Chapter 1 1

 Identify the critical components of economics and learn how to use the guideposts of economic thinking.  Define opportunity cost. 2

 1776 The Wealth of Nations  Wealth ◦ Not about gold or silver ◦ About productivity  Self-interest leads to helping others! 3 Who’s your daddy?

 The study of how individuals make choices and use scarce resources  We all have unlimited wants but limited resources 4

 Scarcity – there is less of a good freely available from nature than people would like  If it has a price, it’s scarce!  Choices – always involve trade-offs 5

 Resources – ingredients (inputs) used to produce goods and services ◦ Human resources ◦ Physical (capital) resources ◦ Natural resources 6

 Poverty ◦ Is subjective ◦ We may one day eliminate “poverty” ◦ 2014 FPL: $19,790 family of 3  Scarcity ◦ Is objective ◦ Will always be present ◦ We have limited resources and unlimited wants 7

 Life in 1750 ◦ Life is “solitary, poor, nasty, brutish, and short” – Thomas Hobbes ◦ Work 70+ hr/wk to survive ◦ Life expectancy: 37 years  Contrast this with life today 8

 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 ◦ Price ◦ Government ◦ First-come, first-served 9

1. The use of scarce resources is costly, so decision makers must make trade-offs ◦ There’s no such thing as a free lunch ◦ Opportunity cost – what is given up to get something 10

1. The use of scarce resources is costly, so decision makers must make trade-offs ◦ Public elementary school, not free  Admission is $0  Costs are higher taxes, less medical care 11

2. 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 subjective benefit or satisfaction a person expects from a choice or course of action 12

2. Individuals choose purposefully – they try to get the most from their limited resources ◦ People behave rationally ◦ Rational is not the same as  Ethical  Safe  Healthy 13

3. Incentives matter – choice is influenced in a predictable way by changes in incentives ◦ ALL ECONOMICS IS BASED ON THIS STATEMENT! ◦ Incentive – a threat of a reward or punishment ◦ Responses to incentives vary 14

3. Incentives matter – choice is influenced in a predictable way by changes in incentives ◦ Altering incentives alters people’s behavior!  The Peltzman Effect,

4. Individuals make decisions at the margin ◦ Marginal – used to describe the effects of a change in the current situation ◦ “marginal” = “additional” ◦ Decisions aren’t all or nothing 16

4. Individuals make decisions at the margin ◦ Diamond water paradox ◦ Total benefit ≠ marginal benefit 17

4. Individuals make decisions at the margin ◦ Marginal ≠ average ◦ Average cost = total cost / total produced ◦ Marginal cost = cost of producing an additional unit of a product 18

4. Individuals make decisions at the margin ◦ Marginal thinking allows us to answer questions like  How many times should you visit that buffet?  Should you buy that third burger? 19

4. Individuals make decisions at the margin 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…? 20

4. Individuals make decisions at the margin Jordin wants to buy some beer. She can buy five beers for $2 each or she can purchase a six pack for $ What’s the marginal cost of the 6 th beer? 21

5. Although information can help us make better choices, its acquisition is costly ◦ Gathering information isn’t free ◦ Limited knowledge and uncertainty are common ◦ The bigger the decision, the more resources you’ll use gathering information and “shopping” 22

6. Beware of the secondary effects: economic actions often generate indirect as well as direct effects ◦ Secondary effect – the indirect impact of an event or policy that may not be easily and immediately observable 23

6. Beware of the secondary effects: economic actions often generate indirect as well as direct effects ◦ Changes in government policy often alter incentives and have unintended consequences ◦ Example: mortgage lending, payday loans 24

6. Beware of the secondary effects: economic actions often generate indirect as well as direct effects ◦ Government spending does not create jobs! ◦ Where does the money come from? 25

7. The value of a good or service is subjective ◦ Preferences differ among individuals ◦ Circumstances can change value 26

7. The value of a good or service is subjective ◦ Moving goods to those who value them most is a source of economic progress 27

8. The test of a theory is its ability to predict ◦ Scientific thinking – developing a theory from basic principles and testing it against real world events ◦ Average outcomes instead of anecdotal outcomes 28

 Positive Economics ◦ What is ◦ Can be proven true or false  Normative Economics ◦ What ought to be ◦ Cannot be proven true or false 29

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1. Violation of ceteris paribus principle  ceteris paribus: other things constant ◦ When the price of ice cream falls, quantity demanded will rise. Ceteris paribus! ◦ Outcomes change when we dont hold all else constant. 31

2. The belief that good intentions guarantee desirable outcomes 32

3. Thinking association (correlation) is causation 33

4. Fallacy of composition: belief that what is true for one is true for all 34