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Section 1 Basic Economic Principles Tatiana Pino January 10 2011 Is Life Getting Better or Worse Objective measures to analyze Life expectancy Health Income Education Entertainment Life is getting BETTER The Study of Economics Economics is the science of how individuals make choices under scarcity Science developing and testing objective theories Individuals a person or group of people Choice the act of selecting among alternatives Scarcity the concept that there is less of something freely available from nature that people would like i e time money cars etc Scarcity Almost everything is scarce Air is not scarce is not a choice although clean air may be scarce 1 Not the same thing as poverty Scarcity objective Poverty subjective 2 Necessitates rationing Rationing allocating scarce goods to those who want them In a market economy price is used to ration goods 3 Leads to competitive behavior good Allows for productivity and better goods and a range of prices Similar to Darwin s Natural Selection theory What do we do in the face of scarcity When will the world run out of oil NEVER First get the apples from the floor cheapest then when those run out grab them from the first branches more expensive then when those run out go to the next level of branches even more expensive etc As oil becomes more scarce the prices will rise to a point where people will no longer want to spend that much and will begin to search for alternatives Resources Resources an input to produce an economic good something used to make something else Human resources human capital intelligence strength etc Physical resources physical capital man made objects Natural resources oil land etc Capital human made resources used to produce goods and services ONLY human resources and physical resources Twelve Key Elements of Economics Using the economic way of thinking things are not always as they appear January 12 2011 1 Incentives Matter 2 Incentives matter choice is influenced in a predictable way by changing incentives i e the money game the safer they make cars the more reckless people drive the more accidents more fatalities Influences ALL people even altruists Individuals are rational they try to get the most from their limited resources Greatest benefit at least possible cost What is rational for one person may not be rational for everyone i e beer vs liquor same price will choose one based on preference If indifferent and prices vary will go with cheaper option Utility the subjective benefit or satisfaction a person expects from a choice or course of action happiness Cannot compare it across people i e pain tolerance on scale from 1 10 2 There is No Such Thing as a Free Lunch Because resources are scarce trade offs must be made Even if it s free to you it is no free to society took people and money to produce the product Opportunity cost the highest valued alternative that must be sacrificed when choosing an option 2nd best option i e an hour of your time how you spend your next 15 With every choice you rick the life you would have had with every decision you lose it Richard Bach Failure to understand this is one of the biggest mistakes made in economic reasoning 3 Decisions are Made at the Margin Marginal describes the effect of a change in the current situation Change or additional i e Supersizing your extra value meal only 0 59 difference drive or fly Law of Diminishing Marginal Utility as consumption increases the marginal utility derived from additional consumption will eventually decline 3 As you comsume more of something your happiness about it goes down i e hearing your favorite song over and over in the beginning and you enjoy it but after a couple months of hearing it you re sick of it and it no longer makes you happy January 19 2011 Diamond Water Paradox water is more readily available although more essential and is there for cheaper than diamonds which are rare to come by even though they re are not essential to our existence and are therefore more expensive Whatever is less abundant no matter its essentiality to us will always have a higher monetary value i e entertainers get paid more than teachers and nurses Look at chart in notebook Marginal thinking may also be why a stepwise criminal justice punishment system punishment gets worse with level of the crime might be more effective that a capital punishment system death penalty for small crimes There would be no incentive to stop someone from committing horrible crimes because the stakes would be the Cost Benefit Analysis when making a decision one compares the marginal benefits and the marginal costs 1 All actions generating more benefits than costs should be undertaken Benefits Costs 2 No actions generating more costs than benefits should be undertaken Benefits Costs same To be economically efficient Go Stop People will rationally choose to not be fully informed when making decisions i e When buying a new car will do research for the best deal and the best car for you big purchase i e When buying a pencil no research may be undertaken because the cost of the pencil is very small small purchase 4 Voluntary Trade Promotes Economic Progress i e Hot dog guy selling hot dogs voluntary i e Gunman asking for your wallet coercion Coercion Someone will devote resources to make you worse off if you do not comply 4 A Because the value of a good or service is subjective voluntary trade moves goods from people who value them to less people who value them more i e class candy exchange January 24 2011 B Trade makes larger output and consumption levels possible because it allows us to specialize in what we do The Law of Comparative Advantage Individuals economies and nations should produce that which they can best i e spend time doing your occupation How much of what you have or use everyday do you make yourself make at a lower opportunity cost and trade for something else This way you maximize what you have i e Should LeBron James clean his own house although he can probably do it the best and the fastest absolute advantage NO If he does that s time he s not using to do things that will make him a lot of money make commercials practice basketball Who should mow Wage per hour Hours Cost 5 20 5 2 25 40 the lawn Bob Bob s Dad Comparative Advantage T Shirts Wage DJ Pauly D 20 50 Comparative Advantage The Situation 10 24 x 2 48 26 x 2 52 Cheaper for The Situation to do the work than Pauly D if The Situation s wage is less than 25 5 C Voluntary Exchange makes it

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