Adam Smith believed that individuals pursuing their own interests would be directed by the invisible hand of market prices toward the production of those goods that were most advantageous to society Free good something that is limitlessly abundant sunlight dirty air seawater everything else is scarce Resource aka factors of production anything used to produce other goods and services land labor capital entrepreneurship Return to factors of production Land rent Labor wages Capital interest Entrepreneurship profit 3 general categories of resources Profit combining resources to make them more valuable revenue cost 1 Human resources the productive knowledge skill and strength of human beings 2 Physical resources things like tools machines and buildings that enhance our ability to produce goods human made resources aka capital 3 Natural resources things like land mineral deposits oceans and rivers Scarce goods Education Food Clothing Household goods National defense Leisure time Entertainment Clean air Pleasant environment Pleasant working conditions Limited resources Land Natural resources Machines and other human mad physical resources Nonhuman animal resources Human resources Technology Ex government bailed out GM Chrysler when they were making losses If the government didn t bail them out lots of people would have lost jobs We have cronyism do favors for people who can do favors for us Subsidizing loss get more of it We don t have capitalism in the US Scarcity and poverty are not the same Scarcity is objective Poverty is subjective not enough income for a decent level of living Because of scarcity we need a way to ration Government sector political status and ability to manipulate political process are key factors People devote time and resources to lobbying and favor seeking rather than to productive activities First come first served inefficient creates long lines Capitalism price market economy encourages production of goods and services to generate income Communism way from each according to his ability to each according to his need Arbitrary tallest prettiest Chance random lottery Competition encourages discovery and innovation two important sources of growth and higher living standards Opportunity cost the one thing you would do if you weren t doing the other two components time and money The Economic Way of Thinking the opportunity cost 1 The use of scarce resources is costly so decision makers must make trade offs trade off being a Completely subjective people think they know your opportunity cost b When you use resources you re always giving up the opportunity cost to use them in a different way i Ex seat belts on a bus are they worth it Individuals choose purposefully therefore economically they try to get the most from their limited resources 2 3 a Economizing behavior b Utility Incentives matter changes in incentives influence human choices in a predictable way Both monetary and nonmonetary incentives matter a As the option becomes more costly less is chosen b When the payoff derived from a choice increases people are more likely to choose it Ex does FSU want you parking in handicapped spaces How do you know 4 Economic thinking is marginal additional thinking a People make decisions at the margin i Ex The value meal costs 50 cents more its marginal cost but will give you one extra food item the fries its marginal benefit ii Ex ordering dinner one course at a time ordering dessert cost calories 5 Information is a costly good a People will seek to acquire some information but at some point they will decide that the expected benefit derived from gathering still more information is simply not worth the cost b Rational ignorance before you make a decision you do a cost benefit analysis if the cost of something is greater than the benefit of finding it out you remain rationally ignorant 6 Remember the secondary effect a Economic actions often generate indirect as well as direct effects i Ex taxing the number of windows in a home people built houses with less windows 7 The value of a good or service is subjective a Preferences differ between individuals 8 The test of a theory is its ability to predict a The idea is to predict how incentives will affect decision makers and compare the predictions against real world events If the events in the real world are consistent with a theory we say that the theory has predictive value and is therefore valid b Economists usually do not try to predict the behavior of a specific individual instead they focus on the behavior of a large number of individuals Positive and Normative Economics Positive economics doesn t have to be correct just has to be testable objective Scientific economics attempts to determine what is Ex If I eat less exercise more I should lose weight Normative economics opinion subjective What ought to be Can neither be confirmed nor proven false by scientific testing Their validity rests on value judgments Pitfalls to Avoid in Economic Thinking 1 Violation of the ceteris paribus condition can lead one to draw the wrong conclusion a Ex if incomes rise people buy more if incomes double inflation is constant if radio sales stay same the radio sales won t increase because of the increase in technology and decrease in the need want for radios 2 Good intentions do not guarantee good outcomes economists like better results a Ex If they make a law saying children under the age of 2 must be in a seatbelt during flights more people will choose to drive instead of fly because that means they have to buy an extra ticket But since automobile accidents are more common than airplane accidents there has now been an increase in fatalities contradicting the initial intent on reducing the number of fatalities while traveling 3 Association is not causation a Ex Every time it rains I see people with umbrellas Conclusion rain causes umbrellas people having umbrellas doesn t cause it to rain 4 The fallacy of composition what s true for one might not be true for all a Ex To avoid morning traffic I leave earlier for work but that doesn t help me if everyone else decides to leaver earlier as well b Ex Rick Perry We ve done a lot of things right in Texas Elect me and we ll do the same for the US TOOLS OF THE ECONOMIST used to answer 3 questions What do we produce How do we produce it Who gets4 it 1 Opportunity Cost 2 Trade creates value better off a Voluntary exchange when individuals engage in a voluntary exchange both parties are i Trade is a
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