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The Economic Point of View

The Economic Point of View. Glen Whitman Dept. of Economics CSUN. The Economic Model of Pretty Much Everything. Goals. Constraints. Choices. Example: The Consumer. Satisfaction of Preferences. Income, Prices. Buying Decisions. Example: The Firm. Profit Maximization.

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The Economic Point of View

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  1. The Economic Point of View Glen Whitman Dept. of Economics CSUN

  2. The Economic Model ofPretty Much Everything Goals Constraints Choices

  3. Example: The Consumer Satisfaction of Preferences Income, Prices Buying Decisions

  4. Example: The Firm Profit Maximization Technology, Factor Prices, Consumer Demand Prices, Product Characteristics, Store Location, Hours...

  5. The Basic Lesson of All Economics:Incentives Matter • Alter constraints to alter choices. • What you reward, you get more of. • What you punish, you get less of.

  6. Thinking About Incentives • Non-economist: “People are like robots; they follow their programs.” • Lousy economist: “People respond to incentives in foreseeable ways.” • Good economist: “People respond to incentives, often in unforeseeable ways.”

  7. Incentives: Getting It Wrong • Vipers in an Italian town • Socialized healthcare in Canada • The Soviet nail quota • Incentive pay for welders and secretaries

  8. The Soviet Nail Quota “Who needs a nail as big as that?” “Who cares? The important thing is we fulfilled the plan for nails in one fell swoop.”

  9. Incentives: Getting It Right • Think about the goals of those you’re trying to influence. • Check for compatibility between what you want and what you’re rewarding/punishing. • Beware of substitution effects.

  10. Opportunity Cost Preview:Is This a Profitable Business? • You are the sole proprietor and manager of a massage parlor. • Weekly revenue: $7000 • Weekly expenditures: $6200 • What is your profit?

  11. Is This a Profitable Business?continued • You could have worked somewhere else instead of being self-employed. Forgone salary: $1000/week • Accounting profit = $7000 - $6200 = $800/week • Economic profit = $7000 - $6200 - $1000 = -$200/week

  12. Opportunity Cost Preview:Is This a Profitable Investment? • You are given $1,000,000 to manage. • You spend all year managing the money. • By the end of the year, you have gained $60,000. • Was this a wise investment?

  13. Is This a Profitable Investment? continued • You could have had another job. Forgone income: $45,000 • You could have put the money in the bank. Forgone interest (at 5%): $50,000 • Economic Profit = $60,000 - $45,000 - $50,000 = -$35,000

  14. Opportunity Cost • Opportunity cost = the value of the next best opportunity forgone in making a choice • Includes explicit costs: wages, rent payments, etc. • Also includes implicit costs: • forgone income from owner’s time • forgone income from firm-owned assets • forgone interest on capital

  15. The Economic Telecommunications System • A market economy relies on people to use information they don’t have. • Two features of the market make this possible: • The price mechanism • The profit/loss mechanism

  16. The Price Mechanism • Prices are signals of scarcity. • Scarcity: the relationship between how much people want of something and how much there is • Higher prices imply greater scarcity. • People consume less, economize more • Lower prices imply lower scarcity. • People consume more, economize less

  17. The Profit/Loss Mechanism • Above-normal profits in an industry attract entry of more firms. • More resources allocated to this use • Below-normal profits in an industry force the exit of existing firms. • More resources allocated to other uses

  18. The Price-Profit Process • Increased demand for a good/service leads to higher prices. • Higher prices lead to higher profits. • Higher profits attract more firms. • Greater competition drives prices and profits back down. • Net effect: more resources pulled into production of this good/service.

  19. Seeking Profit in a Dynamic Marketplace • Profits are usually transitory: in the long run, they tend to disappear. • But the transition time is crucial. • Various factors can speed up or slow down the transition time, including barriers to entry. • Some of these factors may be under your control.

  20. Summary:Thinking Like an Economist • Always think about the incentives you have and the incentives you create. • Take into account all costs of your choices, not just the explicit ones. • Maintain a dynamic perspective to keep up with the market.

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