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4 people respond to incentives incentive something

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4. People Respond to Incentives -Incentive: Something that induces a person to act, i.e. the prospect of reward or punishment. - Rational people respond to incentives. - The Peltzman Effect : A professor, Sam Peltzman, was investigating the desirability of mandatory seatbelt laws. This is proof that people do not naturally react to incentives, because if they did then they wouldn’t of had to pass a mandatory seatbelt law in the first place. - Critical Idea: When you change something, people are going to alter their behavior. Examples: a) When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUV’s. b) When cigarette taxes increase, teen smoking will decrease. 5. Trade Can Make Everyone Better Off *This is the general principle of comparative advantage. - Rather than being self sufficient people can specialize in producing one good or service and exchange it for other goods. - Countries also benefit from trade and specialization: Countries can get a better price by buying goods from abroad. 6. Markets are Usually A Good Way to Organize Economic Activity - Market: A group of buyers and sellers (need not to be in a single location). General Examples: You are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired. or sell the car “as is”. In each of the following scenarios, should you have the transmission repaired? Explain. Blue book values the car at $6500 if the transmission works, $5700 if it doesnt. Benefit of fixing the transmission = ($6500-$5700) = $800 Therefore, it is worthwhile to have the transmission fixed. Blue Book values the care at $6000 if transmission works, $5500 if it doesnt. The benefit of fixing the transmission is only $500 (Determined by $6000-$5500) Therefore, paying the $600 to fix the transmission is not worthwhile. NOTE: The $1000 you previously spent on repairs is irrelevant. What matters is the cost and benefit of the marginal repair (the transmission). The change in incentives from scenario A to scenario B caused your decision to change.
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- “Organize Economic Activity” means determining... a) What goods to produce b) How to produce them c) How much of each to produce d) Who gets them: A question of distribution * One way to answer all of these questions, is in relation to markets. - A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. - Famous insight by Adam Smith in ‘The Wealth of Nations’ (1776): Smith originally identified how market economy’s work, and he discovered that each of these households and firms acts as if it is “led by an invisible hand” that controls things. - The invisible hand works through the price system by: a) The interaction of buyers and sellers determines prices b) Each price reflects the good’s value to buyers and the cost of producing the good.
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