Example of Sunk Cost

Consider the cost of producing a book, say Michael Parkin's Macroeconomics. Assume that 15,000copies are produced. The total cost of producing the copies includes the cost of the authors' time in writing the book, the cost of editing, the cost of making the plates for printing, the cost of the paper and ink, and perhaps the cost of advertising. If the total cost amounts up to $900,000, then the average cost of one copy would be $60.

Suppose a second printing is brought onto agenda. Should another 10,000 copies be produced? In deciding whether to proceed, the costs of writing, editing, making plates, and so forth are irrelevant in that they have already been incurred in the previous 15,000 copies. That is, they are sunk costs.

1.2.4. Positive vs. Normative

The questions economics asks and attempts to answer fall into two categories. Positive economics is an assertion about economic reality that can be supported or rejected by reference to the facts. It is used to understand the behavior and operation of economic systems, rather than passing judgments on them. Normative economics reflects opinions and values, judging whether the outcomes are good or bad. Simply speaking, positive economics deal with what is while normative economics is concerned with what should be.

Not so normative as arts nor so positive as science

The peculiarity of economics derives itself from these two kinds of statements, normative statements and positive statements, distinguishing economic discipline from both art and science that are either normative or positive. Economics, on the other hand, is not so normative as art nor so positive as science. In fact, many economists confront one another on a number of economic topics such as what the proper role of government should be.

1.2.5. 4 Steps to Reach a Conclusion

Theories or models are formal conclusions achieved or discovered through scientific procedures. In economic analysis and research though, it is not so "scientific". As in physical experiments, variables and factors can be controlled and manipulated very precisely, enabling you to anticipate almost everything. Economists, nevertheless, do research and perform experiments in a much more complex and unpredictable situation, trying to achieve conclusions primarily by observation. They are unable to control known variables in ways they want them to, not to mention those possibly missed out, scrambling the data or simply misleading them. What physicists discover can be formulated exactly in mathematics as they are in reality, and always correct; whereas things an economist discovers do not always hold true and some of them arouse dispute.

Anyway, to study economists problems, economists employ a process of theoretical investigation called the scientific method comprised of 4 steps:

1. Identify and define the question as well as relevant variable.
2. Make assumptions, that is the prerequisites or condition for the theory to apply.
3. Formulate a hypothesis, that is how variables relate to and affect one another.
4. Validation of the hypothesis, testing the predictions against actual evidence.

If the answer to step 4 is negative, then either the hypothesis is incorrect or the previous two steps do not go smoothly; otherwise, hypothesis passes the validity test and a theory or model is confirmed.

1.3. From economic Theories to economic Policy

1.3.1. The Building of Theories and Models

A model is a formal statement of a theory. No matter what discipline, be it physics, meteorology, astronomy or economics, researchers use models to explain the world, and models are built upon variables. A variable is a measure that can change from time to time or from observation to observation. Price is a variable, it differs from time to time. But why does it alter itself? No, it does not alter itself. That it hardly stay still is because other variables have impacts on it, either positive or negative, linear or nonlinear. The real world is so complex that we just cannot make out all the variables that govern it, but abstract some of them, to put together a model. In this sense, models are all simplifications, stripping away detail to expose only those that are important to the question being asked. An intuitive example of modeling is the charting of a map. Most maps are two-dimensional representations of a three-dimensional world, showing only things we are concerned about, omitting pretty much of the geographical details.

Now we know what a variable is and why a model is different from the real world. But how exactly it is built? One of the techniques, or scientific methods, is the device of All Else Equal, or ceteris paribus. Very handy it is when we try to isolate the impact of one single factor upon something. What is the impact of a 10% rise in gasoline price on driving behaviors, ceteris paribus, or assuming that nothing else changes? We can tell that a reduction in driving occurs, but how much less, assuming no simultaneous change in other related things, income, number of children, population, laws and so forth?

In a word, the concept helps us simplify reality in order to focus on the relationships that we are interested in. We can then delve into the relationship between just two variables by simply assuming that all else remain intact during any procedure.

Economists literally find 3 means to represent a model or convey an economic idea, words, graphs, and equations. Pros and cons exist for each of them. Words convey simple ideas effectively, but not adequate for multi-variable models or two-variable model that is to show the mathematical nature of the quantitative relationship. Graphs do this job intuitively, and in a more specific as well as accurate way. It does not only give you the big picture, but also shows you what it is like at a specific point. Equations are not used as frequently as the former two, but presents us the underlying process, so more suitable for in-depth research and modeling. Below is a graph depicting the demand curve how Matthew responds to telephone price changes.

Matthew's Telephone Call Demand Curve

The relationship between price and quantity demanded presented graphically is called a demand curve. Demand curves have a negative slope, indicating a negative relationship between them. Lower prices cause quantity demanded to increase, and vice versa.

1.3.2. Economic Policy and 4 Criteria for Judging

Theories and models are positive statements, helping us understand the mechanism of the world, but the formulation of economic policy requires a second step, the step to further these theories and models into practice to get to what we think it should be. What are the objectives? How to define better, that is what changes to our situation are positive? Do we better off or worse off? Four criteria are frequently applied in making these judgments:

• Efficiency
  In economics, efficiency means allocative efficiency. An efficient economy is one that produces what people want and does so at the lowest possible cost. More technically, an efficient change in the allocation of resources is one that at least potentially makes some people better off without making others worse off. Since most changes in an economy will leave some people better off and others worse off, we have to devise a way of comparing gains and losses from a given change. So, a change is considered at least potentially efficient if the value of the resulting gains exceeds that of the resulting losses.
• Equity
  Fairness. Few people agree on what is fair and what is unfair, though. For thousands of years, philosophers wrestle with the principles of justice to guide social decisions.
  Despite the impossibility of defining equity or fairness universally, public policy makers judge and regulate the fairness of economic outcomes all the time.
• Growth
  Economic growth is an increase in the total output of an economy. That is what happens when we invent new and better ways of producing what we use now and develop new products and services. However, all economic policies do not encourage economic growth, some discourage it.
• Stability
  Economic stability refers to the condition in which national output is steady or growing, with low inflation and full employment of resources. An economy may at times be unstable, characterized by high unemployment and severe inflation. The causes of instability and attempts to stabilize the economy by government regulation are the subject matter of macroeconomics.

Date: 2016-01-14; view: 761