Prinecomi lectureppt ch01
- 2. Misconception • Economics is the “dismal science” • Thomas Malthus, economist (1798) – Prediction: due to limited resources and population growth, humankind will experience widespread starvation. • Today – Seven billion people • What did Malthus miss? – He did not account for increases in technology and agricultural productivity.
- 3. Purpose of this Course • Main goal of this course: provide you with the tools you need to be able to make your own assessments about the economy – Discover how the world works – Be an informed citizen – How to live your life to the fullest – Understand the stock market – Make better personal finance decisions – Understand social security and health care
- 4. Big Questions 1. What is economics? 2. What are the five foundations of economics?
- 5. What is Economics? • Scarcity – The limited nature of society’s resources – Nothing is infinite in nature—not even air and water! • Economics – The study of how people allocate their limited resources to satisfy their nearly unlimited wants – The study of how people make decisions
- 6. Unlimited Wants? Really? • Which do you prefer? – $10 or $20? – One vehicle or two? – One meal a day or three? – 200 gigabytes of disk space or 400? • Idea: – More is preferred to less. This leads to unlimited wants. We will generally never say “no” to having more. It doesn’t mean we’re “greedy” • Question: – How does this relate to scarcity?
- 7. Microeconomics versus Macroeconomics • Microeconomics – Concerned with decisions of individuals, households, and businesses – What happens to my consumption if I lose my job? – Jim decides to buy a house while the interest rate is low. • Macroeconomics – Looks at the broader economy, including inflation, growth, employment, interest rates, and productivity – What happens to the economy if there is widespread unemployment? – The Federal Reserve decreases interest rates to spur spending and kick start the economy
- 8. Microeconomics versus Macroeconomics • Microeconomics – Individual units that comprise the economy • Examples – Individual choosing to take a job in Florida or California – Couple decides to start a family – Firm choosing to open another factory – Effect of government intervention on a single market
- 9. Microeconomics versus Macroeconomics • Macroeconomics – The study of the broader economy • Examples – Inflation – Economic growth and productivity – Unemployment – Interest rates – Aggregate demand and supply
- 10. Economics in Ferris Bueller • Here is a stereotypical representation of a “boring” economics class. Hopefully, you’ll enjoy this course a little more.
- 11. The Five Foundations of Economics 1. Incentives matter 2. Life is about trade-offs 3. Opportunity costs 4. Marginal thinking 5. Trade creates value
- 12. 1. Incentives Matter • Incentives – Factors that motivate you to act or exert effort – People respond to incentives! – Incentives are everywhere, and financial gain often plays a prominent role • Positive incentives – Tax refund, pay raise, employee of the month award, sticker and a smiley face, extra credit • Negative incentives – Taxes, jail, fees, fines, spankings, getting grounded, getting fired, failing class
- 13. Direct and Indirect Incentives • Direct incentives – Generally easy to recognize – “Do my yard work and I’ll give you $40” – “Get straight A’s and I’ll give you $500” • Indirect incentives (using second example) – Maybe the child now has been given an indirect incentive to cheat! – Another indirect incentive: don’t get involved in extracurricular activities.
- 14. Unintended Consequences • Unintended consequence – An unplanned result (usually negative and unwanted) of an incentive • Example: social safety net – Most agree that we need a safety net for those without employment or low income – However, what if the money from the safety net is higher than he can make at a job? – Indirect incentive to stay on welfare rather than work!
- 15. Unintended Consequences • Imagine you are low-skilled and out of work. 1. You could get a full-time low-wage job and get $400 per week. 2. You could remain on welfare, and get $450 per week and not work. • Which do you choose? – Option #2 is clearly better. More pay and zero work! – It’s not that you’re lazy, you’re just intelligently responding to the indirect incentive given to you! • How to solve this? – Fix programs to eliminate incentives to remain on welfare when work is possible.
- 16. Incentives and Innovation • Patents and copyrights – Incentives to innovate – Why work hard, bear all costs (time and monetary) if someone could just steal your idea for profit? • Result of a strong patent system? – More innovation, since people are rewarded for new popular inventions – Innovation economic growth, higher standards of living – But … those big, greedy pharmaceutical companies!
- 17. 2. Life is About Trade-offs • With scarcity, decisions incur costs • Individual examples – Go to theater: do I watch the action movie or the romantic comedy? – Go to food court: do I eat at Sbarro’s or Fuji Garden? – After high school: do I attend Ohio State or Michigan? – Which president do I vote for?
- 18. Trade-offs and Policy • Governments face trade-offs as well – Spend tax dollars on education or the highway system? – Should we penalize polluting companies? • Gain: cleaner air, better health • Loss: less industry, higher prices in some sectors? – Different cultures may have different values. Often depends on wealth.
- 19. 3. Opportunity Cost • Opportunity Cost – The highest-valued alternative that must be sacrificed in order to get something else – Not all alternatives, just the next best choice • In economics: – The cost of something is what you give up to get it Scarcity Choice Opportunity Cost
- 20. Opportunity Cost • Easy example: go to the mall or the pool? – Opportunity cost of going to the mall: • Lost opportunity to go to the pool – Opportunity cost of going to the pool: • Lost opportunity to go to the mall – Decision-making key: • Minimize opportunity cost by selecting the option that has the largest benefit. Go to whichever you enjoy more, the pool or mall. • Another example – A business makes a profit. That’s great! – However, could it have made MORE profit producing something else? This is the economical way of thinking.
- 21. 4. Marginal Thinking • Economic thinking – Systematically evaluating a course of action – Requires a purposeful evaluation of available opportunities to make the best decision • Marginal thinking – Evaluate whether the benefit of one more unit of something is greater than the cost – Margin examples: one more unit (slice of pizza), one more hour of activity (studying, sleeping)
- 22. Marginal Thinking Example • Suppose you are vacuuming your living room. Will you move the couch and china cabinet to vacuum underneath them? • Marginal benefits – A small additional amount of carpet is cleaned • Marginal costs – Vacuuming now takes more time and effort • Cost-benefit analysis at the margin – Do the action (move furniture) only if the marginal benefits are greater than the marginal costs – Depends on your valuation of the clean room and the time and effort it takes you to move the furniture
- 23. Economics in Seinfeld • Jerry faces personal trade-offs with a woman he is dating. • Think about his marginal cost-benefit analysis
- 24. Is Going to College Worth It? • Let’s examine a college education using opportunity costs and marginal thinking. • We often hear people (especially politicians!) say phrases like the following: – College graduates earn $1 million more in their lifetimes than high school grads. – Everyone should go to college. – College will benefit everyone. – We expect all our nation’s children to go to college.
- 25. Is Going to College Worth It? 2218 Age Yearly Earnings 0 • X = direct costs of college • Y = opportunity cost of not working while in college • Z = college premium; extra money earned. X Y Z A B = College = High school In terms of X, Y, and Z, go to college if: Z > X + Y Go to college if marginal benefits are greater than marginal costs!
- 26. Is Going to College Worth It? • Difficult question: – Are the benefits of college greater than the costs of college for everybody? – Think about this: some may have big direct costs or opportunity costs; others will have a small benefit. • Answer: – If the answer to the previous question is “no,” then not everyone should go to college. – Economists would disagree with such blanket statements as “everyone will benefit from a college education.”
- 27. • Other non-monetary benefits of college – Statistically not as likely to be hit by unemployment during rough economy • 9.7% versus 5.2% for H.S. and Bachelor degree unemployment in 2009 – College-grad jobs may have better hours, better working conditions – Sense of accomplishment – Education leads to positive externalities (benefits to others) Is Going to College Worth It?
- 28. 5. Trade Creates Value • Markets – Bring buyers and sellers together to exchange goods and services • Trade – The voluntary exchange of goods and services between two or more parties – Key word = voluntary – You don’t engage in trade if it makes you worse off; therefore, trade only occurs if both parties feel they gain from the trade!
- 29. Comparative Advantage • Without trade, you would have to produce everything you consume. – You would have to make your own food, clothing, housing, and electronics. – You would have to do all your own services as well (hair-cutting, plumbing, dentistry, education) • Comparative advantage – The situation in which an individual, business, or country can produce at a lower opportunity cost than a competitor – Allows gains from trade to occur
- 30. Trade • Specialization – You go to Starbucks to get coffee. – You go to the doctor when you’re sick. – You don’t have to do everything yourself: people specialize in what they’re best at (lowest opportunity cost) and you can trade with them. • Trade controversies – India or China may have a comparative advantage (relative to USA) in labor-intensive goods. – Result: outsourcing of jobs – What if this causes an American worker to lose his job?
- 31. Conclusion • Misconception: economics is the dismal science. • Economists ask, and answer, big questions about life. This is what makes the study of economics so fascinating. • Understanding how an entire economy operates and functions may seem like a daunting task. It is not nearly as hard as it sounds. • Once you learn a few key principles and practice them, you can learn the basics of economics.
- 32. Conclusion • Economics is the study of how people allocate their limited resources to satisfy nearly unlimited wants. • The five foundations of economics: 1. Incentives 2. Trade-offs 3. Opportunity cost 4. Marginal thinking 5. Trade creates value
- 33. Practice What You Know What can be said about scarcity? A. Scarcity forces us to make choices. B. Scarcity doesn’t affect the super- wealthy. C. Scarcity only affects commodities such as oil. D. Scarcity generally doesn’t affect our day- to-day living.
- 34. Practice What You Know Which of the following situations illustrates an incentive? A. Dave snacks all afternoon and isn’t hungry for dinner. B. Dirk’s children misbehave during dinner. C. Lee gives his children candy if they behave during dinner. D. Jaime goes to a restaurant for dinner.
- 35. Practice What You Know The opportunity cost of buying a good is A. the sum of values of all the other goods you could have purchased. B. the value of the next-best alternative you could have purchased. C. irrelevant since you will purchase your highest-valued good. D. the average of values of all the other goods you could have purchased.
- 36. Practice What You Know With regards to marginal thinking, an individual will do an action if A. the probability of success is greater than 50%. B. the action has positive benefits. C. the costs of the action are small. D. marginal benefits > marginal costs.
- 37. Practice What You Know The governor decides to increase funding for education. However, this will mean decreasing funding for infrastructure. This situation illustrates A. trade-offs. B. comparative advantage. C. incentives. D. markets.
Editor's Notes
- #3: Lecture notes: This “derogatory” term of dismal science was first used by historian and satirical writer Thomas Carlyle in the nineteenth century. He called economics the “dismal science” after he read a prediction from economist Thomas Malthus stating that because our planet had limited resources, continued population growth would lead to widespread starvation. Today, the efficiency of agricultural production has enabled seven billion people to live on this planet. There isn’t widespread starvation either. Economists, like meteorologists, often get a bad rap: when we are right, no one notices; but when we are wrong, people demand answers.
- #4: Lecture notes: And much more! It may sound like a lofty goal, but studying economics can change the way you view and think about things. Sometimes this is referred to as “thinking like an economist.” You’ll be able to do a logical, cost-benefit analysis on just about everything, which helps with decision-making. The textbook also has many media examples, and these PowerPoint slides include them. In addition, the slides have some in-class activities and “beyond the book” notes.
- #6: Lecture notes: “Scarcity” is often considered the most basic concept in economics. If scarcity didn’t exist, we wouldn’t have to study economics at all! You may have to ask the students what “allocate” means. Allocate: to distribute. How do I distribute my income? What do I buy? I can’t buy everything I want. How does the last bullet of making decisions make sense? We’ll talk about opportunity cost in a bit, but for now, you can think of it this way: If I have limited time, money, what do I do with it? I have to make a choice. If a society has limited land, labor, capital, timber, water, oil . . . What do we do with those resources? We have to make a choice!
- #7: “Beyond the Book” Slide Answer to question: Our wants outweigh our ability to produce those wants with our resources at hand. We can’t all freely have everything we want, because we don’t have enough of it to go around. That is the basic essence of scarcity.
- #8: Lecture notes: Broadly, economics can be split into two parts: Micro and Macro. Roughly: Micro = small; Macro = big. The two examples for Micro and Macro may seem similar, but they are different. The Micro examples look at a single person, while the Macro examples look at economy-wide phenomena.
- #11: Economics in the Media Lecture tip: The clip mentioned on the slide can be found in the Interactive Instructor’s Guide. Access the direct link by clicking the icon in the PowerPoint above.
- #12: Lecture notes: The rest of this chapter will discuss each of the five foundations in detail.
- #13: Lecture tips: Instructors: Do you give attendance quizzes? If so, you can ask students why they come to class. Possible answers include getting a good grade, not wanting to fail, wanting to get easy attendance points, etc. If you DIDN’T offer attendance points, maybe your attendance in class would be lower!
- #14: Lecture notes: Direct incentives: “Here is what I want you to do, and here is what I am going to do in order to get you to do it.” Indirect incentives: You can think of an indirect incentive as a secondary change in behavior that was brought about by the original incentive. See the next slide about “unintended consequences.” Maybe the parents are trying to get the kid to study more, but they don’t necessarily want him to quit clubs and sports to do so. They certainly don’t want him cheating either!
- #15: Lecture notes: Society has a direct incentive to alleviate poverty and suffering. Less poverty and suffering = lower crime, better health. However, does a safety net give people an incentive to stay on welfare rather than work? For example, imagine you are low-skilled and out of work: You could get a full-time low-wage job and get $400 per week. You could remain on welfare, and get $450 per week and not work.
- #16: Lecture notes: Possible fixes for the system? Time limits on welfare Negative tax rates for low-income workers (this will incentivize work, not welfare)
- #17: Lecture notes: It’s not that new inventions are always the result of someone looking to get rich. Many times, it’s just people finding a better (or faster or cheaper) way to get things done, or someone making a great new product. However, we want to reward people when this happens. Rewarding innovation is a way to guarantee that innovation will continue to happen in the future. How would you like it if you spent years of your own money, blood, sweat, and tears on a great idea, only to have someone steal your ideas one month after you start selling it? You may never innovate again! Last bullet: It may take a lot of time, effort, and expense to develop new medicines. Sometimes, they have to have over 10,000 people in drug studies. If the drug really works, a company can enjoy a patent on the drug for 20 years before generics are made. Suppose a cure for cancer is finally discovered. Don’t you think we ought to reward the person or company that invented the cure? Or inversely, do you think that a possible monetary reward makes some people work harder to find a cure? The answer to both questions is probably yes.
- #18: Lecture notes: We can’t see both movies in the same night. We can’t go to both universities. We can’t vote for both candidates.
- #19: Lecture notes: In more developed countries, higher standards of living already exist, and the cost of pollution control will not cause the economy’s growth to slow down to unacceptable levels. People in these countries are much less likely to accept more pollution in order to raise the level of income even further. In less developed countries, where income is already very low, people are generally not willing to give up what little income they have in order to have cleaner air and water.
- #20: Lecture notes: Every time we make a choice, we experience an opportunity cost. The key to making the best possible decision is to minimize your opportunity cost by selecting the option that gives you the largest benefit.
- #21: Lecture notes: Profits on a balance sheet are only part of the story, because they only measure how well a business does relative to the bottom line. Accountants cannot measure what might have been better. Suppose that your business had decided against an opportunity to open a new store. A few months later a rival opened a very successful store in the same location you had considered. Your profits were good for the year, but if you had made the investment in the new store, your profits could have been even better. So when economists mention opportunity cost, they are assessing whether or not the alternatives are better than what you are doing, which considers a larger set of possible outcomes.
- #22: Lecture notes: Marginal thinking can be quite challenging, but understanding how to analyze decisions at the margin is essential to becoming a good economist. Think of marginal as examining decisions “one step at a time.” How much benefit will ONE more hour of sleep give me? What do I give up by sleeping one more hour? In other words, what are the costs of sleeping for one more hour?
- #23: Lecture notes: So what’s the answer? Should you move the furniture? Answer: It depends. Different people will have different answers! Perhaps a person with strong preferences for a spotless home will gain a large benefit from knowing that every square inch of the carpet is cleaned. Perhaps you are a strong individual (or have a friend), and the furniture can be moved at a low cost. Or, maybe the carpet is extremely dirty under the furniture, and the benefits of cleaning it would be large. In either of these cases, the decision could be rationally made to move the furniture. On the other side . . . Maybe you don’t care if there is a little dust under the couch. Maybe you don’t have a friend to help easily move the furniture. Maybe the carpet isn’t that dirty under the cabinet, so cleaning it would yield a low benefit. In either of these cases, the cost-benefit marginal analysis will rationally tell you to not move the furniture. The costs are greater than the benefits.
- #24: Economics in the Media Lecture tip: The clip mentioned on the slide can be found in the Interactive Instructor’s Guide. Access the direct link by clicking the icon in the PowerPoint above.
- #25: “Beyond the Book” Slide The first statement is a statistic skewed from selection bias (beyond the scope of this course). The other statements are normative statements (see the next chapter). Ask your students if they’ve heard some of these statements (or something similar).
- #26: “Beyond the Book” Slide Instructors: Emphasize the axis labels. Also, note that we start at age 18 (when we choose college or not). Then, click to draw the red and green lines. Show them that we have person A and person B. Also, we label three AREAs . . . X, Y, and Z. Ask the students: Who went to college (A or B)? Click to reveal that A went to college . . . Why do earnings fall at old age? Perhaps phased retirement, less hours worked. This is true regardless of education level. What does area X stand for? X is the direct costs of going to college. Tuition, textbooks, fees. You have to pay someone to get the education. Click to reveal. What does area Y stand for? Y is the opportunity cost of going to college. This area represents wages you COULD HAVE earned while working for 4–5 years. You can ask your students how many of them are currently working full-time. Chances are, very few of them are. Click to reveal. What does area Z stand for? Z is the benefits of college, or the “college premium.” It is the extra money a college grad earns each year because of his degree. Click to reveal. When should a person go to college? Give a mathematical statement in terms of X, Y, and Z to answer this question! Answer is shown on slide. Click to reveal.
- #27: “Beyond the Book” Slide Should Lebron James or Bill Gates have gone to college? No, they would have given up huge earnings. Not worth it for them. We’re not all superstars like Lebron or Bill Gates, but we all should make this choice; we all need to think of our OWN costs and benefits. Suppose you could take over a crab-fishing boat and earn $96,000 per year. Would you want to give up four years of that income to go to college? Could you earn more than that by doing a different career after college? Or, suppose you took some technical and shop classes in high school and got a job offer to be a welder making $65,000 per year. Does college still sound as appealing? For some people, college will just bring debt and heartache. Other people will greatly benefit, and college is right for them.
- #28: “Beyond the Book” Slide Previously, we just looked at the monetary earning effects of college. Here are other benefits.
- #29: Lecture notes: Markets bring trading partners together and help to create order out of chaos. Markets have grown from infrequent gatherings, where exchange was done by trading goods and services for other goods and services, into more sophisticated systems that use cash, credit, and other financial instruments. Markets don’t have to be a physical place: think Amazon, eBay, and Craigslist. Trade (from the text) Voluntary trade among rational individuals is beneficial to everyone involved. Imagine you are on your way home from class and you want to pick up a gallon of milk. You know that milk will be more expensive at a convenience store than it will be at the grocery store five miles away, but you are in a hurry to study for your economics exam and are willing to pay up to $5 for the convenience of getting it quickly. At the store, you find that the price is $4 and you happily purchase the milk. This ability to buy for less than the price you are willing to pay provides a positive incentive to make the purchase. But what about the seller? If the store owner paid $3 to buy the milk from a supplier, and you are willing to pay the $4 price that he has set in order to make a profit, the store owner has an incentive to sell. This simple voluntary transaction has made both sides better off.
- #30: Lecture notes: By fostering the exchange of goods, trade helps to create additional growth through specialization. Comparative advantage harnesses the power of specialization. As a result, it is possible to be a physician, teacher, or plumber and not worry about how to do everything yourself. The physician becomes proficient at dispensing medical advice, the teacher at helping students, and the plumber at fixing leaks. The physician and teacher call the plumber when they need work on their plumbing. The teacher and plumber see the doctor when they are sick. The physician and the plumber send their children to school to learn from the teacher. This trading of services increases the welfare of everyone in society. Trade creates gains for everyone involved.
- #31: Lecture notes: Some countries have highly developed workforces capable of managing and solving complex processes. Other countries have large pools of relatively unskilled labor. As a result, businesses that need skilled labor gravitate to countries where they can easily find the workers they need. Likewise, firms with production processes that rely on unskilled labor, look for employees in less developed countries. By harnessing the power of increased specialization, global companies and economies are able to increase production and growth.
- #34: Clicker Question Correct answer: A Each choice we make results in an opportunity cost.
- #35: Clicker Question Correct answer: C An incentive is a motivator to get someone to change their behavior. The children are given a positive incentive to behave.
- #36: Clicker Question Correct answer: B We can’t purchase ALL of the goods. Opportunity cost is just the value of the next best thing. Answer “A” is not correct, or else opportunity cost could be infinite!
- #37: Clicker Question Correct answer: D We need to compare the costs and benefits of the action!
- #38: Clicker Question Correct answer: A It also illustrates scarcity, choice, and opportunity cost.