EFL Lesson 2

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EFL Lesson 2

• Opportunity Cost
• Incentives

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Economic Reasoning Principle 1 People choose,
and individual choices are the source of social
outcomes.
Review

• Scarcity necessitates choices not all of our
  desires can be satisfied. People make these
  choices based on their perceptions of the
  expected costs and benefits of the alternatives.

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President Hugo Chavez has nationalized
(unilaterally stripped away) the Venezuelan oil
holdings of Exxon Mobil Corporation and
ConocoPhillips.
The poverty of some nations and the wealth of
others is not an accident it is the result of
choices.
Result?
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• Economic Freedom
• Rank 148 in world
• Regional Rank 28 of 29
• Poverty Increasing

Since 1998, President Hugo Chávez has pursued a
military buildup, hobbled political opponents
through electoral manipulation, imposed foreign
exchange controls, undermined speech and property
rights, and politicized the state oil company
that dominates the economy. Last year, Chávez
confiscated control from private-sector oil
companies and nationalized the largest
electricity supplier and the biggest telephone
company. . . . These policies hurt the
lower-income groups. Venezuela has one of the
world's highest inflation rates. Price controls
on food, medicines, and basic services discourage
private production and result in shortages.
http//www.heritage.org/research/features/index/co
untry.cfm?idVenezuela20
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ERP-5 Understanding based on knowledge and
evidence imparts value to opinions.

• Opinions matter and are of equal value at the
  ballot box. But on matters of rational
  deliberation the value of an opinion is
  determined by the knowledge and evidence on which
  it is based. Statements of opinion should
  initiate the quest for economic understanding,
  not end it.

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ERP 3 People respond to incentives in
predictable ways.
Review

• Choices are influenced by incentives, the rewards
  that encourage and the punishments that
  discourage actions. When incentives change,
  behavior changes in predictable ways.
• Incentives may be positive or negative.
• Incentives may be monetary or non-monetary.

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ERP 2 Choices impose costs people receive
benefits and incur costs when they make decisions.
NEW

• The cost of a choice is the value of the
  next-best alternative foregone, measurable in
  time or money or some alternative activity given
  up.

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How Do You Know When
Something Is Scarce?

• Scarcity Forces You to
• CHOOSE

SCARCITY CHOICE
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Opportunity Cost the foregone alternative
Think next-best
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Scarcity IS Even in the face of abundance . .
.

• Whats scarce when youre
• in the Mall of America?
• at the all-you-can-eat buffet?

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Opportunity Cost the Next-Best
Alternative

• Identifying Opportunity Cost
• What are the considered alternatives?
• Prioritize the alternatives What is the best
  and what is the next-best?
  
• What would you do not what could you do?
• What does the decision-maker perceive to be the
  benefits of each alternative?
  

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Peoples Choices are always RATIONAL

• Rational choice choosing the alternative that
  has the greatest excess of benefits over costs.
  
• If ALL choices are rational, then the challenge
  is to understand the decision-makers perception
  of costs and benefits.
  

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Opportunity Cost Analysis
What was the 1st decision you made this morning?
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Opportunity Cost Analysis
Decision Maker YOU
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Opportunity Cost Analysis
Decision Maker YOU
More sleep
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Opportunity Cost Analysis
Decision Maker YOU
More sleep
X
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Opportunity Cost Analysis
Decision Maker YOU
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Use the concept of opportunity cost to discuss
the following questions

• Who might choose to get bumped from a flight?
• Should Tiger Woods mow his own lawn?
• What is the cost of attending college?
• for LeBron James?
• for you?

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Characteristics of Cost

• Costs are the results of ACTIONS
• (Remember that people choose, and choices impose
  costs.)
  

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Characteristics of Cost

• Costs are the results of ACTIONS
• Costs are TO people things have no cost
• People choose so people bear costs.
• governments, societies, countries, nations
  dont choose people do.
  
• Dont confuse cost and price

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Characteristics of Cost

• Costs are the results of ACTIONS
• Costs are TO people things have no cost
• All costs lie in the FUTURE
• The future is uncertain. When we choose, we
  anticipate costs, but we dont know for sure
  until the act of deciding is complete.
  
• Cost ? Consequence

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Characteristics of Cost

• Costs are the results of ACTIONS
• Costs are TO people things have no cost
• All costs lie in the FUTURE
• Costs are frequently not monetary (although we
  may value them in dollar terms)
  

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Opportunity Cost of Govt Policies

• Other Government programs that you could have
  done.
  
• What the resources used by government could have
  produced in the private sector.

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Should we ration?
Back to Scarcity Whats the Question? (And what
does opportunity cost have to do with it?)
Given that we MUST ration, what is the best
mechanism?
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Rationing DVDs
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Methods of Rationing Scarce Goods and Services

• prices
• command (someone decides)
• majority rule
• contests
• by force
• voting

• first-come-first-served
• sharing equally
• lottery
• personal characteristics
• need or merit

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Why is price rationing the most common method of
allocating scarce goods, services, and resources
in our economy?

• The outcome is clear
• Individuals can affect the outcome based on their
  desire for the product
  
• It directs resources to their most highly valued
  uses
  
• Individuals power and freedom is enhanced
• It provides incentives for both consumers and
  producers to reduce scarcity.

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Prices POWERFUL Incentives

• When prices change, opportunity costs change
  and thats an incentive!
  
• People react to changes in incentives in
  predictable ways.
  
• Both consumers and producers react to prices in
  ways that help us to deal with scarcity.
  

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Choices are made at the Margin

• Steps in our economic way of thinking
• Scarcity IS
• Because of scarcity people must CHOOSE
• All choices bear COSTS the value of the
  next-best alternative
  
• Very few choices are all or nothing
  choices are made at the margin

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Marginal Analysis Do you want another one?
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Choices are made on the margin

• Margin
• The next one
• A little more or a little less

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Making the Choice

• People will choose to do an activity so long as
  the Marginal Benefit is equal to or greater than
  the Marginal Cost
  
• The Rule
• IF MB MC then DO IT
• IF MB

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The Big Ideas from Lesson 2

• Scarcity forces us to choose and every choice has
  an opportunity cost.
  
• When opportunity costs change, incentives change,
  and choices change.
  
• Because costs lie in the future, the important
  costs and benefits occur at the margin.
  
• Money price rations goods in markets.