For all those interested in "The Economic Way of Thinking" - my new infoposter "ECONOMICS" is now available: - the poster gives an overview of the development of economic theory from its beginnings. - the poster shows the historical roots of economic ideas and their application to contemporary economic policy debates. View and order at http://www.cee-portal.at/PrestaShop Best regards Martin Kolmhofer

1. The Economic Way of Thinking

3. What is economics all about?

5. It´s all about people…

6. Unlimited Wants: More Time, More Fun, More Choices… (Only perfect beings want nothing) Limited Resources: Time, Energy, Money,…

7. Choices must be made…

10. How to distribute resources rationally in the economy? Capitalist solution is the Price Mechanism Those who are willing to pay the price will get the goods and services

11. VIDEO: The Price Mechanism in Action

12. Example: Supply of a big city. Who coordinates? NOBODY Process of impersonal social interaction is coordinated through prices Prices are signals that tell us what we have to do in order to be useful for other people - This is how it was possible to create a society based on the division of labour Millions of people in society coordinate their plans through markets

13. Recognizing Order

16. Adam Smith (1723 – 1790) was the first economist who investigated how this process of social coordination works: Rational, self-interested behaviour does not produce chaos, but usually produces social coordination

18. Cooperation Through Mutual Adjustment Your choices and plans change the opportunities available to others and social coordination is a process of continuing mutual adjustment to the changing net advantages that their interactions generate. Example: Freeway – smoothly coordinated flow Drivers will disperse themselves evenly over the lanes. Why? Drivers are alert of the net advantages of each lane and therefore try to move out of any lanes that are moving slowly and into those that are moving faster. This speeds up the slow lanes and slows down the fast lanes until all lanes are moving at the same rate (until no driver perceives any net advantage to be gained by changing lanes) It all happens quickly, continuously, and far more effectively than if someone at the entrances passed out tickets assigning each vehicle to a particular lane.

19. Cooperation Through Mutual Adjustment The same basic principles are at work in the rest of society. Individuals chose their actions on the basis of the net advantages they expect. Their actions alter, however minutely, the relative benefits and costs of the options that others perceive. When the ration of expected benefit to expected cost for any action increases, people do more of it. When the ratio falls, they do less. The fact that almost everyone prefers more money to less is an enormous aid in the process, an extremely important lubricant, if you will, in the mechanism of social coordination. Modest changes in the monetary cost and monetary benefit of particular options can induce large numbers of people to alter their behavior in directions more consistent with what other people are currently doing. And this is the primary system by which we obtain cooperation among the members of society in using what is available to provide what people want. This is what the market economy is all about.

20. Rules of the Game Whether the “game” is business, government, science, family, school, traffic, it can’t be played satisfactorily unless the players know at least roughly what the rules are and generally agree to follow them. Examples: CEE Transition Traveling abroad (people do not know exactly what is expected of them or what they can expect from others) If rules are absent or suddenly upset: Social Cooperation can fall apart quickly

24. Appendix 1 Micro vs. Macro

25. If economics is simply an issue of examining how people chose to use this many resources to satisfy this many wants…. … why do we have both Microeconomics and Macroeconomics?

26. Its simply a question of scope. Microeconomics deals with choices of a single entity . (One product, one price, one consumer, one household, one business, or even one industry.) Macroeconomics on the other hand deals with the actions of the economy as a whole. The country´s income (which we call GDP), all prices (or inflation), or unemployment across the entire economy….

27. Appendix 2 Positive vs. Normative Analysis

28. It is crucial that you can distinguish between positive and normative analysis. Positive analysis is factual analysis. You can recognize a positive statement because it can be tested, it can be proven or disproven. There are no personal judgments involved.

29. For example, I could tell you that it’s 72 degrees outside today. You could verify that my statement is true or untrue

30. Normative Analysis on the other hand is opinion-based analysis. You can recognize a normative statement because it involves personal judgments and ideals that cannot be proven or disproven.

31. What if I tell you that ORANGE is better than RED Can you verify this? Can you test it? Can you prove it or disprove it?

32. In the end we need both types of analysis to make policy. The Think Tank groups engage in positive analysis, then turn the finance over to the policy makers who use this information to create policies that they feel are best for society. If you happen to disagree with their policies then you can vote for someone else... Exercise: Take a look at a headline from today’s news. Can you distinguish the positive statements from the normative statements?

33. “ Robinson Crusoe” Economics

34. • How even a one-man economy illustrates economic concepts and categories. • The importance of saving and investment. • How economists explain individual choices. In this lesson you will learn:

35. Before we can analyze an economy composed of billions of interacting people, we should start with just one person and make sure we understand what makes him tick. We are developing general principles about an individual’s purposeful actions in the face of scarcity.

36. Crusoe feels uneasy – decides to take action: Before he can make a sensible decision on how to proceed, Crusoe first needs to see what he has to work with: Economic Goods (Coconuts, Rocks…) Scarce physical items or services that directly satisfy a person’s preferences – as opposed to Free Goods (Air, Gravity…). Crusoe needs to economize his consumer goods (treating a resource with care because it is scarce and can only satisfy a limited number of goals or preferences.) Tradeoffs: Until he finds another source of food (such as fish after he constructs some tools), Crusoe needs to make sure he doesn’t eat his coconuts too quickly. If he decides to use certain rocks in order to make a shelter, Crusoe can’t simultaneously use those same rocks when building a fire. It’s important to realize that an object becomes a good when a person incorporates it into his plans. i.e. “Crusoe Creates Goods With His Mind Powers” For example, certain plants on the island might have medicinal properties, but if Crusoe doesn’t know it, then those plants will not attain the status of economic goods. Economic Goods vs. Free Goods

37. Now that we understand what goods are in general, we can begin to make some distinctions. On the one hand, Crusoe recognizes that there are scarce items that can help him to directly achieve his goals. For example, the running water in the stream can directly quench his thirst, and the coconuts can directly satisfy Crusoe’s hunger. Economists call these consumer goods . On the other hand, there are items that are certainly useful, and which would allow Crusoe to achieve more of his goals if he had more such items— hence they are goods—but they are not directly useful to him. They are only indirectly useful because they help Crusoe to obtain more consumer goods. Economists call such items producer goods or factors of production or means of production. For example, a long stick, in and of itself, doesn’t do anything for Crusoe, and if it were the only object on the island, Crusoe would not consider it a good at all. But because there are coconuts hanging on trees—some of which are out of Crusoe’s reach—suddenly the stick acquires value indirectly. Crusoe now considers the stick to be a good, even though it doesn’t directly satisfy hunger, because it indirectly helps him to achieve his goal. Consumer Goods vs. Producer Goods

38. Land, Labor, and Capital Goods Land: direct gifts of nature (flowing stream, trees…) Labor: productive services Crusoe performs with his body Capital Goods are those factors of production that were created by people (fishing net, shelter…) Types of Producer Goods

41. Opportunity Costs When Crusoe makes a choice, he can’t simply consider the benefits, as he subjectively perceives them. He must also consider the costs. The cost of a particular decision is the value that Crusoe places on the most important goal that he won’t be able to achieve, because of the decision. Economists use the term opportunity cost , which they define as the subjective value placed on the next-best alternative that must be sacrificed because of a choice.