Common Sense Economics What Everyone Should Know About Wealth

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Common Sense EconomicsWhat Everyone Should Know
About Wealth Prosperityby James Gwartney,
Richard Stroup, and Dwight Lee
10 Key Elements of Economics
CommonSenseEconomics.com
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Ten Key Elements of Economics

• Provide an introductory flavor for the course
• Bridge between common sense basic principles of
  economics
• Begin to help you think like an economist
• Provide some explanation as to why our economy
  and our world work the way they do

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Incentives matter.
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What are Incentives?

• Incentives are the costs and benefits of making
  specific decisions.
• Changing incentives alters peoples behavior.
• Incentives operate on all levels- personal,
  familial, industry and societal level.

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Gasoline Prices

• When the price of gas rises, do you change your
  behavior?
• Do you really?
• Whats the difference between short-run changes
  and long-run changes in behavior?

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Volunteerism

• Incentives dont matter only to the greedy and
  selfish.
• What incentives do volunteers have, if not
  monetary?
• Why do you volunteer?

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Seat belts save lives

• Does wearing a seat belt create any incentives?
• Why do people get in more accidents now that cars
  are safer?

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There is no such thing as a free lunch.
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The condition of scarcity

• Our resources are limitedbut our desire for
  goods services is NOT.
• When production costs are high, it is because the
  resource in question is desired for other
  purpose(s) as well.
• A resource is scarce if it has more than one
  valuable use.

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To Choose is to Refuse

• Because we are constantly faced with scarcity, we
  must make choices.
• Every time we choose one thing (material or not)
  we refuse something else.
• We constantly make trade-offs in our decisions.

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But, but, but

• What if someone else buys your lunch?
• Merely a shifting of cost, not an elimination
• And is it really free?

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3. Decisions are made at the margin.
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Marginalism

• Few, if any, decisions are all-or-nothing.
• Marginal means additional
• Marginalism is seldom ignored in our personal
  decisions, but frequently in our conversations
  and in politics.
• To get the most out of our resources, we should
  only take an action when the marginal benefits
  are greater than the marginal costs.

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Marginal Decision Examples

• How clean is your house?
• Do you clean to 100 cleanliness?
• How about when company is coming?
• How about when selling your house?
• You clean to the point where the marginal costs
  outweigh the expected marginal benefits!

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4. Trade promotes economic progress.
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People gain when they trade

• Trade moves goods from people who value them less
  to people who value them more.
• Trade makes larger outputs/consumption possible
  as we specialize.
• Voluntary exchange allows production costs to
  fall through mass production.

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Trade exists at many levels

• Enrolling in this class
• Shopping at Safeway
• Having a garage sale
• Taking a vacation
• Buying imports from China Mexico

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5. Transaction costs are an obstacle to trade.
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Transaction Costs

• Spending resources on
• Searching out trading partners
• Searching out product information
• Negotiating terms of trade
• Closing sales

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Why do we experience transaction costs?

• Physical objects
• Cant get there from here!
• Lack of information
• Finding sellers/ best deals
• Political obstacles
• Taxes, tariffs, licensing requirements,
  regulations, etc.
• Role of middlemen?
• Increase or decrease TC?

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6. Profits direct business toward activities that
increase wealth.
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Why profits are not the enemy

• People of a nation are better off if their
  resources produce valuable goods services.
• Less productive use of resources should thus be
  discouraged.
• This is the function of profits and losses.
• Profit is a reward for transforming resources
  into something of greater value.

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Losses just as important!

• A T-shirt factory has total production costs of
  20,000.
• 1,000 T-shirts sold at 22 each 2,000 in
  profit.
• Wealth has been created for the producer and
  consumer.
• What if shirts can only be sold for 17 each?
• T-shirts are worth less to consumers than the
  resources required to produce them.
• Whats the trade-off if firms continue to operate
  at a loss?

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7. People earn income by helping others.
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Earning Income

• People are different in many waysThis is our
  greatest asset!
• Differences in income arise because they affect
  the value of goods and services individuals are
  willing to provide.
• There is a direct link (ceteris paribus) between
  helping others income.
• If you want a large income- figure out how to
  help others!!!

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Income Variation

• College students are rewarded for studying
• Star athletes and entertainers are rewarded for
  their special skills
• Entrepreneurs are rewarded for their innovations.

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8. Economic progress comes primarily through
trade, investment, better ways of doing things,
and sound economic institutions.
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What is Economic Progress?

• Americans produce and earn THIRTY TIMES as much
  as they did in 1750.
• Why are Americans so much more productive today
  than they were 250 years ago?
• Why is economic progress important?

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Sources of Economic Growth

• Investments in productive assets
• Tools, machines, human capital
• Improvements in technology
• Internal combustion engine, electricity,
  computers, by-pass surgeries, etc.
• Improvements in economic organization
• Legal system, competitive markets, etc.

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9. The invisible hand of market prices directs
buyers and sellers toward activities that promote
the general welfare.
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Invisible What?

• Adam Smith, The Wealth of Nations (1776)
• It is his own advantage, indeed, and not that of
  society which he has in his view. But the study
  of his own advantage naturally, or rather
  necessarily, leads him to prefer that employment
  which is most advantageous to societyHe intends
  only his own gain, and he is in this, as in many
  other cases, led by an invisible hand to promote
  an end which was not part of his intention.

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Friedrich von Hayek

• Primary function of markets is to provide
  information (both to buyers and sellers)
• Consider the price of apples
• Price indicative of what consumers are willing
  and able to pay, but also incorporates costs of
  production/bringing to market
• Things constantly happen to make both consumer
  value production costs vary

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10. Too often long-term consequences, or the
secondary effects, of an action are ignored.
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Unintended Consequences

• Perhaps the most common source of economic error.
• Actions often promote secondary effects.
• Tariffs quotas to protect domestic industries
• Paying for pencils in the 2nd grade class