Economic Logic Assumptions, Rational Behavior, Cost/Benefit Analysis & Incentives

Important Economic Concepts Economists make many assumptions People make rational decisions People respond to incentives

Economists make assumptions to analyze the real world –If assumptions are incorrect => analysis is often wrong Economics is a social science (not exact), so the result of economic policy is uncertain –we can reach conclusions “holding other factors constant” The Role of Assumptions Scientist Economist

Decision Making Economists assumes people make rational decisions meaning the benefits are greater than the costs Is this rational? Rational Behavior Video Play 8 min.

Incentives People respond to incentives Government uses Taxes or Subsidies to alter behavior encourage consumer to use less encourage consumer to use more

Incentives Matter Reading 2) “The pocketbook is mightier than the conscience” 4) “Perverse Incentive” 3) The law of unintended consequences 1) private property vs. communal property

How would Gov’t ↑ taxes on gasoline $3.00 per gallon change the behavior of both consumers and producers? CONSUMERSPRODUCERS

USA vs. Europe Cost of Gasoline USA: $3.70 per gallon England: $7.25 per gallon Average tax per gallon: USA = $0.50 tax per gallon Europe = $3.50 tax per gallon Gov’t incentives can drastically change behavior Economic Lesson:

End Result of High Gasoline Taxes Common European Car in 2004!

Scooters almost as common as cars Luxury SUV- Paris Smallest Car …..