Why Economics Matters

1. بسم الله الرحمن الرحيم Why Economics Matters Farid Abolhassani M.D.

2. Economics: Definition The study of how individuals and societies choose to • Allocate scarce productive resources among competing alternative uses and • Distribute the products from these uses among the members of a society

3. Resources • Time and abilities of individuals • Land and natural resources • Capital • Knowledge of production processes Money is not defined by economists as a resource in itself

4. Scarcity Scarcity means that: There are not, and can never be, enough resources to satisfy all human wants and needs

5. The Cost-benefit Approach To Decisions The major challenge of daily living: Should I do activity x ? Economists’ answer to this question: If B(x) > C(x) Then Do x Otherwise Do not do x End if B(x) and C(x) could always be expressed in monetary terms

6. Reservation Price: Definition The minimum amount of money one asks to give up something Or The minimum amount of money one is ready to pay to benefit from something

7. The Role of Economic Theory Many economists believe that: Useful insights into our behavior can be gained by assuming that we act as if governed by the rules of rational decision making.

8. Common Pitfalls in Decision Making • Ignoring implicit costs • Failing to ignore sunk costs • Focusing on only some of the relevant costs

9. Common Pitfalls in Decision Making • Ignoring implicit costs • Failing to ignore sunk costs • Focusing on only some of the relevant costs

10. Cost of Activity x Cost of activity x = Direct costs + Opportunity cost

11. Opportunity Cost The highest valued alternative sacrificed in order to choose an option is called the opportunity (real) cost of that option

12. The Benefit of Activity x • Benefit of a pleasant activity = Direct Benefit + Reservation Price • Benefit of an unpleasant activity = Direct Benefit – Reservation Price

13. Common Pitfalls in Decision Making • Ignoring implicit costs • Failing to ignore sunk costs • Focusing on only some of the relevant costs

14. Sunk Cost: Definition Costs that are beyond recovery at the moment a decision is made

15. Marginal Analysis Tomans / Number Marginal benefit of pizza 2000 1000 Marginal cost of pizza 0 1 2 3 4 Number - 500

16. Common Pitfalls in Decision Making • Ignoring implicit costs • Failing to ignore sunk costs • Focusing on only some of the relevant costs

17. Buick or Toyota Cb = 100 + 0.05d Cb Cost Ct 500 Ct = 300 + 0.025d 300 100 4000 8000 0 distance

18. The Invisible Hand Wholly unaware of the effects of their actions, self-interested consumers often act as if driven by what Adam Smith called an invisible hand to produce the greatest social good.

19. Economic Analysis Evaluating and choosing among alternative courses of action through examining both the costs and consequences of the alternatives.

20. Efficiency Get the most from scarce resources

21. Elements of Efficiency • Do not waste resources Technical efficiency • Produce each output at least cost Cost-effectiveness efficiency • Produce the type and amounts of output which people value most Allocative efficiency

22. They Are Not the Same Allocative Efficiency Social Desirability

23. Marginal Conditions for Allocative Efficiency • Marginal cost: The additional cost incurred in producing the last unit of an output • Marginal benefit: The additional benefit obtained by consuming the last unit of an output Marginal Benefit = Opportunity cost of resources used up to create the last unit of output

24. Allocative Efficiency: Role of Market • Perfect market Marginal Social Cost = Marginal Social Benefit • Market Failure

25. The Last Remaining Points • Positive questions and normative questions • Microeconomics and macroeconomics