The Seven Principles of Economics

Warm Up: Think Like an Economist If you could choose between two nearly identical products–one that is free and one that you have to pay for–which would you choose? Why? If you were opening a new business, would you select a location closer to or farther away from a business that sold similar or even identical product? Why? If you could make a small change in your daily routine that would save you time and money, would you make the change? Why or why not?

Introduction Economics IS more than just money, taxes, banking, and trade Economists have developed principles that represent a specific way of thinking The number of principles may change depending on the economist, but the overall message is the same

Principle #1: Scarcity Forces Tradeoffs Remember the definition of “Economics” Four Words: What are they? (L R, U W) Scarcity the condition that results because people have limited resources but unlimited wants Must make choices Every choice involves tradeoffs No such thing as a free lunch What choices and tradeoffs do you think about or make? tradeoff: the exchange of one benefit or advantage for another that is thought to be better scarcity-forces-tradeoffs principle: the idea that limited resources force people to make choices and face tradeoffs when they choose no-free-lunch principle: the idea that every choice involves tradeoffs; a restatement of the scarcity-forces-tradeoffs principle

Principle #2: Costs vs. Benefits Principle #1 makes us choose, but how do we decide? Economists assume that people make choices based on estimated costs and benefits Cost v. Benefit analysis Lists Weighted calculations What are the costs v. benefits of sleeping one hour later each day? cost: what is spent in money, effort, or other sacrifices to get something benefit: what is gained from something in terms of money, time, experience, or other improvements costs-versus-benefits principle: the idea that people choose something when the benefits of doing so outweigh the costs cost-benefit analysis: a way to compare the costs of an action with the benefits of that action; if benefits exceed costs, then the action is worth taking

Principle #3: Thinking at the Margin Margin is the border or outer edge “A little more” or “a little less” rather than all or nothing Usually decisions are not a wholesale change Marginal cost: What you give up to add “one unit” to an activity Marginal benefit: What you gain by adding one more unit Example: Studying. Should you study 2 hours for Econ, or 3? margin: the border or outer edge of something thinking-at-the-margin principle: the idea that many decisions involve choices about using or doing a little more or a little less of something rather than making a wholesale change marginal cost: what is given up by adding one more unit to an activity marginal benefit: what is gained by adding one more unit to an activity

Principle #4: Incentives Matter Costs and benefits influence our behavior They are INCENTIVES People respond to them Can be positive or negative What are some examples you can think of? incentive: something that motivates a person to take a particular course of action incentives-matter principle: the idea that people respond to incentives in generally predictable ways

Principle #5: Trade Makes People Better Off Why don’t we all make our own clothes, or grow our own food? Adam Smith: none of us is equally skilled at everything Concentrate on what we do best, and trade for the rest! Examples? trade-makes-people-better-off principle: the idea that people benefit by focusing on what they do well and then trading with others, rather than trying to do everything for themselves

Principle #6: Markets Direct Trade What is a market to you? Economists take a larger view A market is any arrangement that brings buyers and sellers together to do business Can exist anywhere When markets operate freely, both sides will trade until each is satisfied (theory) Result is efficient market Adam Smith: Invisible Hand market: an arrangement that brings buyers and sellers together to do business with each other markets-coordinate-trade principle: the idea that markets are usually the best way to coordinate exchanges between buyers and sellers invisible hand: Adam Smith’s metaphor to explain how an individual’s pursuit of economic self-interest can promote the well-being of society as a whole

Principle #7: Future Consequences Count Do people think long term or short term? Generally shortsighted; they look for immediate benefits and costs Decisions always have long term consequences, though Example: 1968 VT law banned road side billboards; result---people built large sculptures and statues to get attention (19 ft Genie, giant squirrel) Unintended Consequences future-consequences-count principle: the idea that decisions made today have effects in the future law of unintended consequences: the general observation that the actions of people and governments always have effects that are not expected or intended

Conclusion Now you know the principles, it is time to put them into action by analyzing some data on real world situations. But first… http://www.youtube.com/watch?v=VVp8UGjECt4

Conclusion You will now take on the role of economists you will practice analyzing enigmas and applying the principles of economic thinking to explain each enigma in groups. 3 enigmas around the room. Use the handouts provided to complete your group work. EACH STUDENT MUST TURN IN THEIR OWN HANDOUT!