1. Lesson 2: Opportunity Cost & Incentives

2. Joke Of The Day
An economist and an accountant are walking along a large pond and see a frog jumping on the mud. The economist says: "If you eat the frog I'll give you $20,000!" The accountant checks his budget and figures out he's better off eating it, so he does and collects money. Continuing along they see another frog.
The accountant says: "Now, if you eat this frog I'll give you $20,000." After evaluating the proposal the economist eats the frog and gets the money.

3. Joke Of The Day They go on. The accountant starts thinking:
"Listen, we both have the same amount of money we had before, but we both ate frogs.
I don't see us being better off." The economist says:

4. Joke Of The Day
"Well, that's true, but you overlooked the fact that we've just been involved in $40,000 of trade."

5. True or
False?

7. Economic Reasoning Principle #1: People choose, and individual choices are the source of social outcomes.
Scarcity necessitates choices: not all of our desires can be satisfied. People make choices based on their perceptions of the expected costs and benefits of the alternatives.

8. Economic Reasoning Principle # 2: Choices impose costs
Economic Reasoning Principle # 2: Choices impose costs. People receive benefits as they make decisions, but they also incur costs.
The cost of a choice is the value of the next best alternative foregone, measurable in time, money or some alternative value.
What did you give up to be here?
Should you go to college?

9. choices → TRADE-OFFS → forgone alternatives
OPPORTUNITY COST!
choosing is REFUSING!
the cost of something is what you give up

10. Economic Reasoning Principle # 3: People respond to incentives in predictable ways.
Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives are altered, behavior changes in predictable ways.
People do what makes them better off
Marginal Benefit > Marginal Cost (MB > MC)

11. Choices & Opportunity Cost
Decisions require comparing costs and benefits of alternatives
Whether to go to college or to work
Whether to study or go out on a date
Whether to go to class or sleep in
The opportunity cost of an item is what you give up to obtain that item 10

12. Choices & Opportunity Cost
Should Jordan Spieth or Novak Djokovic do their own yard-work, house-work?
What else could they do?
What about me? 10

13. Choices & Opportunity Cost
What is the cost of attending college?
LeBron James, Kobe Bryant, Dwight Howard
Jackie Chan
You
What is given up? 10

14. More Examples A free Dave Matthews concert
Getting bumped from a flight
Why attend college right after high school?
Another Rolo, a second washing machine
More oranges
More automobiles
More buildings
More roads
More Examples

15. More Examples Auto industry bailout Financial industry bailout
Afghanistan/Iraq wars
BP oil spill
Bush era tax cuts
The war on terror
Health care for all
College for all
More Examples

16. There are only trade-offs and OPPORTUNITY COSTS
Policy Conundrum
There are no solutions.
There are only trade-offs and OPPORTUNITY COSTS

17. Should We Ration? (Scarcity)
Given that we MUST ration, what is the best mechanism? Let’s do an activity!

18. Rationing Scarce Goods
How much do you like it?
Rank how much you value the item.
1 to 10
10 = TOTALLY AWESOME :>)
1 = PATHETIC :<(

19. Scarcity & Rationing How much do you like it? Rank from 1 to 10 $10
Rationing STUFF!
How much do you like it?
Rank from 1 to 10
$10
Gift
Card

20. Scarcity & Rationing How much do you like it? Rank from 1 to 10
Rationing STUFF!
How much do you like it?
Rank from 1 to 10

21. Scarcity & Rationing How much do you like it? Rank from 1 to 10
Rationing STUFF!
How much do you like it?
Rank from 1 to 10

22. How could we improve this outcome?
Methods of Allocation
Given the method of allocation just used to ration the STUFF…
How could we improve this outcome?

23. Voluntary Trade Creates Wealth!
Methods of Allocation
Allow Trade
Set up a market
Voluntary Trade Creates Wealth!

24. Rationing STUFF!
Do you want to trade?

25. Rationing STUFF!
Do you want to trade?

26. Rationing STUFF!
Do you want to trade?

27. Rationing STUFF!
Do you want to trade?

28. Rationing STUFF!
Do you want to trade?
$10
Gift
Card

29. Rationing STUFF!
Do you want to trade?
$10
Gift
Card

30. Methods of Allocation Lottery Contest Arbitrary criteria Force
Share equally
First-come, first serve
Need
Merit
Market Transactions (exchange/prices)

31. Markets Typically Do A Good Job Of Rationing
Goods go to those with the highest value.
Goods are produced by those with the lowest opportunity cost.
Voluntary trade increases well-being.
It makes people better off!
What do markets look like?

32. What is a Market? Buyers Sellers specific product information
property rights
competition
voluntary trades
well-being

35. Markets: Circular Flow
Households
Develop resources to their fullest potential and offer them for sale in factor markets.
Earn income from sale of resources and purchase goods & services to maximize well-being (utility).
Firms
Employ resources in their most useful capacity to produce goods and services.
Sell goods and services to maximize well-being (profit).

36. How Do Markets Work?
Buyers and sellers each perform cost/benefit analysis
Price is a measure of relative scarcity
Price represents opportunity cost
Price sends signals/incentives to players
Buyers
Sellers

37. Markets: Supply & Demand
D = MB = WTP (value)
Diminishing marginal benefit
Rolos, washing machine
S = MC = WTS (opportunity cost)
Rising marginal cost
wheat/oranges

38. Big Ideas choices → TRADE-OFFS → forgone alternatives
OPPORTUNITY COST!
choosing is REFUSING!
the cost of something is what you give up.

39. Big Ideas People do things that make them better off
People respond to incentives in predictable ways
The rules of the game (institutions) shape how decisions are made
Decisions determine outcomes

40. Big Ideas Voluntary trade creates well-being
Markets do a good job of allocating scarce resources to meet society’s many competing wants/desires

42. There are only trade-offs and OPPORTUNITY COSTS
Policy Conundrum
There are no solutions.
There are only trade-offs and OPPORTUNITY COSTS

43. Fire Department Auction