The Economic Approach Ch 1 Monday May 11 2015 12 30 PM 1 Adam Smith Father of Econ a b 1776 The Wealth of Nations Wealth Not about gold or silver About productivity i ii i c Self interest leads to helping others the best way to increase wealth As a baker I m going to make bread today so I can make a living so people give me money so I can feed my family 2 ECONOMICS the study of how individuals make choices and use scare resources a We all have unlimited wants but limited resources i Wanting to help children with cancer want to help them and give them everything HOWEVER havelimited money and limited time 3 Economics is about a SCARCITY there is less of a good freely available from nature than people would like b c a b If it has a price it s scarce Gold is more scare than silver The higher the price the more scarce i ii iii CHOICES always involve trade offs have opportunity costs RESOURCES ingredients inputs used to produce goods and services i ii iii Human Resources knowledge and skills gained through experience training education Physical capital resources labor machines tools used to make stuff Natural resources 4 Scarcity is not Poverty Poverty i ii iii Scarcity Is subjective We may one day eliminate poverty 2014 FPL 19790 family of 3 i ii iii Is objective Will always be present We have limited resources and unlimited wants 5 Scarcity Necessitates Rationing a RATIONING allocating a limited supply of a good or resource among iii Scarcity b 2014 FPL 19790 family of 3 i ii iii Is objective Will always be present We have limited resources and unlimited wants 5 Scarcity Necessitates Rationing a b c RATIONING allocating a limited supply of a good or resource among people who would like to have more of it Competition for scarce goods always present Method of rationing influences the nature of competition i ii iii Price Government First come first served 8 Guideposts to Economic Thinking 6 The use of scarce resources is costly so decision makers must have trade offs i ii iii No such thing as a free lunch OPPORTUNITY COST what is given up to get something Public elementary school not free 1 2 Admission is 0 Costs are higher taxes less medical care Individuals choose purposefully they try to get the most from their limited resources ECONOMIZING BEHAVIOR choosing the option that offers the greatest benefit at the least possible cost UTILITY the subjectivebenefit of satisfaction a person expects from a choice or course of action 1 I wanted to go for a run today but I didn t feel like I maximized my utility for the day So I cleaned my house instead REVEALED PREFERENCE Actions speak louder than words 2 People behave rationally Rational is not the same as 1 2 3 Ethical Safe Healthy a EX people who ride bikes without helmets their decision to not wear the helmet was a rational decision because they like the wind in their hair it was NOT healthy or safe or ethical but it was rational Incentives matter choice is influenced in a predictable way by changes in incentives i ii iii ALL ECONOMICS IS BASED ON THIS STATEMENT INCENTIVE a threat of a reward or punishment Responses to incentives vary 1 Dogs are more likely to listen to commands when there is a i ii iii iv healthy or safe or ethical but it was rational Incentives matter choice is influenced in a predictable way by changes in incentives Individuals make decision at the margin i ii iii iv i ii iii iv v ALL ECONOMICS IS BASED ON THIS STATEMENT INCENTIVE a threat of a reward or punishment Responses to incentives vary 1 Dogs are more likely to listen to commands when there is a treat reward involved Altering incentives alters peoples behavior 1 The Peltzman Effect 1975 the effect of safety regulations are offset by changes in behavior a b c Studied the idea of how seatbelts save lives realized the seatbelts altered peoples behavior Because people felt more safe with seatbelts in place people drive more recklessly MARGINAL used to describe the effects of a change in the current situation 1 Thinking on the margin driving down Tennessee st changes in speed due to environment cops people amount of traffic marginal additional Decisions aren t all or nothing Diamond water paradox 1 We need water cheap people want diamonds but do NOT need more expensive 2 Total benefit DOES NOT EQUALmarginal benefit Price reflects marginal value 3 Marginal DOES NOT mean average 1 2 AVG Cost Total Cost Total Produced Marginal Cost Additional Cost cost of producing an additional unit of a product a Amount for product 1 Amount for product 2 marginal cost vi Marginal thinking allows us to answering questions like 1 How many times should you visit the buffet vii Marginal cost of the first plate 17 how much paid I get 0 benefit out of the second plate of additional food a b Should you buy that third burger 2 While waiting in line to buy two burgers at 1 00 each and a drink for 1 50 Renegade notices that the restaurant has a value meal containing three burgers and a drink all for 4 25 For Renegade the marginal cost of the third burger would be 1 Two Burgers and a drink vii Should you buy that third burger 2 While waiting in line to buy two burgers at 1 00 each and a drink for 1 50 Renegade notices that the restaurant has a value meal containing three burgers and a drink all for 4 25 For Renegade the marginal cost of the third burger would be 1 Two Burgers and a drink a 1 1 1 50 3 50 2 3 burgers and a drink a 4 25 3 Marginal Cost a 4 25 3 50 0 75 a 2 5 beers 10 2 3 6 Pack a 10 50 Marginal Cost a 10 50 10 0 50 viii Jordin wants to buy some beer She can buy five beers for 2 each or she can purchase a six pack for 10 50 What s the marginal cost of the 6th beer 1 5 Beers Although information can help us make better life choices it is acquisition is costly i ii iii Gathering information isn t free Limited knowledge and uncertainty is common The bigger the decision the more resources you ll use gathering information and Shopping Beware of secondary effects economic actions often generate indirect as well as direct effects i ii Human trials Animal trials SECONDARY EFFECT the indirect impact of an event policy that may not be easily and immediately observable 1 2 Changes in government policy often alter incentives and have unintended consequences 1 EX mortgage lending payday loans 2 Loan sharks can t pay lender car taken Government spending does not create jobs Where does money come from iii iv The value of a good or service is subjective Preferences differ among different people
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