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ENGINEERING ECONOMICS

LECTURE 1

HUMA FAWAD
HITEC, TAXILA
SEPTEMBER 2018 –JANUARY 2019

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Course Learning Objectives
Students will have the ability to understand about the
Economics Principles implied in Businesses,
Manufacturing and Service Concerns and how an
engineer evaluate the dynamics of an organization to take
decisions for the economic well being of the concerned
entity.

To build a baseline for students to understand and


evaluate the basic concepts of Cost Benefit Analysis, Cost
of Production, Depreciation, Taxes, Breakeven Analysis of
organizations and units on Micro and Macro levels.

Engg. Economics – MS 201 Huma Fawad 2017 1-2


Introduction:
Thinking Like an Economist 1

3 Assessment Criteria
• Distribution of marks is as follows:
• Assignment: 20%
• Quizes: 10%
• Sessional 1 & 2 Exams: 30%
• Final Exam: 40%
• Class Attendance Schedule as per standard 75% in the Semester would be followed.

• Books:
• Economics by Stanley
• Engineering Economics (Schaum Outline Series)
• Engineering Economy by William G. Sullivan, Elin W. Wicks, C. Patrick Koelling (16th
Edition)
• Macro Economics by Paul Crompton, Micheal Swann
• Microeconomics by Micheal Swann, William A. Mceachern
• Principles of Microeconomics by Joshua Gans, Stephen King, N. Gregory Mankiw

Engg. Economics MS-201 Huma Fawad 1-3


Introduction:
Thinking Like an Economist 1

Economics
Economics is a social science that analyzes the production,
distribution and consumption of goods and services.
It is the study of how individuals and societies choose to us
the scarce resources that exsist in nature to fulfill their wants
and needs through a decision-making mechanism, social
customs, and political realities of the society.
• The three central coordination problems any economy
must solve:
1. What, and how much to produce
2. How to produce it
3. For whom to produce it
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Introduction:
Thinking Like an Economist 1

Objectives
The objective is the goal or desired outcome of a choice

• Individuals may try to maximize utility given the


constraints of income, time, prices, etc.
• Firms may have objectives such as the maximization of
profits, sales, market share, etc. or the minimization of
costs per unit
• Social objective, maximize the well being of the
members of society

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Introduction:
Thinking Like an Economist 1

Scarcity
• Scarcity exists because individuals want more than can
be produced
• Scarcity means the goods available are too few
to satisfy individuals’ desires

• The degree of scarcity is constantly changing

• The quantity of goods, services and usable resources


depends on technology and human action

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THE ECONOMIC PROBLEM: SCARCITY & CHOICE
Economics is the study of choices when there is scarcity.
Here are some examples of scarcity and the trade-offs
associated with making choices:
• You have a limited amount of time. If you take a part-time
job, each hour on the job means one less hour for study or
play.
• A city has a limited amount of land. If the city uses an acre
of land for a park, it has one less acre for housing, retailers,
or industry.
• You have limited income this year. If you spend $17 on a
music CD, that’s $17 less you have to spend on other
products or to save.
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THE ECONOMIC PROBLEM:
SCARCITY AND CHOICE
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•Three basic questions must be answered in order to understand an


economic system:
– What gets produced?
– How is it produced?
– Who gets what is produced?

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FACTORS OF PRODUCTION
The resources used to produce goods and services; also known as production
inputs.
• Natural resources/Land
Resources provided by nature and used to produce goods and services.

• labour
The physical and mental effort people use to produce goods and services.

• human capital
The knowledge and skills acquired by a worker through education and experience.

• physical capital & Financial Capital


The stock of equipment, machines, structures, and infrastructure that is used to
produce goods and services.
Input of funds

• entrepreneurship
The effort used to coordinate the factors of production—natural resources, labor,
physical capital, and human capital—to produce and sell products.
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Introduction:
Thinking Like an Economist 1

Economic Terminology
• Goal of this class is to describe how economics works
in the real world
• You will be introduced to many terms that occur in
business and in discussions of the economy
• For example:
• Opportunity cost
• Marginal benefit and marginal cost
• Market and economic forces
• Demand Supply
• Production Function
• Optimization, etc
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Introduction:
Thinking Like an Economist 1

Opportunity Cost

• Opportunity cost is the benefit forgone of the next-best


alternative to the activity you have chosen

• Opportunity cost should always be less than the benefit


of what you have chosen

• Opportunity cost is the basis of cost/benefit economic


reasoning

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Introduction:
Thinking Like an Economist 1

Marginal costs and marginal benefits


• Using economic reasoning, decisions are often made by
comparing marginal costs and marginal benefits
• Marginal cost is the additional cost over and
above costs already incurred
• Marginal benefit is the additional benefit above
and beyond what has already accrued

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Introduction:
Thinking Like an Economist 1

Marginal costs and marginal benefits


The economic decision rule:
• If the marginal benefits of doing something exceed the
marginal costs, do it.
MB > MC  Do it!

• If the marginal costs of doing something exceed the


marginal benefits, don’t do it.

MC > MB  Don’t do it!

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Introduction:
Thinking Like an Economist 1

Opportunity Cost
Examples of opportunity cost:

1. Individual decisions
• The opportunity cost of college includes:
• Items you could have purchased with the
money spent for tuition and books
• Loss of the income from a full-time job
2. Government decisions
• The opportunity cost of money spent on the war
on terrorism is less spending on health care or
education
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Introduction:
Thinking Like an Economist 1

Economic and Market Forces


• Economic forces are mechanisms that ration scarce goods

• A market force is an economic force that is given


relatively free rein by society to work through the market

• The invisible hand is the price mechanism that guides


our actions in a market. The invisible hand is an example
of a market force.
• If there is a shortage, prices rise
• If there is a surplus, prices fall

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Introduction:
Thinking Like an Economist 1

Economic and Market Forces


• What happens in society can be seen as a reaction to,
and interaction of:
• Economic forces
• Social forces
• Historical forces

• Social, cultural, and political forces influence market


forces
• Political and social forces often work together against
the invisible hand

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Introduction:
Thinking Like an Economist 1

Economic Insights
• Theories tie together economists’ terminology and
knowledge about economic institutions
• Theories are too abstract to apply in specific cases and
are often embodied in economic models and principles
• An economic model is a framework that places
the generalized insights of the theory in a more
specific contextual setting
• An economic principle is a commonly held
insight stated as a law or general assumption

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Introduction:
Thinking Like an Economist 1

The Invisible Hand Theory


• According to the invisible hand theory, a market
economy, through the price mechanism, will allocate
resources efficiently
• Prices fall when quantity supplied is greater than
quantity demanded
• Prices rise when the quantity demanded is greater
than the quantity supplied

• Efficiency means achieving a goal as cheaply as possible

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Introduction:
Thinking Like an Economist 1

Microeconomics and Macroeconomics


• Economic theory is divided into two parts;

• Microeconomics is the study of individual choice,


and how that choice is influenced by economic
forces. It is the study of economics of a single unit,
a household, a business, a production house etc
• Macroeconomics is the study of the economy
as a whole, same type of industries, households,
country, geographically, globally etc

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Introduction:
Thinking Like an Economist 1

Microeconomics and Macroeconomics


• Microeconomics studies such things as:
• The pricing policy of firms
• Household’s decisions on what to buy
• How markets allocate resources among
alternative ends

• Macroeconomics studies such things as:


• Inflation
• Unemployment
• Economic growth

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The Scope of Economics

Examples of microeconomic and macroeconomic concerns


Production Prices Income Employment
Microeconomics Production/Output Price of Individual Distribution of Employment by
in Individual Goods and Income and Wealth Individual
Industries and Services Businesses &
Businesses Wages in the auto Industries
Price of medical industry Jobs in the steel
How much steel care Minimum wages industry
How many offices Price of gasoline Executive salaries Number of
How many cars Food prices Poverty employees in a firm
Apartment rents
Macroeconomics National Aggregate Price National Income Employment and
Production/Output Level Total wages and Unemployment in
salaries the Economy
Total Industrial Consumer prices
Output Producer Prices Total corporate Total number of
Gross Domestic Rate of Inflation profits jobs
Product Unemployment
Growth of Output rate

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Introduction:
Thinking Like an Economist 1

Economic Institutions
• To apply economic theory to reality, you've got to have
a sense of economic institutions
• Economic institutions are laws, common practices,
and organizations in a society that affect the economy
• Economic institutions differ significantly among nations

• They sometimes seem to operate differently than


economic theory predicts

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Introduction:
Thinking Like an Economist 1

Economic Policy Options

• Economic policies are actions (or inactions) taken by


the government to influence economic actions
• Objective policy analysis keeps value judgments
separate from the analysis

• Subjective policy analysis reflects the analyst’s views


of how things should be

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ENGINEERING ECONOMICS
LECTURE 2

HUMA FAWAD
HITEC , TAXILA
SEPTEMBER 2018–JANUARY 2019

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Engineering Economics Systematic evaluation of
the economic merits of proposed solutions to engineering
problems

 Rational Decision- making


Process
 The Engineer’s Role in
Business
 Types of Strategic
Engineering Economic
Decisions
 Fundamental Principles in
Engineering Economics
Bose Corporation

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Introduction:
Thinking Like an Economist 1

Opening Story - Bose


26 Corporation
• Dr. Amar Bose, a graduate of electrical Engineering,
an MIT professor, and Chairman of Bose Corporation.
• He invented a directional home speaker system that
reproduces the concert experience.
• He formed Bose Corporation in 1964 and became the
world’s No.1 speaker maker.
• He became the 288th wealthiest American in 2002 by
Forbes magazine.

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Rational Decision-Making Process
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1. Recognize a decision
problem
2. Define the goals or
objectives
3. Collect all the relevant
information
4. Identify a set of feasible
decision alternatives
5. Select the decision criterion
to use
6. Select the best alternative

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Introduction:
Thinking Like an Economist 1

What is Decision Making?

• We all make decisions of varying importance


every day, so the idea that decision making can
be a rather sophisticated art is not valid
• Studies have shown that most people are much
poorer at decision making than they think!.
• An understanding of what decision making
involves, together with a few effective
techniques, will help produce better decisions

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Introduction:
Thinking Like an Economist 1

Decision Making
1. What is
Decision Making? 2. Barriers to Good
Decision Making

3. Decision
Making Process

4. Decision Making
Tools

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What is Decision Making?

• Decision making is the cognitive process leading


to the selection of a course of action among
alternatives.
• Every decision making process produces a final
choice. It can be an action or an opinion.
• It begins when we need to do something but we
do not know what. Therefore, decision making is
a reasoning process which can be rational or
irrational, and can be based on explicit
assumptions or tacit assumptions.
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Introduction:
Thinking Like an Economist 1

Barriers to Good Decision Making

• Hasty - Making quick decisions without having


much thought.
• Narrow - Decision making is based on very limited
information.
• Scattered - Our thoughts in making decisions are
disconnected or disorganized.
• Fuzzy - Sometimes, the lack of clarity on important
aspects of a decision causes us to overlook certain
important considerations.
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Decision Making Process
Steps Tips
1. Identify a problem or  A lot of decision making goes wrong at the starting point.
 the more specific your definition of the decision is to made, the
opportunity. clearer will be your analysis and the likelihood of success.

2. Gather Information  Successful decision makers explore all of the possible choices of
the situation.
3. Analyze Situation  In fact many of the less obvious choices turn out to be the most
effective ones.
4. Develop Options
In many cases, we may lack sufficient information to make an
informed decision.

5. Evaluate Alternatives  Analyze the advantages and disadvantages of each choice

6. Select the preferred  Synthesize all what you learned in previous steps and make a
conclusion that you believe to be your “best” choice.
alternatives
7. Act on decision and  Once you have selected your best choice, you need to develop
and implement a specific and concrete plan of action.
monitor the results,  As you begin taking the steps in your plan, you will discover that
making necessary adjustments need to be made.
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adjustments.
Introduction:
Thinking Like an Economist 1

Decision Making Tools

Tools to facilitate better decisions:

• SWOT ANALYSIS
• SIX THINKING
• DECISION MATRIX
• FORCE FIELD ANALYSIS
• ISHIKAWA DIAGRAM
• MIND MAPPING
• SOCRATIC QUESTIONING

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Introduction:
Thinking Like an Economist 1

SWOT Analysis

• SWOT analysis is a great technique for identifying


your Strengths and Weaknesses and study any
Opportunities and Threats you face.
• It is also a powerful strategic planning tool used to
evaluate a project or in a business venture or in any
other situation of an organization or individual
requiring a decision in pursuit of an objective.
• It involves monitoring the Management environment
internal and external to the organization or
individual.
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SWOT Analysis – Strategic Use

• Orienting SWOTs to An Objective - If SWOT analysis does not start with


defining a desired end state or objective, it runs the risk of being useless.
• If a clear objective has been identified, SWOT analysis can be used to help
in the pursuit of that objective. In this case, SWOTs are:

Strengths Weaknesses
Attributes of the organization Attributes of the
that are helpful to achieving the organization that are harmful
objective. to achieving the objective.
Opportunities Threats
External conditions that are External conditions that are
helpful to achieving the harmful to achieving the
objective. objective. 1-35
SWOT Analysis – Creative Use

• Creative Use of SWOTs – If the objective seems


attainable, the SWOTs are used as inputs to the
creative generation of possible strategies, by
asking (usually in groups) and answering each of
the following four questions, many times:
Strengths Weaknesses
How can we Use each How can we Stop each
Strength? Weakness?

Opportunities Threats
How can we Exploit each How can we Defend against
Opportunity? each Threat?
Source: http://en.wikipedia.org/wiki/SWOT_Analysis 1-36
SWOT Analysis – Internal and External
Factors

• The aim of any SWOT analysis is to identify the key


internal and external factors that are important to
achieving the objective. SWOT analysis groups key
pieces of information into two main categories:
Strengths
Internal Factors
 Organization

Weaknesses
Opportunities

External Factors
 External Environment
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Threats
Introduction:
Thinking Like an Economist 1

SWOT Analysis – Errors to Be Avoided

• Conducting a SWOT analysis before defining and agreeing


upon an objective (a desired end state). SWOTs should not
exist in the abstract. They can exist only with reference to an
objective.
• Opportunities external to the company are often confused
with strengths internal to the company. They should be kept
separate.
• SWOTs are sometimes confused with possible strategies.
SWOTs are descriptions of conditions, while possible
strategies define actions.

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Introduction:
Thinking Like an Economist 1

Decision matrix

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Introduction:
Thinking Like an Economist 1
Force field analysis

• Force Field Analysis is best carried out in small group of about six to eight
people using flip chart paper or overhead transparencies so that everyone
can see what is going on.
• The first step is to agree the area of change to be discussed. This might be
written as a desired policy goal or objective.
• All the forces in support of the change are then listed in a column to the left
(driving the change forward) while all forces working against the change are
listed in a column to the right (holding it back).
• The driving and restraining forces should be sorted around common themes
and should then be scored according to their 'magnitude', ranging from one
(weak) to five (strong).
• The score may well not balance on either side.

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Introduction:
Thinking Like an Economist 1

Force field analysis

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Six Thinking Hats

Argument vs. Parallel Thinking


Introduction:
Thinking Like an Economist 1
Six Thinking Hats
Framework

• Confusion is the biggest enemy of good thinking


• We try to do too many things at a time
• Juggling with six balls at a time is rather difficult
• Tossing up one ball at a time is much easier

• Six Hat Thinking does one thing at a time and in the


end the full picture emerges

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Introduction:
Thinking Like an Economist 1
Six Thinking Hats
Western Thinking = Argument

• Western thinking was designed about 2300


years ago by the Greek “Gang of Three”:
• Socrates – simply point out what is “wrong”
• Plato – we see only shadow “truths”
• Aristotle – things fit into “boxes” (categories)

• Western thinking is concerned with “what is”


determined by analysis, judgment and
argument.
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Introduction:
Thinking Like an Economist 1
Six Thinking Hats
Adversarial vs. Parallel Thinking
Adversarial Thinking
A B

Parallel Thinking
A

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Six Thinking Hats
Parallel Thinking

It was six men much


inclinedTo learning,
Who went to see the Elephant
(Though all of them were
blind),
That each by observation
Might satisfy his mind.

John Godfrey Saxe's ( 1816-1887)

version of the famous Indian legend 1-46


Six Thinking Hats
Parallel Thinking
Wall
Fan

Spear

Snake

Rope And so these men of Indostan


Disputed loud and long,
Tree Each in his own opinion
Exceeding stiff and strong,
Though each was partly in the
right,
And all were in the wrong!
Six Thinking Hats
Parallel Thinking

A wise man was passing by and he saw this. He stopped and


asked them, "What is the matter?" They said, "We cannot
agree to what the elephant is like.“

The wise man calmly explained to them, "All of you are right.
The reason every one of you is telling it differently is because
each one of you touched a different part of the elephant. So,
actually the elephant has all those features.“

"Oh!" everyone said. There was no more fight. They felt


happy that they were all right.
Introduction:
Thinking Like an Economist 1
Six Thinking Hats
Parallel Thinking

• Using parallel thinking they could all walk around


and “look” at each part of the elephant together.
So at each moment each person is looking in
parallel from the same point of view and in the
same direction.
• This is almost the exact opposite of argument,
adversarial, confrontational thinking
• Each party deliberately takes an opposite view
• Each tries to prove the other wrong
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Introduction:
Thinking Like an Economist 1
Six Thinking Hats
Directions and Hats

• By using standard labels (like; front, back, left side, right


side, north, south, east, west) we can choose which
direction we want to look.
• What are the different directions thinkers can be invited
to look?
• This is where the hats come in:
• There are six colored hats corresponding to the six
directions of thinking: white, red, black, yellow, green,
blue.
• Why hats?
• A hat indicates a role (i.e. I see you have your thinking
cap on…)
• A hat can be put on or taken off with ease
• A hat is visible to everyone around
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Six Thinking Hats
The Six Hats

White Hat

Blue Hat
Red Hat

Green Hat Black Hat

Yellow Hat

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Six Thinking Hats
The WHITE Hat = Facts and Data

• The White Hat calls for information known or


needed.
• Think of white paper, which is neutral and carries
information:
• …What information do we have?
• …What information is missing?
• …What information would we like to have?
• …How are we going to get missing information?

When you are asked for White Hat thinking, you are being
asked to put aside proposals and arguments - and to focus
directly on the information.
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Six Thinking Hats
The RED Hat = Feelings / Intuition

• The Red Hat signifies feelings, hunches, and


intuition.
• Think of red and fire and warm:
• …Putting on my red hat, this is what I feel about the
project
• …My gut feel is that it will not work
• …I don’t like the way this is being done

Because the Red Hat signals feelings, they can come into
the discussion without pretending to be anything else.

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Six Thinking Hats
The BLACK Hat = Issues / Concerns

• The Black Hat is judgment – the devil’s


advocate or why something may not work.
• Think of a stern judge wearing black robes who
comes down heavy on wrong-doers.
• The Black Hat is the caution hat.
• …The regulations do not permit us to do that
• …We do not have the capacity to meet the demand

The Black Hat is very valuable but overuse can be a


problem.
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Six Thinking Hats
The Yellow Hat = Benefits

• The Yellow Hat symbolizes brightness and


optimism.
• Think of sunshine.
• The Yellow Hat is for:
• The logical positive view of things
• Feasibility and how something can be done
• Benefits that are logically based:
– …This might work if we moved the plant nearer the
customers
– …The benefit would come from repeat customers
Yellow Hat thinking requires a deliberate effort. Benefits
are not always immediately obvious and we might have to
search for them. 1-55
Six Thinking Hats
The GREEN Hat = New ideas / Possibilities

• The Green Hat focuses on creativity; the


possibilities, alternatives, and new ideas.
• Think of vegetation and rich growth.
• The Green Hat is for:
• New ideas and additional alternatives
• Putting forward possibilities and hypotheses
• Creative efforts
– …We need some new ideas here
– …Could we do this a different way?
The Green Hat makes time and space available for
creative thinking.
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Six Thinking Hats
The BLUE Hat = Managing the Thinking

• The Blue Hat is used to manage the thinking


process.
• Think of the sky and an overview.
• The Blue Hat:
• Is for process control
• Sets the agenda for thinking
• Suggests the next step in the thinking
• Can ask for other hats:
– …I suggest we try some green hat thinking
– …Could we have a summary of your views?
The Blue Hat is for thinking about thinking. It is used for
organizing and controlling the process so that it becomes 1-57
more productive.
Introduction:
Thinking Like an Economist 1
Six Thinking Hats
Framework
• Encourages parallel thinking
• Directs thinking in discrete segments
• Switches thinking from one mode to another
• Explores a subject more thoroughly
• Makes specific time and space for creative thinking
• Separates ego from performance

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Six Thinking Hats
• White Hat: Looks objectively at data and information. Is neutral
and concerned with facts and figures.

• Red Hat: Legitimizes feelings and gives an emotional view, hunches,


and intuition.

• Yellow Hat: Is positive and constructive. The yellow color symbolizes


sunshine, brightness and optimism.

• Black Hat: Is logical, negative, judgmental, and cautious. Is gloomy,


suggests why it cannot be done.

• Green Hat: Is about new ideas and creative thinking.

• Blue Hat: Controls the thinking process. The blue hat is concerned
with control and the organization of the thinking process.

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Introduction:
Thinking Like an Economist 1

Six Thinking Hats

White Hat:
Red Hat:
Information Feelings, Intuition,
Information we know Emotions
Information we would like Permission to express
to know feelings
Information we need No need to justify
Information that is missing Represents feelings right
now
How are we going to get
that information Keep it short
Includes hard facts to A key ingredient in decision
doubtful information making 1-60
Introduction:
Thinking Like an Economist 1

Six Thinking Hats

Yellow Hat:
Black Hat:
Logical Positive
Logical Negative The optimistic view
The pessimistic view Reasons must be
Reasons must be given given
Points out thinking that Needs more effort
does not fit the facts, than the black hat
experience, regulations, Looks for the
strategy, values concept behind the
Points out potential idea
problems
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Introduction:
Thinking Like an Economist 1

Six Thinking Hats

Green Hat: Blue Hat:


New Ideas, Possibilities Managing the Thinking
Creative thinking “Control” hat
Seeking alternatives Organizes the thinking
and possibilities Sets the focus and
Removing faults agenda
Doesn’t have to be Summarizes and
logical concludes
Generates new Ensures that the rules
concepts are observed 1-62
Introduction:
Thinking Like an Economist 1
Ishikawa Diagram (fishbone)

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Introduction:
Thinking Like an Economist 1

Mind Mapping Diagrams

• graphical representations of thought


processes for brainstorming, problem
solving, rational analysis, and
decision marking.
• It includes thousands of ready-made
graphics that you simply stamp to
create your drawing
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Introduction:
Thinking Like an Economist 1
Mind Mapping Diagrams

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