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The Core Principles
Transcript of The Core Principles
Principles of economics I
The core principles
The study of economics makes individuals cognizant of their environment and thus, better decision makers.
Why is the study of economics relevant?
Economics is the scientific study of the way in which humans make choices about production, consumption and wealth when faced with scarce resources.
Is Usain Bolt underpaid?
Why are whales threatened with extinction and not chickens?
Why do prices keep rising?
Should we block cheap imports that destroy local industries?
Why are some countries poor and others rich?
ii. the toolbox
i. The Basics
UWI Mona - 2014/2015 Summer School
FSS SR4: Mon 7-9pm, Wed 5-7pm & Thu 5-7pm
Lecturer: Crystal S. Johnson
Material: OurVLE and all lectures
Recommended Text: "The Undercover Economist"
iii. the economy
1) The Core Principles
2) Production & Consumption Possibilities
3) The Market Model
4) Interfering in the Market
5) Market Failures
Mid-sem. exam - 50%
on parts i. & ii.
6) Inflation: The Market for Money
7) Finance: The Market for Loans
8) External Linkages: The Market for Foreign Exchange
9) Economic Growth
10) Economic Statistics
Final Exam - 50%
on Part iii.
"People respond to incentives"
Most people respond to incentives
What are incentives?
=>Motivation: benefits - cost
"Rational Choice Theory"
Australia, 18th Century: Transport ships
High mortality; 40 typical
From 1793, bonus for live deliveries
Fatalities fell to 1
Egypt: Property Tax
Companies only required to pay tax on the value of finished buildings
"Resources are scarce"
Types of Incentives:
Earnings & Costs
Praise & Criticism
Right & Wrong
Joy & Displeasure
Now, with "
People Respond to Incentives
" in mind, consider:
Why do traffic lights have squeegee squads?
Why is there so much car theft?
Moral Hazard: car owners with theft insurance being less vigilant about where they park.
Why is there so much crime in JA?
With such slim chances, why do people buy lottery tickets?
"A ticket to your dreams!"
What are resources?
=> land, time, money
What do we mean scarce?
=> unlimited uses and wants but limited resources
=> Land: house, farm or factory?
=> Time: lecture, work or play?
=> Money: party, books or save?
scarcity -> Choices
"The cost of the best alternative forgone"
next best thing
you could be doing with a scarce resource.
Everything has an opportunity cost.
Rational individuals will try to minimize their opportunity costs.
By being rational, individuals are maximizing the amount that they can get out of their resources (eg. time, money, effort). This follows from observation: individuals seek to get the most and give up the least.
The Budget Constraint
Spending = Earning
Scarcity at the individual level
"Whatever you do, do it to the best of your ability."
=> Is it possible to do
to the best of your ability?
"Prices reflect relative scarcity"
Prices: How much an individual is willing to give up
Scarcity: The gap between demand and supply.
: A meeting of buyers and sellers
the diamond-water paradox
Water: Necessary, but cheap
Diamonds: Rare, but expensive
water is not scarce
diamonds are scarce
Of note ...
Relative price is what counts
Prices anticipate/lag events
Price movements can be disguised
Price movements are irrepressible
The Coffee Market
the invisible hand
Why is there a waiting list for organ transplants?
> REAL VALUES
"Real values matter"
" Returns eventually diminish"
Returns: The benefits of an activity
Diminish: The benefits are still positive but smaller.
=>Returns increase, but at a decreasing rate.
: The addition to output that results from using one additional unit of an input.
Diminishing returns in production
Law of Diminishing Returns
holding all other factors constant, increments to an input eventually yield a diminishing marginal product
The additional satisfaction that results from consuming one more unit of a commodity.
=> How much ice cream can you
Are there diminishing returns to studying?
How profitable are "all-you-eat" buffets?
diminishing marginal returns in consumption
"Exchange improves welfare"
Exchange: Specializing and trading
Welfare: Makes both parties better off
The ability to produce a commodity at a lower opportunity cost
=>Whatever you are “more better” at doing than someone else
Dr. Meeks hires skilled assistants. Why?
Assistants replace wires
If Dr. Meeks did replacements himself, would he earn more?
Assistants have a comparative advantage in wire replacement.
Comparative Advantage is the basis for specialization, which leads to exchange.
It is applicable to individuals, firms, industries, countries and regions.
CA is the reason for:
Why countries trade
Why professional specializations keep narrowing
Of note ...
Calculating opportunity cost
OC of apples =
To identify who has the lower OC, we compare OC of both goods respectively, across the potential traders: individuals, firms, countries, etc.
Specialization creates a need for exchange and therefore markets.
Trade based on comparative advantage is mutually beneficial.
Trade is advantageous even if one country has the
- is better at producing both goods.
THE CORE PRINCIPLES
People respond to incentives.
Resources are scarce.
Prices reflect relative scarcity.
Real values matter.
Returns eventually diminish.
Exchange improves welfare.
Eg. Why do women stay in school longer than men?
=> Exchange, Scarcity, Price, Incentive
RCT focuses on the determinants of individual choices as aggregate social behavior results from the behavior of individuals, who make individual decisions.
In determining preference, the rational individual is assumed to take account of all available information, probabilities of events and potential costs and benefits. He/she is also assumed to act consistently in choosing the self-determined best choice of action.
by Tim Harford