The Economic Way of Thinking INTRODUCTION TO ECONOMICS
1. Everything has a cost. TINSTAAFL “There is not such thing as a free lunch.” Every action costs someone time, effort, or lost opportunity to do something else. Opportunity Cost is the value of the next best choice you did not make. Not all costs are in dollars and cents. See video: Economics Made Memorable, Opportunity Costs, part 1
2. People choose for good reasons. People make decisions based on what they believe is most important to them While this may vary from person to person, it is usually the same for most people for any given choice Rational Choices involve weighing the benefits against the costs – “cost benefit analysis” See video: Economics Made Memorable, Opportunity Costs, part 2
3. Incentives matter. When people make their Rational Choices and weighing the benefits against the costs, they are comparing the incentives involved in making the decision When incentive change, people’s behavior changes in predictable ways Incentives can be positives, such as a reward or added benefit, or a punishment or additional cost
4. People create economic systems to influence choices and incentives. Economic Systems are a means of a society answering the three basic economic questions:1. What to produce?2. How to produce them?3. For whom will they be produced?
4. People create economic systems to influence choices and incentives. Coordinating the needs of the people in a society takes the cooperation of many people involved There are rules, written and unwritten that guide people’s behavior by adding incentives to trade in certain ways See videos: Return to Mocha, part 1 Return to Mocha, part 2 Return to Mocha, part 3
5. People gain from voluntary trade. People will trade when they believe the trade will make them better off Like any Rational Choice, trade is another decision people will have to decide upon weighing benefits against the cost Economic Systems are about trade, and therefore about making Rational Choices
6. Economic thinking is marginal thinking. “Marginal” is the economists term for “one more” In economics, decisions are made “on the margin” – “How much benefit will I gain from one more ______ ?” Remember, as long as MB ≥ MC, we continue to make that choice See the example of Park Hopper passes to Disney World
6. Economic thinking is marginal thinking.• Normally we think of the average, “How much will a trip cost per day?”• In economics we think on the margin, “How much will one more day cost?” • It is clear that the Total Total Price / MarginalDays Price Day Price cost of buying an 1 $120 $120.00 $120 additional day 2 223 111.50 103 decreases rapidly: 3 287 95.67 64 • Day 1: $120 4 298 74.50 9 • Day 2: $103 5 306 61.20 8 • Day 3: $64 6 314 52.33 8 • Day 4: $9 7 322 46.00 8Current rates for Park Hopper tickets to Walt Disney World, Florida • Day 5-7: $8 each
7. The value of a good or service is affected by people’s choices. Value is personal; it is determined by the preferences of the buyers and sellers Keeping in mind rule #2, people seek to maximize their benefit while incurring the least cost Therefore, the value of any given trade-off is based on any individual person’s evaluation of the cost- benefit analysis This includes the decision to buy AND the decision to sell
8. Economic actions create secondary effects. Every decision has side effects both direct and indirect (these are called Externalities or Spill-Overs) These secondary effects, where predictable, are part of the cost-benefit analysis When these secondary effects are not predicted the will result in additional cost or benefits that are not reflected in the initial decision
8. Economic actions create secondary effects. In an Market economy, whenever any information is unknown or unavailable in the decision making process, it is considered a “market failure.” A Market Failure occurs whenever any of the requirements for a competitive market (such as, adequate competition, knowledge of prices and opportunities) are lacking.
8. Economic actions create secondary effects. Examples of Secondary Effects 1. Aspirin Aspirin is a very inexpensive pain reliever and fever reducer. When invented, it was considered a “miracle drug” for these reasons. Initially unknown, aspirin also thins the blood making it less likely to clot and has become an important treatment for people with heart conditions People who take aspirin are receiving this extra benefit at no extra cost – A Positive Externality or Spill Over Benefit
8. Economic actions create secondary effects. Examples of Secondary Effects 2. Independence from Foreign Oil As the world becomes more industrialized, more nations demand fossil fuels causing prices to rise. A big push in the United States is find and utilize more sources of fossil fuels domestically, for example, by increasing drilling. While increasing the domestic supply of oil may lower prices of gasoline, a secondary effect would include pollution and environmental disasters such as oil spills out at sea – A Negative Externality or Spill-Over Cost
8. Economic actions create secondary effects. Because people behave in (mostly) predictable ways, the institutions such as government and businesses will make choices expecting secondary effects that will impact the decisions people and consumers will make. In this way, creating these secondary effects amounts to changing the incentive as per rule #3
9. The test of a theory is its ability to predict. Theories differ from laws in that theories have not been tested on every single possibility In economics, most of what is dealt with is theory since only MOST people behave in predictable ways Theories and models are the basis for economic prediction and is what makes economics useful as a study