Economics Module 2 Notes Module 2 1 Thinking like an Economist By the end of this module you should be able to 1 Relate incentives to predicted behavior 2 Identify the opportunity costs associated with choices 3 Identify comparative advantage and absolute advantage 4 Calculate total bene ts and total costs using a table where appropriate marginal bene ts and marginal costs using a table where appropriate 5 Apply marginal analysis to determine the optimal quantity using a table or a graph when appropriate Module 2 2 Incentives behavior Incentives bene ts or costs of an action that in uence people s decisions and Stated another way incentives can make people do something they wouldn t otherwise do Working for a desired end goal Ex Your mom telling you if you do your chores you ll get money Incentives are important to economics for two reasons how people respond to them and how they are created and used People tend to respond predictably to incentives but sometimes people respond in unpredictable ways For example People regularly pay more for a good or service than they would have if There are companies that have chosen to pollute even though they faced a Many students choose not to study or complete work even though it harms they had used a coupon ne when they did so their grades In these cases and many others like them the issue is not that these people are immune to incentives rather the incentives were usually not strong enough For incentives to work as expected they must meet two criteria First the incentive must be meaningful to the individual Telling a very wealthy person they can save 75 cents on a box of cereal if they clip a coupon may have less e ect than telling someone who is unemployed and running out of savings Second an incentive must be clearly tied to the behavior Most state and local governments ne people who are caught driving above the speed limit This is supposedly a disincentive to speed The problem is the disincentive the ne has no practical predictable relation to the activity driving fast Most drivers are not ticketed most of the time when they speed so they do not expect a ne or consequence So even though money is meaningful to most people it is not clearly tied to the behavior until after the fact There is no strong connection between speeding and nes Behavioral economics a eld dedicated to studying how people and businesses maximize their satisfaction and the role incentives play Most of the models used in economics operate under the assumption that people make rational choices meaning they weigh their costs and bene ts and make the decision that maximizes their bene t There are also complicating factors at work including choice overload decision fatigue physical and mental stress lifestyle peer pressure etc To try to identify a single incentive that triggers a decision may be impossible in some cases Some behavioral economists have put forth the theory that it is more likely humans are predictably irrational in most cases Module 2 3 Opportunity cost Since resources are limited every time you make a choice about how to use them you are also choosing to decline other options Economists use the term opportunity cost to indicate what must be given up to obtain something that s desired Opportunity cost the loss of potential gain from other alternatives when one alternative is chosen Opportunity cost sacri ce A fundamental principle of economics is that every choice has an opportunity cost For example If you sleep through your economics class the opportunity cost is the If you spend your income on video games the opportunity cost is you If you choose to marry one person you give up the opportunity to marry learning you miss cannot spend it on movies anyone else Since people must choose they inevitably face trade o s in which they have to give up things they desire to get other things they desire more In some cases recognizing the opportunity cost can alter personal behavior Imagine you spend 8 on lunch every day at work but bringing a lunch from home would cost only 3 a day so the opportunity cost of buying lunch at the restaurant is 5 each day Five dollars each day does not seem to be that much but if you project what that adds up to in a year 250 workdays a year 5 per day equals 1 250 it s the cost of a decent vacation Opportunity cost also comes into play with societal decisions Universal health care would be nice but the opportunity cost of such a decision would be less housing environmental protection or national defense These trade o s also arise with government policies For example after the terrorist plane hijackings on September 11 2001 many proposals such as the following were made to improve air travel safety The federal government could provide armed sky marshals who would travel inconspicuously with the rest of the passengers The cost of having a sky marshal on every ight would be roughly 3 billion per year Retro tting all U S planes with reinforced cockpit doors to make it harder for terrorists to take over the plane would have a price tag of 450 million Buying more sophisticated security equipment for airports like three dimensional baggage scanners and cameras linked to face recognition software would cost another 2 billion The single biggest cost of greater airline security doesn t involve money It s the opportunity cost of additional waiting time at the airport According to the United States Department of Transportation more than 800 million passengers took plane trips in the United States in 2012 Say that on average each air passenger spends an extra 30 minutes in the airport per trip Economists commonly place a value on time to convert an opportunity cost in time into a monetary gure Because many air travelers are relatively highly paid businesspeople conservative estimates set the average price of time for air travelers at 20 per hour Accordingly the opportunity cost of delays in airports could be as much as 800 million passengers 0 5 hours 20 hour or 8 billion per year Module 2 4 Comparative Advantage and Absolute Advantage Absolute Advantage The principle of absolute advantage builds a foundation for understanding comparative advantage It is commonly used to compare the economic outputs of di erent countries or individuals Absolute advantage the ability of an individual or group to produce more of a good or service than others with given the same resources To give an example products are di erent The two countries use the exact same