The document discusses economic systems and how societies answer basic economic questions about what, how, and for whom to produce goods and services. It describes three main types of economic systems: command economies where the government determines production, traditional economies where production is determined the same way it always has been, and market economies where consumer and producer interactions determine production. It also discusses how people's choices have consequences and externalities, and how economic thinking involves marginal analysis of costs and benefits.

1. zThe Economic
Way of
Thinking
Unit 2

2. z
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?

3. z
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

4. z
4. People create economic systems to
influence choices and incentives.
Command Economy
 The central government answers the 3 basic questions for
everyone
Traditional Economy
 The 3 basic questions are answered the same way the society
has always answered them

5. z
4. People create economic systems to
influence choices and incentives.
Market Economy
 The interaction of consumers and producers determines the
answers to the 3 basic questions
 See videos:
 Return to Mocha, part 1
 Return to Mocha, part 2
 Return to Mocha, part 3

6. z
5. People gain from trade
voluntarily.
 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

7. z
6. People’s Choices Have
Consequences for the Future.
 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. z
6. People’s Choices Have
Consequences for the Future.
 In a 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.

9. z
6. People’s Choices Have
Consequences for the Future.
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

10. z
6. People’s Choices Have
Consequences for the Future.
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

11. z
6. People’s Choices Have
Consequences for the Future.
 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

12. z
Basic Principles of Economic Reasoning
(thought)
 Name some decisions you might make now that will impact you
in the future?

13. z
The Boring School Mystery. Or… Why do some
jobs pay more than others?
 Most high school students believe school is boring. Yet most
students graduate from high school.
 Why do students stay in school if school is so boring?

14. z
7. 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, we will continue to make a choice as long as
Marginal Benefit (MB) ≥ Marginal Cost (MC)
 See the example of Park Hopper passes to Disney World

15. z 7. Economic thinking is marginal
thinking.
Days
Total
Price
Total Price /
Day
1 $185 $185.00
2 306 153.00
3 437 145.67
4 546 136.50
5 575 115.00
6 589 98.16
7 603 86.14
Rates for Park Hopper tickets to WDW, Florida
• 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
cost of buying an
additional day
decreases rapidly
Marginal
Price
$185
121
131
109
29
14
14

16. z
8. 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

17. z
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