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Economic Guideposts

Economic Guideposts

1. “There is no such thing as a free lunch”. Everything has a cost .

1. “There is no such thing as a free lunch”.

Everything has a cost. The use of resources to produce one good diverts resources from the production of other goods that are also desired.

The next best alternative use of a resource that had to be given up is called the opportunity cost of the option.

Costs balance our desire for more of one good against our desire for alternative goods

Costs balance our desire for more of one good against our desire for alternative goods that could be produced instead.

The consideration of costs channels scarce resources to their most highly valued use. The opportunity cost of your current employment is the dollar amount that your next best employer will pay you. Your current employer must pay you at least equal to your next best alternative or risk losing you to the competing opportunity.

2. Incentives Matter.

As the benefit of an option rises, other things constant, a person will be more likely to choose that option. In contrast as the cost of an option rises, other things constant, a person will be less likely to choose that option. Policy and rule changes alter the incentive structure and therefore change the decisions people make

3. Thinking at the Margin.

Marginal analysis examines additional benefit and additional costs of changing the status quo?

One should continue to undertake an option as long as the marginal benefit of doing so is greater than or equal to the marginal cost of doing so.

Should you work an extra hour? Yes, as long as the marginal benefits are greater/equal than the marginal cost of working.

How would an additional outstanding running back influence the quality of a football team? Adding

How would an additional outstanding running back influence the quality of a football team?

Adding the running back is a marginal change. If the running back position was previously a team weakness, the new player may make a substantial difference. On the other hand, if the team was already strong at this position, the new player may exert little influence on the overall performance of the team.

The overall performance of the team is a total concept, while the change that results from the addition of the new player is a marginal concept. Should the running back be added?

4. The Value of a Good or a Service is Subjective. People have different preferences

4. The Value of a Good or a Service is Subjective.

People have different preferences. Therefore the value of a good or a service is not fixed.

The value depends on several things, including who uses it and under what circumstances.

5. Economic Actions Generate Secondary Effects Secondary Effects may be different from the immediate effects

5. Economic Actions Generate Secondary Effects

Secondary Effects may be different from the immediate effects.

The immediate effects of an aspirin are a bitter taste in one’s mouth. The secondary effect, which is not immediately observable, is relief from a headache.

Drinking a bottle of wine might immediately make one feel a warm, jolly feeling .

Drinking a bottle of wine might immediately make one feel a warm, jolly feeling. The secondary effects are likely to be a sluggish feeling the next day.

Changes in economic policy often alter the incentive structure, which indirectly affects how much people work, earn, invest, and conserve for the future.

The impact of the secondary effect is often observable only after the passage of time, and then only to those who know what to look for in evaluating them.

How could requiring protective child seats for infants on airplanes end up killing more children?

How could requiring protective child seats for infants on airplanes end up killing more children?

The immediate effect of this regulation would be increased safety for children in planes.

The secondary effect is that the requirement to purchase a separate seat for infant’s increases the cost of flying and creates an incentive for some parents to substitute auto travel for plane travel.

Thus the regulation has increased the number of cars on the road. Traveling by car is far more dangerous then flying.

As a result there is an increased level of risk that children will be injured

As a result there is an increased level of risk that children will be injured while traveling.

It is important to examine the incentive structure of any policy to determine if the secondary effects are in line with the intended immediate effects.

If the secondary effects are in contradiction to the immediate goal then the policy is a failure and resources have been wasted.

Efficiency requires that the marginal benefit is greater then the marginal cost. One cannot determine the costs accurately if only immediate effects are examined.

Trade Enhances Value

Value can be created by exchanges that move goods to individuals who value them more.

Transaction costs reduce our ability to produce gains from potential trades.

Transaction costs are the time, effort, and other resources needed to search out, negotiate, and consummate an exchange.

Middlemen are people or businesses who bring buyers and sellers together. For example, a grocery store purchases food from producers and makes it available in a convenient location for consumers to buy.

Middlemen reduce transaction costs and therefore stimulate trade.

Specialization and division of labor increase output for three reasons: Specialization permits individuals to take

Specialization and division of labor increase output for three reasons:

Specialization permits individuals to take advantage of their existing skills.

Specialized workers become more skilled with time.

Division of labor allows for the adoption of mass-production technology.

Market prices will bring the actions of buyers and sellers into harmony. If the quantity

Market prices will bring the actions of buyers and sellers into harmony.

If the quantity buyers want to purchase exceeds the quantity sellers are willing to provide, price will rise.

The higher price will discourage consumption and encourage production of the good or service, bringing the amount demanded and the amount supplied into balance.

Alternatively, if buyers are unwilling to purchase the current output of a goods, inventories will accumulate and there will be downward pressure on price.

In turn, the lower price will encourage consumption and retard production until the amount demanded by consumers is once again in balance with the production of the good.

Private Property and Incentives

Private property is a necessity for trade. One cannot trade what they do no own.

Private property rights include: The right of exclusive use, Legal protection against invaders, The right to transfer to another.

 

Through trade private owners can gain by employing their resources in ways that are beneficial to others.

Because of the ability to sell resources, the private owner has a strong incentive to care for and properly manage their property.

Private property provides accountability for misuse of property by both the resource owner and non-owners.