Economic Logic Assumptions, Rational Behavior, & Incentives

Branches of Economics Microeconomics looks at individual parts of economy: –How households & firms make decisions and interact in specific markets Macroeconomics looks at the entire economy: –Economy-wide phenomena including: inflation, unemployment, interest rates & GDP (economic growth)

Economists make many assumptions to analyze problems –Ceteris paribus: Latin for “All other things being equal” The art in economic analysis is deciding which assumptions to make… The Role of Assumptions Scientist Economist

Important Economic Assumptions: People make decisions based at the margin People are rational People respond to incentives

Marginal Analysis

Selling Airline Tickets Diamonds vs. Water Lesson: A consumer’s willingness to pay for any good is based on the marginal benefit of an extra unit (the last unit sold)

Decision Making Economics assumes people are rational Is this rational? 8 min. Rational Behavior Video

Incentives People respond to incentives: –Taxes encourage less activity –Subsidies encourage more activity Market System Command System

USA vs. Europe Cost of Gasoline USA: $3.70 per gallon England: $8.00 per gallon

Taxes alter the behavior of consumers by providing an incentive or disincentive Taxes per Gallon: USA = $0.50 tax per gallon England = $3.50 tax per gallon Incentives

How does taxing gasoline in Europe change behavior of both consumers and producers? CONSUMERSPRODUCERS

End Result of High Gasoline Taxes Common European Car

Scooters almost as common as cars