Economic Principals of Analysis A. People Respond to Incentives 1. Even if money/resources aren’t the only things that motivate people, they typically are important. B. Beware of unintended consequences 1. Incentive changes (see above) a. Example: Red Light Cameras/ Reducing Speed Limits: Led to less fatal crashes, but more crashes overall. 2. There are complicated science/ engineering effects that were themselves unanticipated. a. Example: Cancer patients taking antioxidants C. Evaluating the benefits/costs of a policy should always include opportunity costs/benefits (forgone costs/benefits) – TRADEOFFS 1. Example: DDT & Malaria D. Economists like to think “at the margin.” 1. Example: Disney Land – Only given two ‘E’ Tickets (best rides there), theme park guests needed to decide on the margin if they wanted to buy more tickets. Eventually, the park changed to one upfront fee for all rides. Now you pay for the better rides with your time in line. 2. Sunk Cost Fallacy: wasting money you spent by not using something you bought a. Example: A church bought a new speaker system that was very ugly and people called the “rotting potato.” They then paid more money for a cover that made it look even worse. The church used the cover even though it was uglier because they had spent money on the cover and did not want to be wasteful. E. All of the above potentially can be applied to multiple arenas of human activity, not just the market. *Assignment given on Blackboard Common Fallacies A. Chess Man Fallacy 1. Make policies and assume people will move/act like you think they will B. “Ceteris Paribus” Conditions 1. “Omitted-Variables” Problems a. Classroom size example: There was a study done on classroom size and one study had different results than the rest. Generally when you reduce class size you need to hire more teachers (less qualified teachers are hired). The difference in the studies was that most of the studies hired new teachers while the other study kept the same teachers and did not hire any new ones.C. Confusing Correlation with Causation 1. Example: A certain team winning the Super bowl causes the Stock market to go up or down. 2. There may be causation, but it is the reverse of what is advertised. a. Example: Wet Streets cause it to rain. 3. The two things that you observe are both correlated with some third phenomenon and it is that third phenomenon that is causal. a. Example: Flu shots and complications: It was found that complications from the flu shot were less common in people who lived a healthy lifestyle (washing hands etc.) b. Self Selection Problem i. Example: Tuberculosis: Highest rates were in Arizona and New Mexico. However, this was because when you have tuberculosis it is better to live in a warm, dry climate. ii. Charter School vs. Public schools: A studied was performed to see if Charter Schools were better than Public Schools. Students were chosen to attend a charter school by a lottery so that it would be a random selection of students. c. Random chance i. Study done on cancer and water: The water in the town was not causing certain cancers, the people chosen just had higher risk of cancer in their genes. ii. Random Number Generator: Ran 20 times and ran a correlation. Picked a 10 Percent chance that numbers would be correlation with each other. Result: Exactly two were correlated (10%) D. Fallacy of Composition 1. What is true for an individual will also be true for a group of individuals a. Look at indifference curves 2. Kenneth Arrow: Assume every individual has a “normal indifference curve.” Does this mean a country can have an indifference curve? a. Arrow Impossibility Theorem: NO, only when there is a pure dictatorship.Election Example: Voter rank candidates by preference: Voters I II III A B C B C A C A B Election results: A vs. B A>B If transitive, A > C B vs. C B>C A vs. C C>A Result: A >B >C > A > B >C….etc. Assumptions 1. There are well defined property rights a. No Externalities 2. There are no public goods 3. We are able to use an “as if” assumption of price-taking behavior (Competitive Assumption). Demand 1. A demand curve is a representation of a demand function. a. Demand of Beer = (Price of beer, Y, Price of Whiskey, Price of Goldfish, Tastes) i. It holds everything constant except for the price of beer. ii. Demand Curves shifts when other variables (except Price of beer) change.Example: Subsidy given to consumers S 1. Both P & Q change 2. “Incidence”: some of the subsidy is shared with the sellers. The price does not go up by the full subsidy. 3. Label does not matter (Relabel it as a subsidy to the sellers and you should get the same result). Labor Market Surplus of labor S Import of Foreign Cars in India S Red line = shortage D2 D1 P2 P1 Q1 Q2 D1 D1 Min Wage QuotaEntry & Exit Questions: Profit Potentials 1) Types of Firms: Price Taking, Oligopoly , Monopoly 2) Property Rights are well defined  external goods, common pool resource programs 3) Non-Market activity (Firms, Military, Families) Monopoly S = Marginal Cost Peq Marginal Rev. Demand Qeq Intersection at Marginal Revenue and Marginal cost sets quantity, but price is determined by the demand curve. Red triangle = Trading Surplus Green Triangle = Consumer Surplus Entrepreneur – makes money by creating the market 1. Joseph Schumpeter – role of the entrepreneur is to engage in creative destruction aka destroys currents markets by making a new one. 2. Temporarily immune from entry 3. World is a better place because of creative destruction a. Example: Smart phones replacing basic phones 4. Consumer Surplus causes standard of living to get better over time.What motivates People? 1. Nash equilibrium: Selfish utility - In an auction setting people will generally shade between 0 and 16 percent. General competitive market works in this case 2. In the Token Example: A normal strategy would be to keep all the tokens for yourself. However, in class over 300 tokens were in the group pot. This means that a standard economic model fails. We do not know why the model does not work, but it happens all the time. a. Philanthropy – money and