What Seven Principles Guide an Economic Way of Thinking?1-3

What Seven Principles Guide an Economic Way of Thinking?

Money, taxes, banking, and trade are economics, but economics principles apply to much more

Economic way of thinking is thinking about the wider world seeing ordinary events in a new way

Principle 1: Scarcity Forces Tradeoffs

Principle 1: Scarcity Forces Tradeoffs

Desire = unlimited

Resources = scarce

Scarcity causes us to make choices

Tradeoff—when you choose one thing over another

Principle 1: Scarcity Forces Tradeoffs

TINSTAAFL—even accepting a free lunch involves tradeoffs. Someone had to pay.

Principle 1: Scarcity Forces Tradeoffs

All decisions involve tradeoffs Going to a party the night before your midterm

leaves less time for studying Having more money to buy stuff requires

working longer hours, which leave less time for leisure

What should you do next summer? Work at the mall? (money, but boring) Internship? (low/no pay, but valuable experience) Volunteer? (no pay, but help others)

TIME IS SCARCE

Principle 1: Scarcity Forces Tradeoffs

Example:

Say this summer you plan a road trip w/ your bff to follow your favorite band Buy a car

2 cars fit your budget Option 1: Luxury sedan (15 mpg) Option 2: Eco model (+30 mpg)

Principle 2: Cost Versus Benefits

Principle 2: Cost Versus Benefits

How do we decide which alternative to choose?

COST-BENEFIT ANALYSIS Cost: money, time, effort, other sacrifices Benefit: whatever you gain

People choose something when the benefits of doing so are greater than the costs

Principle 2: Cost Versus BenefitsEx) Sleep 1 hr later

Costs

No time for good bfast

No long morning shower

No study time for tests before school

Less time to get dressed

More likely to be late for class

Benefits

Pleasure of sleeping longer

Lower water bill

May do better on test w/ rest

Less time to worry what to wear

Less likely to fall asleep in class

Principle 2: Cost Versus Benefits

Ex) (Road Trip)

Where to sleep? Tent at inexpensive campground? Hotel?

Choice is personal

Do benefits of a shower and bed outweigh the higher cost?

Principle 3: Thinking at the Margin

Principle 3: Thinking at the Margin

Most choices involve thinking in terms of a littler more of this or a little less of that, rather than all or nothing

Ex) study one more hr, buy one more pair of shoes, eat one more slice of pizza, etc

When we add or subtract one more unit we are thinking at the margin

Principle 3: Thinking at the Margin

Marginal cost—what you give up to add one unit of an activity

Marginal benefit—what you gain by adding one more unit

Principle 3: Thinking at the Margin

Ex) You’ve spent 2 hrs studying for a test. Should you study another hour or go to bed? Compare marginal cost and marginal benefit

Ex) (Road trip) Band announces that it is extending its tour to one more city. Is going worth the time and money?

Principle 4: Incentives Matter

Principle 4: Incentives Matter

Costs and benefits act as incentives

https://www.youtube.com/watch?v=W2hhIWbz0Ns

“Incentives are the cornerstone of modern life and understanding them—or often, ferreting them out—is the key to solving just about any riddle, from violent crime to sports cheating to online dating.” Steven D. Levitt and Stephen J. Dubner,

Freakonomics

Principle 4: Incentives Matter

Ex) Why would people stand in line on a city sidewalk in the heat of summer for several hrs just to get a concert ticket?

Principle 4: Incentives Matter

Positive and Negative Incentives Teachers use points/grades to encourage

students to complete assignments Honor societies/awards Jail/fines to discourage breaking laws

Principle 4: Incentives Matter

Ex) (Road Trip)

You are pulled over for driving 65mph in a 50 mph zone. And it’s a construction zone.

Fine = $300

You decide not to speed from now on…

Principle 5: Trade Makes People Better Off

Principle 5: Trade Makes People Better Off

Why doesn’t your family make their own clothes?

Build all your own furniture?

Grow all its own food?

Produce your own medicine?

Principle 5: Trade Makes People Better Off

“It is the maxim of every prudent master of a family never to attempt to make at home what it will cost him more to make than to buy. The taylor [tailor] does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a taylor.” Adam Smith, The Wealth of Nations, 1776

Principle 5: Trade Makes People Better Off

By focusing on what we do well and then trading w/ others, we will end up w/ more and better choices than trying to do everything for ourselves

Principle 5: Trade Makes People Better Off

Ex) (Road Trip)

You have car trouble, and neither you nor your friend is a mechanic. You push the car to the nearest gas station. The mechanic says you have a dead battery. You offer to trade your 2 tickets for that night’s concert for a new battery. The mechanic agrees. You are disappointed about missing the concert, but everyone involved agrees that trading the battery for the tickets make you all better off than you were that morning.

Principle 6: Markets Coordinate Trade

Principle 6: Markets Coordinate Trade

Market—any place buyers and sellers meet (could be an actual place or more intangible like the Internet)

Free Market—market w/ little or no govt interference. Buyers and sellers trade until satisfied Result: an efficient market that serves

everyone’s interest w/out guidance from a person or an institution

Principle 6: Markets Coordinate Trade

Markets usually do better than anyone/anything else at coordinating exchange between buyers and sellers.

Adam Smith used “invisible hand” metaphor

https://www.youtube.com/watch?v=ulyVXa-u4wE

Principle 6: Markets Coordinate Trade

Ex) (Road Trip)

You feel the invisible hand at work when you visit a supermarket—mangos from Mexico, bananas from Belize, Shrimp from Thailand, cheese from France, and salmon from Alaska How does the grocery store manage to stock

itself w/ so many fresh foods from around the world at prices you’re willing to pay?

Answer: markets coordinate trade w/ remarkable efficiency

Principle 7: Future Consequences Count

Principle 7: Future Consequences Count

In general, people are short-sighted concerned w/ immediate costs/benefits

Decisions made today have consequences not only for today but also in the future

Principle 7: Future Consequences Count

“The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences…The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy.” Henry Hazlitt, Economics in One Lesson

Principle 7: Future Consequences Count

Part of thinking like an economist = trying to imagine all the possible consequences of a decision

Principle 7: Future Consequences Count

Ex) 1968—Vermont passed a law that banned roadside billboards and other large signs in order to protect the state’s scenic beauty

Businesses instead built sculptures, including a giant squirrel in red suspenders and a 19-ft high genie

Principle 7: Future Consequences Count

The actions of people and governments always have effects that are not expected, or that are “unintended.”

Principle 7: Future Consequences Count

Ex) (Road Trip)

Some intended consequences, some unintended Short term—found out what it was like to be on

your own, away from family, learned about being independent, handling difficult situations, etc.

Long term—insurance went up from speeding ticket

Student Question

Create a table about the 7 principles of economic thinking

Draw a symbol for each of the seven economic principles

Principle One-sentence summary

Scarcity forces tradeoffs