of existing equipment, the larger existing firms would tend to be the leaders, as they have more to gain by adopting it. (e) I ask about which car is more efficient. By now, the students will know to say "it depends," so we go through some of the things it depends on. The most efficient car to drive is a function of: a) miles per gallon (affects the dollar cost of driving); b) miles driven (MPG is more important the more miles are driven); c) the price of gasoline; d) safety preferences (since smaller, higher MPG gas cars tend to be less safe); e) noise preferences (since smaller cars tend to be noisier); f) comfort preferences; g) family situation (number of family members influences the desired capacity of the car); h) insurance demographics (age, sex, location, and accident record affects the insurance costs of different cars); i) height and weight of occupants (for height and width requirements, such as the Wilt Chamberlain ads for VW bugs); j) carpooling arrangements; k) expected depreciation in resale value; l) length of time you plan to keep the car; etc. I use this to make them see that efficiency problems in economics are almost always multidimensional and typically involve trade‑offs among several goods or bads. I continue with
the same approach to more issues until students master the concept. I
personalize it with questions like: what's the most efficient grade for you
to get in this class (focusing on trade‑offs and getting the lowest of
a particular grade to minimize costs); is it efficient to come to class;
what's the best way to study, etc. This approach lends itself to student
involvement and problem‑solving ability at a tremendous rate (students
out of my class several years remember that IT DEPENDS is the right framework
for answering efficiency questions). Production Efficiency versus
Allocative Efficiency John W. Reifel,
Students readily grasp the concept of
production (or technological) efficiency but frequently struggle to grasp
allocative efficiency. The following simple example is useful in
distinguishing the difference. Note that in any given year it would be
possible to allocate all of the country's scarce resources into producing
millions of large speedboats such that every household in Though boating enthusiasts may be happy
with this resource allocation many other households clearly would not.
Households that live far from bodies of water where they could use their
boats would be unable to derive satisfaction from them. The frail, those who
fear water, and those who suffer from seasickness would be unable to derive
satisfaction from them. These other groups of people would much prefer that
the scarce resources alternatively be allocated to producing housing,
clothing, hospitals, cars, etc. which do give them satisfaction. This distinction can be used to refresh
and deepen students' understanding of the production possibilities concept.
Production efficiency is required to develop a PPC with speedboats on one
axis and all other goods lumped together on the other axis. Allocative
efficiency involves choosing the combination of boat and other good
production that gives society the greatest possible satisfaction from the use
of its scarce resources. Engineering Efficiency vs.
Economic Efficiency Carole E. Scott, State University of West Georgia While an engineer would measure the efficiency of an electric motor in terms of the ratio of energy input to energy output, the economist measures the economic efficiency of an electric motor in terms of the ratio of the dollar cost of operating the motor to the dollar value of the energy output. Thus, while the engineer might rate two electric motors as being equally efficient, the economist might not rate them as equally efficient. For example, the armature of one might be wound with silver wire, and the other with copper. The more costly motor, if each does the job equally well, would be economically inefficient relative to the other, less expensive motor. Ralph Byrns It is often easier to describe what efficiency is by first explaining the meaning of inefficiency. Offer a number of examples of inefficient situations. For example: (a) I have been washing my own dishes but break so many that it costs me $800 per year. You can rent me a dishwasher for $200 per year that cuts my time and energy costs in half and doesn't break dishes. Inefficiency exists until we make the appropriate transaction. (b) Laws once "protected" women by forbidding their employment except in 8:00 to 5:00 office work, or as grocery clerks, nurses, or school teachers. Breaking down barriers that arbitrarily discriminate on the basis of race, age, or sex drives production costs down because comparative advantages can then be more fully realized. (c) Laws limiting work by convicts because this would be "unfair" to competitors drives net prison costs up. (You can argue that, just as climate can determine comparative advantage, incarceration [or its absence] may shape comparative advantage as well.) Inmates could be required to pay room and board and compensate their victims with their earnings. Industrial training should increase the job opportunities of ex‑convicts and reduce rates of recidivism. And competitors of prison industries could be compensated for retooling and retraining, much as trade adjustment assistance (TAA) has at times been paid to losers from freer international trade. After students see that Pareto moves are possible from inefficient situations, the concept of efficiency becomes clearer to them. Efficient Rationing in a
Prisoner of War Camp Mark Evans, California State University-Bakersfield Students often have difficulty in isolating distribution from production, and in distinguishing between efficiency and equity. A classic article, "The Economic Organization of a Prisoner of War Camp," (R.A. Radford, Economica, 12, Nov. 1945, 189‑201) provides clear examples of these distinctions: production and the distribution of income were largely exogenous, with all prisoners receiving the same Red Cross and German rations. Yet, money and an elaborate price system evolved to redistribute an equal (equitable?) distribution of commodities. After reading Radford's article and/or hearing a lecture on it, students grasp that rationing mechanisms must be evaluated from the perspectives of both efficiency and equity. I use a definition of distributional
preference drawn from revealed preference: a distribution is efficient if no
two individuals can agree to any trade. At first, barter and middlemen
activity were widespread in Radford's POW camp. Later, barter tended to
"dry up" when a price system consisting of cigarette money and a
central store/exchange mart with market clearing prices evolved. Whenever the
authorities attempted to ration goods by some procedure other than market
clearing prices, a resurgence of barter and middleman activity followed. I
mention to my class that this is consistent with a theorem in welfare
economics: price rationing exhausts all possibilities for mutual gain through
trade. Simply put, we would expect barter to disappear if no additional
"deals" can be struck, and its disappearance under price rationing
lends empirical support to the claim that price rationing is distributionally
efficient. When I first define distributional
efficiency and discuss it in the context of the thousands of products and
millions of consumers in a modern economy, students often suggest that it is
surely a utopian notion whose status is unobservable ("How would we ever
know if all, or even most, trades have been consummated?") After
considering what happened in a German POW camp during World War II, they
appreciate this parable of welfare economics and the contribution price
rationing makes to the quality of their lives. |
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