What is Economics? Lesson 3: The Ideas
Chocolate, Vanilla, or Strawberry When a woman working for a consumer polling firm asked three shoppers about their favorite ice cream flavors, two said they prefer chocolate to vanilla and two said they prefer vanilla to strawberry. After answering the woman's questions, the shoppers were treated to a free serving of ice cream, but they could choose between only two flavors: chocolate and strawberry. To the woman's surprise, two of the shoppers picked strawberry. Had they lied to the woman about their preferences?
Neapolitan! Not necessarily. The shoppers could have ranked the flavors this way: One prefers chocolate to vanilla and vanilla to strawberry. One prefers vanilla to strawberry and strawberry to chocolate. One prefers strawberry to chocolate and chocolate to vanilla. While two of the shoppers prefer chocolate to vanilla and two prefer vanilla to strawberry, it's also true that two prefer strawberry to chocolate.
Readings and Assignments • Economic Reasoning Intro to 1 • Junior Achievement Chapter 1 • “Barstool Economics” • “Heidi’s Bar” • “Death by Bureaucrats” • “Something for Nothing” • “The Individual in Society” • Lessons for the Young Economist, 1
The Economics of Real People Economics deals with the real actions of real men. Its [laws] refer neither to ideal nor to perfect men, neither to the phantom of a fabulous economic man (homo oeconomicus) nor to the statistical notion of an average man. . . . Man with all his weaknesses and limitations, every man as he lives and acts, is the subject matter of [economics]. —Ludwig von Mises, Human Action
Praxeology Study of human action. Etymologically defined as "the science of human action"
Fundamentals of Human Action • Purposeful Human (Individual) actions • Teleological (Intentional), and end in view • Exchanges, economizing • More satisfactory state of affairs • Scales of value, opportunity costs • ORDINAL • Time, production takes time* • Before • During • After
Means • General conditions • Time • Production • Working time • Maturing time • Entrepreneurship • Goods • Consumers’ goods (1st order) • Producers’ goods (higher order) • Land • Labor • Capital
Economics • The study of the conscious, purposive actions of individuals, seeking to relieve some "felt uneasiness" and thus to accomplish the most urgent goal on his or her personal scale of subjective values. • Individuals are able to act to attain various goals because of the nature of our "ordered universe."
Principles that underlie the interaction of individual choices • There are gains from trade. • Markets move (tend) toward equilibrium. • Resources should be used as efficiently as possible to achieve society’s goals. • Free markets lead to more efficiency. • When markets don’t achieve efficiency, government intervention is seen by many to improve society’s welfare, which leads to more regulations, ad infinitum.
Making Choices: The Rules • When making choices, people ALWAYS chose the option that will make them better off. • This is called Self Interest. • This is subjective • People will make a choice if, and only if, the expected benefits of the choice are greater than the expected costs. • This is called Rational Decision Making. • These are perceived benefits versus Costs. • Don’t judge!!
Choice • Because the world is characterized by scarcity, we are forced to make choices. • We must allocate scarce resources among competing uses. • Wood that is used for tables cannot be used for crutches. • Land that is kept undeveloped cannot be used to build housing for the poor.
What is the Study of Economics really about? • Economics can be defined as the study of exchanges • Robinson Crusoe? • Scarcity • The Economic Problem • Tradeoffs • Economizing
Scarcity, Goods and Bads • An item that costs something is called scarce. • Anything with a price on it is called an economic good—these include goods and services. • A free good is a good for which there is no scarcity. • An economic bad is anything you want to get rid of (pollution, disease, garbage)
Clarifying Concepts • Scarcity means that not enough is available for free. • A shortage occurs when not enough is available at the current price. A shortage is a problem of price. • Poverty occurs when the goods are scarce, and those who need them do not have the income to obtain them. Poverty is a problem of income.
Lets Play a Game • Round 1 • You give me $0.05 and I will give you $0.50 • Round 2 • You give me $0.05 and I will give you $0.25 • Round 3 • You give me $0.05 and I will give you $0.10 • Round 4 • You give me $0.05 and I will give you $0.05 • Round 5 • You give me $0.05 and I will give you $0.01
Let’s Play a Game • Do 20 Push-ups and I will pay you $0.25. • Do another 20. • Do another 20. • Do another 20. • Do another 20. • Do another 20. • Do another 20. • Do another 20. • Do another 20.
A Little More or a Little Less • Most choices focus on choosing a little more or a little less of something. • Consider your choices when you ate breakfast. • More fruit – Less fruit? • One juice or two? • When we make choices based on a little more or a little less, we call it Marginal Decision Making
Choices are Made at the MARGIN……More Pop? Source: The Onion __________ Costs?
Making the Choice • People will choose to do an activity so long as the Marginal Benefit is equal to or greater than the Marginal Cost: • The Rules • IF MB ≥ MC then DO IT • IF MB < MC then DO LESS
But be careful • Not all alternatives • We all prioritize • “Put in order”
Characteristics of Cost Costs are the results of ACTIONS Costs are to people; things have no cost People choose – so people bear costs. “Governments,” “societies,” countries, nations don’t choose People do. Don’t confuse cost and price
Characteristics of Cost Costs are the results of ACTIONS Costs are TO people; things have no cost All costs lie in the FUTURE The future is uncertain. When we choose, we anticipate costs, but we don’t know for sure until the act of deciding is complete. Cost ≠ Consequence (Getting a speeding ticket!!)
Rational Self-Interest Economists believe that people choose options that give them the greatest satisfaction. This means that people: use all available time and information, weigh the costs and benefits of all available alternatives, and choose the alternative that they believe will bring them the most benefit at the lowest cost. This is the alternative that they believe will bring them the most satisfaction. This does not mean that people are innately selfish. Self-interest is not greed.
TANSTAAFL • Since the world is characterized by scarcity we are forced to make choices. • Since we are forced to make choices we face costs.
Sunk Cost Fallacy • Don’t think about costs already spent. • Remember all costs are future. • Sitting through a boring movie? • Nickel and diming for a junker?
Opportunity Cost Analysis What was the 1st decision you made this morning?
Opportunity Cost Analysis Decision Maker: YOU
Opportunity Cost Analysis Decision Maker: YOU More sleep
Opportunity Cost Analysis Decision Maker: YOU More sleep X
Opportunity Cost Analysis Decision Maker: YOU
More Examples • Ask me about……. • Driving to NY to see the Yankees • Free Neil Young concert • Cuban cigars • Burundi Coffee • Being here
Goods to Produce Goods • Resources are the elements needed to produce goods. Resources are also called • factors of production • inputs • They are: • Land(includes natural resources) • Labor(physical and intellectual services of people) • Capital(plant, machinery, equipment used in production) • Entrepreneurs
Resources in Production land Producers of Goods Resource Suppliers rent labor wages capital interest entrepreneur Wages/profit (loss)/Pure interest
Marginal Opportunity Cost • The Production Possibilities Curve (PPF) illustrates the concept of opportunity cost. Each point on the PPF means that every other point is a forgone opportunity. • The PPF bows outward because there are ever-increasing marginal opportunity costs to the production of any good.
% of resources % of resources devoted to devoted to production production Pounds Number of guns of butter of butter Row of guns 0 0 100 15 A 20 4 80 14 B 40 7 60 12 C 60 9 40 9 D 80 1 1 20 5 E 100 12 0 0 F A Production Possibilities Table
Y 10 If the slope of the production curve is -2 at A, the opportunity cost of 1X is 2Y. 9 8 A 2Y 7 . 6 5 1X 4 3 2 1 0 1 2 3 4 5 6 7 8 9 X A Production Possibility Frontier for a Society
1 pound of butter 2 pounds of butter 5 pounds of butter 4 guns 3 guns 1 gun A Production Possibilities Frontier (PPF) A 15 B 14 C 12 D 9 Butter E 5 F 4 7 9 11 12 0 Guns
Specialization • Economic agents (individuals, firms, nations) will be better off if they choose to produce those things for which they have the lowest opportunity costs, and trade for those with higher costs. • Agents do this because such choices involve giving up the least amount of other things.
A Production Possibility Curve for a Society • Comparative advantage explains why opportunity costs increase as the consumption of a good increases. • Some resources are better suited for the production of some goods than to the production of other goods.
Specialization & Trade • Comparative Advantage: the ability to produce a good or service at a lower opportunity cost than someone else. • Law of Association: • proposition that the joint output of trading partners will be greatest when each good is produced by the low opportunity cost producer.
Determining ComparativeAdvantage (Output Method) • 1. Which nation has an absolute advantage in producing CDs? • 2. Which nation has an absolute advantage in producing beef? • 3. Which nation has a comparative advantage in producing CDs? • 4. Which nation has a comparative advantage in producing beef? • 5. Should Japan specialize in CDs or beef? • 6. Should Canada specialize in CDs or beef?
This increase in output is due to specialization: Each person specializes in the task that he or she is good at performing. Leads to greater efficiency! Follow your bliss!