Section 1 - Twelve key elements of economics

Section 1 - Twelve key elements of economics - Climbing the...

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Unformatted text preview: Climbing the Economic Mountain! Climbing the Economic Mountain! Section 4 Twelve Key Elements of Practical Personal Finance Section 3 Ten Elements of Clear Thinking About Economic Progress and the Role of Government Section 2 • The Financial Crisis of 2008 • Lessons from the Great Depression • The Seven Major Sources of Economic Progress Supply and Demand • Supply and Demand: Applications and Extensions • Supply and Demand: Basics Section 1 Twelve Key Elements of Economics Section 1 Basic Economic Principles 2 Overview What is Economics? Basic terms and definitions The twelve key elements of economics Four pitfalls to avoid when engaging in sound economic reasoning 3 Is Life Getting Better or Worse? “the first 10 years of this century will very likely go down as the most dispiriting and disillusioning decade Americans have lived through in the post WWII era” – Times Magazine, from article End of the 2000’s: Goodbye to the Decade from Hell 4 Is Life Getting Better or Worse? NBC/Wallstreet Journal Poll: Rate this last decade: Awful: 36% Not Good: 31% Fair: 18% Good: 10% Great: 5% Was this decade the worst in recent history? Is life getting worse? 5 Is Life Getting Better or Worse? What objective measures should we analyze?..... Life Expectancy Health Income Education Entertainment 6 Is Life Getting Better or Worse? 7 Who’s got the better mustache? 8 Is Life Getting Better or Worse? Just look at the changes in…. Our transportation 9 Is Life Getting Better or Worse? Just look at the changes in…. Our technology 10 10 Is Life Getting Better or Worse? our medicine our entertainment 11 11 Is Life Getting Better or Worse? 12 12 The Study of Economics Economics is the science of how individuals make choices under scarcity Science: developing and testing objective theories Individuals: a person or group of people Choice: The act of selecting among alternatives 13 13 The Study of Economics Scarcity: The concept that there is less of something freely available from nature than people would like. ex. time, money, cars, etc. 14 14 Scarcity 1. Scarcity is not the same thing as poverty 15 15 Scarcity 2. Scarcity necessitates rationing a. Rationing – Allocating scarce goods to those who want them. b. In a market economy, price is used to ration goods 16 16 Scarcity 3. Scarcity leads to competitive behavior… …. And competition is good! 17 17 What do we do in the face of scarcity? When will the world run out of oil? 18 18 Resources Resources: An input used to produce an economic good 1. Human resources (human capital) 2. Physical resources (physical capital) 3. Natural resources Capital: Human­made resources used to produce other goods and services. 19 19 Example of Human Capital 20 20 Twelve Key Elements of Economics Using the economic way of thinking, things are not always as they appear: 21 21 #1 Incentives Matter Incentives matter: choice is influenced in a predictable way by changing incentives ex. Killer Seatbelts ex. 5th grade spelling tests ex. Prices 22 22 #1 Incentives Matter 23 23 #1 Incentives Matter This economic principle influences all people Students Politicians Altruists Criminals 24 24 #1 Incentives Matter Individuals are rational: they try to get the most from their limited resources. “greatest benefit at least possible cost” Note: What is rational for one person may notbe rational for everyone 25 25 #1 Incentives Matter Utility: The subjective benefit or satisfaction a person expects from a choice or course of action. 26 26 #2 There is No Such Thing as a Free Lunch Because resources are scarce, trade­offs must be made. Even if it is free to you, it is not free to society! 27 27 #2 There is No Such Thing as a Free Lunch Opportunity Cost: The highest valued alternative that must be sacrificed when choosing an option ex. An hour of your time ex. how you spend your next $15 ex. Airbags vs. AIDS research 28 28 #2 There is No Such Thing as a Free Lunch Opportunity Cost: “With every choice you risk the life you would have had; with every decision, you lose it.” – Richard Bach 29 29 #2 There is No Such Thing as a Free Lunch What is usually the biggest cost of getting your college degree? Foregone Earnings! 30 30 #2 There is No Such Thing as a Free Lunch Failure to understand this principle is one of the biggest mistakes made in economic reasoning. Ex. Government bailout and stimulus package Ex. Some Recycling Programs 31 31 #3 Decisions Are Made at the Margin Marginal: Describes the effect of a change in the current situation. Marginal = Change or Additional ex. Ponderosa Buffet ex. Supersizing your extra value meal ex. Drive or Fly 32 32 #3 Decisions Are Made at the Margin Law of Diminishing Marginal Utility: as consumption increases, the marginal utility derived from additional consumption will eventually decline 33 33 #3 Decisions Are Made at the Margin The Diamond­Water Paradox: Don’t confuse total value with marginal value! 34 34 #3 Decisions Are Made at the Margin This helps us answer questions about our world: 1. Why do top pro­wrestlers and actors typically make more than top nurses and teachers? > 35 35 #3 Decisions Are Made at the Margin 2. Why do people cheat on their spouses? 36 36 #3 Decisions Are Made at the Margin Marginal thinking may also be why a stepwise criminal justice punishment system might be more effective than a capital punishment system 37 37 #3 Decisions Are Made at the Margin *Cost­benefit analysis: when making a decision one compares the marginal benefits and the marginal costs* To be economically efficient: 1. All actions generating more benefits then costs should be undertaken 2. No actions generating more costs then benefits should be undertaken 38 38 #3 Decisions Are Made at the Margin 39 39 #3 Decisions Are Made at the Margin This is why people will rationally choose to not be fully informed when making decisions. ex. New car vs. New pencil 40 40 #4 Voluntary Trade Promotes Economic Progress Voluntary vs. Coerced Coercion: Someone will devote resources to make you worse off if you don’t comply 41 41 #4 Voluntary Trade Promotes Economic Progress A. Because the value of a good or service is subjective, voluntary trade moves goods from people who value them less to people who value them more 42 42 #4 Voluntary Trade Promotes #4 Voluntary Trade Promotes Economic Progress 43 #4 Voluntary Trade Promotes Economic Progress B. Trade makes larger output and consumption levels possible because it allows us to specialize in what we do best How much of what you have or use everyday do you make yourself? 44 44 #4 Voluntary Trade Promotes Economic Progress The Law of Comparative Advantage: individuals, economies, and nations should produce that which they can make at a lower opportunity cost and trade for everything else. ex. Should LeBron James clean his own house? ex. Who should mow the lawn 45 45 #4 Voluntary Trade Promotes Economic Progress C. Voluntary Exchange makes it possible for firms to achieve lower per­unit costs by adopting mass production methods. 46 46 #5 Transaction Costs Are an Obstacle to Trade Transaction Costs: The time, effort, and other resources needed to search out and complete an exchange. 47 47 #5 Transaction Costs Are an Obstacle to Trade Leaves a role for middleman.... Middleman: A person who buys and sells goods or services or arranges trades. A middleman reduces transaction costs. 48 48 #6 Prices bring the choices of buyers and sellers into balance Sellers prefer to sell things for higher prices Buyers prefer to buy things for lower prices Market prices brings these two conflicting forces into balance. 49 49 #7 Profits direct businesses toward activities that increase wealth Profit: An excess of sales revenue relative to the opportunity cost of production. A profit occurs only when the value of the good produced is greater than the value of the resources used for its production. 50 50 #7 Profits direct businesses toward activities that increase wealth Loss: A deficit of sales revenue relative to the opportunity cost of production Losses are penalties imposed on those who produce goods that are valued less than the resources required for their production 51 51 #7 Profits direct businesses toward #7 Profits direct businesses toward activities that increase wealth 52 #7 Profits direct businesses toward activities that increase wealth Are profits a bad thing? Are losses a bad thing? 53 53 #7 Profits direct businesses toward activities that increase wealth 54 54 #7 Profits direct businesses toward activities that increase wealth The economic philosophy of business failure: “The mark of your ignorance is the depth of your belief in injustice and tragedy. What the caterpillar calls the end of the world, the master calls a butterfly” – Richard Bach 55 55 #8 People Earn Income by Helping Others The process by which some people become rich will make everybody richer. Ex. Bill Gates Wrong Right! 56 56 #8 People Earn Income by Helping Others 57 57 #9 Production, Not Just Jobs, Provides the Source of High Living Standards Lets boost the economy! 1. Hole­digging Decree: 2. Window­breaking Bill: 58 58 #9 Production, Not Just Jobs, Provides the Source of High Living Standards 59 59 #9 Production, Not Just Jobs, Provides the Source of High Living Standards Lets boost the economy! 1. Agricultural Adjustment Act (1933) 2. Car Allowance Rebate System (2009) 60 60 #9 Production, Not Just Jobs, Provides the Source of High Living Standards Does stimulus spending really stimulate? 61 61 #10 Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions 1. Investments in productive assets and in the skills of workers enhance our ability to produce goods and services 62 62 #10 Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions However, investment requires us to give up consumption VS. 63 63 #10 Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions 64 64 #10 Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions 2. Improvements in technology spur economic progress. As a student can you do more with: Computer, printer, internet or paper, pencil, and books 65 65 #10 Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions Creative Destruction: The replacement of old products and production methods by innovative new ones that consumers judge to be superior. 66 66 #10 Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions 3. Improvements in economic organization can promote growth Growth comes from a legal system that promotes: Private property rights Competition Personal and economic freedom 67 67 #11 The invisible hand directs people toward activities that promote the general welfare The Invisible Hand Principle: The tendency for people, while pursuing their own interests, to promote the economic well­being of society. Ex. Lines at Walmart 68 68 #11 The invisible hand directs people toward activities that promote the general welfare Prices and market order: 1. Prices communicate information to decision makers 2. Prices coordinate the actions of market participants 3. Prices motivate economic players 69 69 #11 The invisible hand directs people toward activities that promote the general welfare 70 70 #12 Long­term consequences, or the secondary effects, of an action are often ignored A person “…must trace not merely the immediate results but the results in the long run, not merely the primary consequences but the secondary consequences, and not merely the effects on some special group but the effects on everyone” ­ Henry Hazlitt, 1979 Economics in One Lesson 71 71 #12 Long­term consequences, or the secondary effects, of an action are often ignored Secondary effect: the indirect impact of an event or policy that may not be easily and immediately observable. ex. Yacht tax ex. Trade restrictions ex. 1st graders 72 72 4 Pitfalls to avoid in economic thinking Don’t make these mistakes when trying to engage in correct economic thinking 73 73 4 Pitfalls to avoid in economic thinking 1. Violation of ceteris paribus principle ceteris paribus: other things constant ex. Buying Roses 74 74 4 Pitfalls to avoid in economic thinking 2. The belief that good intentions guarantee desirable outcomes ex. Endangered species act ex. Anti­depressant medication 75 75 The Nirvana Fallacy Nirvana Fallacy: The logical error of comparing the actual situation with its idealized counterpart rather than the actual alternative Ex. Child Labor and sweatshops 76 76 The Nirvana Fallacy 77 77 4 Pitfalls to avoid in economic thinking 3. Fallacy of composition: belief that what is true for one might be true for all ex. Standing at a football game 78 78 4 Pitfalls to avoid in economic thinking 4. The belief that association is causation ex. Initials and performance ex. Superstitions 79 79 The Economic Way of Thinking 80 80 Review Know the definition of economics and what is meant by the term scarcity 12 key elements of economics 1. Incentives matter 2. No such thing as a free lunch (opp. cost) 3. Decisions are made at the margin 4. Trade promotes economic progress 5. Transaction costs and middlemen 6. Prices bring the choices of buyers and sellers into balance 7. The economic role of profits and losses 8. Productive activity creates wealth 9. Production, not just jobs, leads to higher living standards 10. Growth comes from investment, technology, and good institutions 11. The invisible hand and the role of prices 12. Secondary effects. 81 81 Review Know the 4 pitfalls to avoid in economic thinking: 1. violation of the ceteris paribus principle 2. The belief that good intentions guarantee good outcomes 3. The fallacy of composition 4. The belief that association = causation 82 82 ...
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This note was uploaded on 04/02/2012 for the course ECON 2000 taught by Professor Joabcorey during the Spring '12 term at Florida State College.

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