Unit 1 What is Economics?

Unit 1What is Economics?

Economics • The study of the use of scarce resources that have alternative uses • Two key components of definition: • Scarce resources • Resource – anything used to produce an economic good or service • Not enough resources to do everything we might want to do • Alternative uses • A given resource has multiple uses • Because of scarcity, decisions must be made relating to what those resources are used for, and how much of those resources are used for a given use

Branches of Economics • Microeconomics • Looks at economic decisionmaking by individuals, households, & businesses • Macroeconomics • Focuses on the workings of an economy as a whole

Positive vs. Normative Economics • Positive Economics • Describes how things are • Example: • What impact will increased enrollment, salary increases, and rising maintenance costs have on next year’s school district budget? • Normative Economics • Focuses on how things ought to be done • Example: • What actions should we take now to reduce expenses in order to balance next year’s budget? • Various options are examined, impacts assessed, and actions recommended

7 Principles That Guide an Economic Way of Thinking

Principle #1:Scarcity Forces Tradeoffs • Scarcity – not enough resources to do everything we would want to do • Those resources have alternative uses • When you choose to use a given resource for something, you are unable to use that resource for anything else • Whenever you choose one thing over another, you are making a tradeoff

TANSTAAFL • “There Ain’tNo Such Thing As AFree Lunch” • Every choice someone makes involves tradeoffs, whether they realize it or not • Example: you get a free lunch • Lunch might be free to you. • Someone, however, had to pay for that lunch. • That someone had to give up something (payment for lunch, eating that lunch him/herself, etc.) in order for you to get it for free.

Opportunity Cost • The “value” of the next most likely choice for the use of a resource that is given up when making a choice • This is not the actual dollar value of the choice (if it is a resource that has a dollar value) • That limited resource (money) that has alternative uses will go to one of those alternative uses (saving, other spending, investing, etc.) so the dollar value is irrelevant as far as opportunity cost is concerned

Principle #2:Costs Versus Benefits • The scarcity-forces-tradeoffs principle forces us to make choices • Economists assume that individuals make choices based on expected costs and benefits • Costs: what you spend in time, money, or other sacrifices to get your choice • Benefits: what you gain from something in terms of money, time, experience, or other improvements in your situation • People choose something when the benefits of doing so are greater than the costs

Cost-Benefit Analysis • Comparison of costs and benefits • May be formal or informal • Formal: list out costs and benefits side-by-side (on paper, in spreadsheet, etc.) • Informal: just do mentally • Analysis should lead to calculation of which side outweighs the other • Benefits outweigh the costs = go with choice • Costs outweigh benefits = reject choice

In-Class Activity & Assignment Decision Making: Scarcity, Opportunity Cost, & You

Review

The definition of economics is the study of • how governments set social policy. • the influence of the Federal Reserve on history. • how governments dictate which businesses succeed or fail in a country. • the use of scarce resources that have alternative uses.

You have $20. With that $20, you can either put gas in your car, take a date to the movies, or buy new clothes. You cannot, however, do all three choices. Regardless of which alternative you choose, • you will never have enough money to afford all of your alternatives. • you will be unhappy because you wanted to do all the alternatives. • the economics of the situation do not change. • you are making a tradeoff by not choosing one of the other alternatives.

You have $20. With that $20, you can either put gas in your car, take a date to the movies, or buy new clothes. You cannot, however, do all three choices. Your first choice for the use of the $20 is to put gas in your car. Your second choice is to take a date to the movies. Your third choice is to buy new clothes. The opportunity cost for using the $20 to put gas in your car is • $20. • taking a date to the movies. • buying new clothes. • both taking a date to the movies and buying new clothes.

When evaluating the tradeoffs of making a choice, you • quantify each tradeoff in terms of dollars and cents. • count the number of benefits you get from your choice. • count the number of opportunity costs of making the choice. • evaluate the costs versus the benefits of each possible choice.

After doing a cost-benefit analysis, you generally choose the option in which • the benefits outweigh the costs. • the costs outweigh the benefits. • the costs and benefits are equal. • the dollar value is the best for your budget.

Principle #3:Thinking at the Margin • Most decisions every day are not all-or-nothing • Normally a little more of this or a little less of that • Thinking at margin is deciding to add (or subtract) one more unit to (or from) what we already have

Compare marginal costs and marginal benefits • Marginal cost – what you give up to add one unit to an activity • Marginal benefit – what you gain by adding one more unit • Goal is to maximize utility of choice • Utility • The satisfaction or pleasure one gains from consuming a product or service or from taking an action • A choice that, although may not be all that pleasurable, is likely to improve our lives

Diminishing Marginal Utility • Marginal Utility • The extra satisfaction or benefit you will get from an increase of an additional unit of a good or service • Essentially your perceived difference between the marginal benefit and marginal cost from that additional unit

Law of Diminishing Marginal Utility • As you make use of more additional units of a resource, the additional marginal utility you get for each additional unit becomes less and less • The marginal benefit for each additional unit gets smaller • The marginal cost for each additional unit gets larger • Eventually, the marginal costs start to outweigh the marginal benefit for adding additional units, so you no longer want any more • “You can have too much of a good thing”

In-Class Activity Marginal Analysis

Production Table

How Clean is Clean Enough? Statement 1: Local Lake is a disaster. It was once a beautiful, clean area where you could drink the water safely. Now it is dirty from overuse, soil runoff, and overflow from septic tanks. The County Council should clean the lake completely: 100% clean. The technology and know-how are available. There is no excuse for not doing the job completely. Statement 2: We can clean up most of the pollution in the lake for 1/3 of what it would cost to clean it completely. It may be too costly to clean the lake completely. Resources are scarce. If the County Council overspends for the environment, it can accomplish less in other areas that are important, too.

Review

You have 12 hours available for study (homework, test preparation, work on school project), relaxation (watching TV, spending time on Facebook, etc.), and sleeping between when you get home on a school day and when you must get up for school the next day. When you are considering spending an extra hour studying instead of using that hour for sleep or relaxation, you are illustrating the principle of • thinking at the margin. • opportunity cost. • incentives. • TANSTAAFL.

You have nine shirts. You are considering buying a tenth shirt for $30. You could also save that $30 toward purchasing a new smartphone. The additional satisfaction of having a tenth shirt to choose from when getting dressed is called a(n) • economic service. • marginal cost. • marginal benefit. • incentive.

You have nine shirts. You are considering buying a tenth shirt for $30. You could also save that $30 toward purchasing a new smartphone. Having $30 less to purchase that new smartphone is called a(n): • economic service. • marginal cost. • marginal benefit. • incentive.

You only have one pair of shoes that you can wear, and you decide you need more shoes. As you continue to buy additional pairs of shoes, the amount of additional satisfaction you get from owning each additional pair of shoes is less than when you got the previous pair. t the same time, the cost of what you are giving up by getting each additional pair of shoes (can't afford gas, can't go out to eat, can't go to the game, etc.) continues to go up until you feel the cost of buying each additional pair of shoes is not worth the benefit of getting that additional pair. This illustrates the economic concept of • opportunity cost. • incentives. • diminishing marginal utility. • tradeoffs.

Principle #4:Incentives Matter • Incentive – something that motivates a person to take a particular course or action • People respond to incentives in generally predictable ways • Incentives can be both positive (rewards/benefits) and negative (punishments/costs) • Negative incentives sometimes called disincentives

In-Class Activity Why People Trade

Principle #5:Trade Makes People Better Off • None of us is equally skilled at doing everything • It makes more sense to concentrate on what we do best and trade with others for what they do best • End up with more and better choices than by trying to do everything for ourselves

Principle #6:Markets Coordinate Trade • Market – any arrangement that brings together buyers & sellers to do business with each other • Single place (store, flea market, etc.) • Cyberspace (online store, online auction site, etc.)

When markets operate freely or with limited government interference, buyers & sellers can trade with each other until both are satisfied with their sales & purchases • Result is efficient market that serves everyone’s interests without guidance from a person or institution • Markets usually do better than anyone or anything else at coordinating exchanges between buyers & sellers

Principle #7:Future Consequences Count • Decisions made today have consequences not only for today but also for the future • Many only look at immediate costs & benefits • Must also consider long-term effects • Law of Unintended Consequences • Actions of people and governments always have effects that are not expected • Economists spend much of their time trying to predict these unintended consequences

When considering an action, cannot simply focus on the intent of that action • Must look at the incentives (or disincentives) that action creates • The unintended consequences that result from the incentives (or disincentives) created by that action could greatly outweigh the intended benefits of the action

Review

Which of the following does not illustrate an incentive? • You will have to pay a $75 pay-to-participate fee if you want to be on one of your school's teams. • You will get extra credit toward your grade if you maintain an organized notebook for your class. • You will be able to save $100 on a new smartphone if you buy it this weekend instead of waiting until next month. • You will be more popular with people whose opinion you care about (friends, possible dates, etc.) if you wear a certain brand of clothing.

Why are incentives important? • Economists need to factor out incentives when analyzing economic data. • People don't like incentives so they must be avoided. • Incentives can save businesses a lot of money. • People respond to incentives in generally predictable ways.

Unit 1 What is Economics?