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12 Key Elements of Economics

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Kevin Krizan

on 4 September 2018

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Transcript of 12 Key Elements of Economics

Part 1
12 Key Elements of Economics

Element 1. Incentives matter
Incentives are the rewards and penalties associated with choices
. Can be positive (college scholarships) or negative (speeding ticket).

Changes in incentives alter the behavior of people.

Incentives operate on all levels - personal, industrial and societal levels.

Incentives and higher gas prices

Consumers of gas to cut down on driving, car-pool, take mass transit or walk,

Producers of gas to maintain low inventories and increase production

Others to innovate and invent alternative fuels and energy sources (new battery car alternatives)

Incentive Examples
Stop in the hallway?
Mayor Antanas Mockus hiring 400 mimes to stop citizens of Bogota, Columbia from jaywalking
Padlet link:
Element 2:
There is no such thing as a free lunch
Scarcity - resources are limited, but wants are unlimited

Two Principles of Scarcity
(1) People have wants
•We must make choices between our wants and needs
•These are unlimited and constantly changing
•New products, technology, increase or decrease in incomes can all cause changes in wants (and even needs)

(2) Scarcity Affects Everyone
Opportunity Cost
Value of the next-best alternative; The last thing you give up when making a decision

Opportunity Cost is the value (not monetary cost) of the last alternative you gave up

There is no such thing as a free lunch
Element 3:
Decisions are made at the margins
Make choices that generate more
and refrain from actions that are more costly than they are worth
applies to individuals, businesses, government officials and society
What is the marginal benefit and cost of one more hotdog?
Element 4:
Trade Promotes Economic Progress
Maria wishes to buy gasoline and have her car washed. She finds that if she buys 9 gallons of gasoline at $2.50 per gallon, the car wash costs $2, but if she buys 10 gallons of gasoline, the car wash is free. For Maria, the marginal cost of the tenth gallon of gasoline is

a. zero
b. 50 cents
c. $2.00
d. $2.50

Decisions are made at the margin
Consider the following situation:
Answer: b. 50 cents (= $2.50 - $2.00)

How clean is your room?
Do you clean 100% of the dirt away?
How about when someone is coming over?
How about when selling your house?

In each case, you clean to the point where the marginal costs outweigh the expected marginal benefits!

Why do people engage in trade?
Why do you buy things from others rather than producing them yourself?

Would you be better off if you purchased fewer items from others and produced more of what you consume?

Would Americans be better off if we produced more items domestically and purchased fewer from foreigners?

(1) Trade moves goods from people who value them less to people who value them more.

(2) Trade makes larger outputs and higher consumption possible as the result of specialization.

(3) Trade makes larger outputs possible because it facilitates the use of mass production methods.

Sources of Gain From Trade:
Trade promotes economic progress
Going to a car wash
Shopping at a grocery store
Having a garage sale
Taking a vacation
Buying imports from China and Mexico

Trade promotes economic progress
Examples of Trade:
Specialization Example:
Henry Ford - Model T
Element 5:
Transaction costs are an obstacle to trade
Are resources spent on
Searching out trading partners
Searching out product information
Negotiating terms of trade
Closing sales

Why do we experience transaction costs?
Physical objects ~ Can’t get there from here!
Lack of information ~ Finding sellers and best deals
Political obstacles ~ Taxes, tariffs, licensing requirements, regulations, etc.

Does he or she increase or decrease transaction costs?

Transaction costs are an obstacle to trade
What is the role of the middleman (intermediary)?
They reduce the volume of trade and the gains it generates.
Economic progress is helped by relatively low transaction costs.

Why do transaction costs matter?
Usually decrease - could you get your food more efficiently from individual farmers or the grocery store?
Element 6:
Prices bring the choices of buyers and sellers into balance
Both the buyer and the seller, not one or the other, are made better off as the result of any voluntary market exchange.

In a market, there is a buyer and seller.
When a rise in the price of a good or service makes it more expensive for buyers to purchase it, they will normally choose to buy fewer units.
The opposite is true when a price falls.
Thus, there is an inverse relationship between the price of a good and the amount buyers will purchase. This is the law of demand.

Law of Demand
Prices bring the choices of buyers and sellers into balance
Law of Supply
Higher prices will make it more attractive for sellers to provide the good or service.
The opposite is true if prices fall.
Thus, there is a positive relationship between the price of a good or service and the quantity sellers will be willing to supply. This is the law of supply.

Equilibrium occurs at the price where the amount demanded by consumers is just equal to the amount sellers are willing to supply.
In equilibrium, all mutually advantageous exchanges will occur.

Economists often use graphics to illustrate the relationships among price, quantity demanded, and quantity supplied.
Identify equilibrium price and quantity where “X” marks the spot in the graph
Prices bring the choices of buyers and sellers into balance
Search for those opportunities where market conditions are such that they are able to generate revenue sufficient to cover their costs.
Continue to produce a good or service only if consumers value it enough to pay prices sufficient to cover per unit costs.

In a market economy, businesses will:
Element 7:
Profits direct businesses toward activities that increase wealth
People of a nation are better off if their resources produce highly valued goods and services.
Less productive use of resources will be discouraged.
This is the function of profits and losses.

Why profits and losses are our friend…
What is the function of profit and loss in a market economy?
Profit is a reward for transforming resources into something of greater value.
Losses are just as important! They impose discipline on people, businesses and organizations that are not producing valuable goods and services.

Profits direct businesses toward activities that increase wealth
T-Shirt Company
Element 8:
People earn income by helping others
People are different in many ways. We have different specialties or comparative advantages…They are our greatest assets!
Differences in income arise because our differences affect the value of goods and services we help create and supply.
There is a direct link between helping others in ways that they value and the income we earn.
If you want a high income job, figure out how to help others in ways they value!!!

The direct link between providing others with things they value and our personal earnings provides each of us with a strong incentive to develop our talents and skills.
College students are rewarded for improving their knowledge and skills.
Star athletes and entertainers are rewarded for their special skills.
Entrepreneurs are rewarded for their strategic risk-taking.

Element 9:
Production of goods and services people value, not just jobs, provides the source of high living standards.
It is production of value that really matters, not jobs.
If jobs were the key to high incomes, we could easily create as many as we wanted.
All of us could work one day digging holes and the next day filling them up.
We would all be employed, but we would also be exceedingly poor because such jobs would not generate goods and services that people value.

It is not simply more jobs that improve our economic well-being but jobs that produce goods and services people value and are willing to pay for. When that elementary fact is forgotten, people are often misled into acceptance of programs that reduce net wealth rather than create it.

Element 10:
Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions.
Americans produce and earn THIRTY TIMES as much as they did in 1750.

What economic progress?
Investments in productive assets and discovery and development of resources
Tools, machines, “human capital”, minerals
Improvements in technology
Internal combustion engine, electricity, computers, by-pass surgeries, etc.
Improvements in economic organization
Legal system, competitive markets, etc.

Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions.
Sources of Economics Growth:
Element 11:
The “invisible hand” of market prices directs buyers and sellers toward activities that promote the general welfare.
Adam Smith, The Wealth of Nations (1776) claims the following: “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 society…He 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.”
Element 12:
Too often the long-term consequences, or the secondary effects, of an action are ignored.
Why is the failure to consider the unintended secondary effects often a major source of economic error
Policy changes often generate unintended secondary effects.
Consider the following examples.

Intended purpose:
Cheaper rental housing (rent control
Unintended secondary affects: less investment in rental housing, fewer rental units available in the future, decline in the maintenance and quality of rental units, more difficult to find rental housing.

Example 2:
Tariffs and quotas intended to protect domestic industries
Intended purpose: protect struggling industries and their employees negatively impacted by global competition
Unintended consequence: hurt consumers of the taxed or restricted goods, e.g. sugar industry

Example 3:
Paying for pencil stubs in the 2nd grade class
Intended purpose: give students incentive to hold onto their pencils
Unintended consequence: students quickly sharpened their pencils down to the stubs to get the 10 cents.

support (an organization or activity) financially
government giving money to certain groups or people
Sergey Brin and Larry Page
Net Worth - $38,000,000,000 (each)
Jack Dorsey
Net Worth - $27,500,000,000
Bill Gates
Net Worth -
What did these 3 business founders create? Do they add value to your life?

Production Possibilities Curve
Production Possibilities Curve
Production Possibilities Curve
Econ movies - Star Wars - Scarcity
Full transcript