Common Sense Economics What Everyone Should Know About

Common Sense Economics What Everyone Should Know About Wealth & Prosperity by James Gwartney, Richard Stroup, and Dwight Lee Common. Sense. Economics. com 10 Key Elements of Economics Common. Sense. Economics. com 1

Ten Key Elements of Economics n Build a bridge between common sense and economic applications. n Provide a solid foundation in economic reasoning. n Apply common sense to help readers make strategic consumption, savings, investment, career, and voting choices. n Explain why people cooperate in order to help themselves prosper and their nations grow. Common. Sense. Economics. com 2

1. Incentives matter. 10 Key Elements of Economics Common. Sense. Economics. com 3

What Are Incentives? n Incentives are factors that encourage or discourage various types of behaviors, actions or activities. n Changes in incentives alter the way people behave. n Incentives influence behavior at all levelspersonal, familial, business, government, and national. Common. Sense. Economics. com 4

Gasoline Prices… n n When gas prices rise, do you have an incentive to change your behavior? When do you stop talking and start acting? How can you change your behavior in the short -run? How can you alter it in the long-run? Common. Sense. Economics. com 5

Incentives: Producers and Consumers n What is the main incentive of the producer? q n Provide consumers with what they value the most while covering their costs of production and making a profit. What is the incentive of the consumer? q Get the most of what they value from their expenditures. Common. Sense. Economics. com 6

Volunteerism… n Incentives matter to everyone, including volunteers and charitable organizations. n What incentives do volunteers have? Are they only monetary? n Describe some incentives offered to encourage people to volunteer, donate blood and assist Habitat for Humanity in the building of houses. Common. Sense. Economics. com 7

2. There is no such thing as a free lunch. 10 Key Elements of Economics Common. Sense. Economics. com 8

The Condition of Scarcity n Our resources are limited…but our desires for goods and services are NOT. n Something is scarce if it has more than one valuable use. Consider your time. n When resources are used to do one thing, they are unavailable to do others. Common. Sense. Economics. com 9

To Choose Is To Sacrifice n Scarcity forces us to make choices. n Choosing an action means we sacrifice doing something else. n The opportunity cost of a choice is the value of what is given up. Common. Sense. Economics. com 10

There Is No Such Thing As A Free Lunch n n n What if a financial planner offers to buy you lunch? You incur no money cost but you sacrifice time that could have been used to do something else. The value of your next best option is the opportunity cost of going to the “free” lunch. Common. Sense. Economics. com 11

3. Decisions are made at the margin. 10 Key Elements of Economics Common. Sense. Economics. com 12

Marginalism… n n Few, if any, decisions are “all-or-nothing”. Marginal means additional or one more. We are constantly facing marginal choices. To get the most out of our resources, we should only take an action when the additional benefits are greater than the additional costs. Common. Sense. Economics. com 13

Marginal Decision Examples… n How much do you clean your house or room? q q n Do you clean until 100% of the dirt and clutter has been removed when its just you and no company is expected? Do you clean until 100% of the dirt and clutter has been removed when you expect company? You clean as long as the marginal costs are less than the marginal benefits! Common. Sense. Economics. com 14

Apply Marginal Thinking To n n n Weeding an overgrown garden Cleaning up a polluted stream Picking up litter along the highway Eating pizza Eating at an “All You Can Eat” buffet Common. Sense. Economics. com 15

4. Trade promotes economic progress. 10 Key Elements of Economics Common. Sense. Economics. com 16

People Gain When They Trade (Voluntary Exchange) n Moves goods and services from people who value them less to people who value them more. n Makes larger output and consumption possible by allowing us to specialize in doing what we do best. n Makes larger output and lower per-unit costs possible as a result of mass production. Trade leads to larger output and higher income levels. Common. Sense. Economics. com 17

Discuss how trade effects the well being of the trading partners in the following scenarios. n Flea Market n e. Bay n Garage sales n International trade between the U. S. and Mexico Common. Sense. Economics. com 18

5. Transaction costs are an obstacle to trade. 10 Key Elements of Economics Common. Sense. Economics. com 19

Transaction Costs n n Transaction costs: resources spent when making an exchange or transaction. Buyers and sellers spend scarce resources when they q q Search for exchange partners Locate product information Negotiate the terms of trade Finalize and formalize contracts and agreements Common. Sense. Economics. com 20

Why are there transaction costs? n Physical obstacles q n Scarcity of information q n Locate buyers and sellers; assess their reputation; and find best deals Political obstacles q n Movement of goods from sellers to buyers Taxes, tariffs, quotas, licensing requirements, and other regulations Middlemen q q List a few types. Describe how they impact the costs of transacting in a complex world. Common. Sense. Economics. com 21

6. Profits direct business toward activities that increase wealth. 10 Key Elements of Economics Common. Sense. Economics. com 22

Profits: Friend or Foe? n n n People are better off if their resources are directed toward the production of goods and services valued highly relative to costs. Users should be encouraged to undertake productive projects. Profits and losses perform this function. Profits provide rewards to those who transform resources into goods and services that are valued more than costs. Losses impose a penalty on the unproductive use of resources. Common. Sense. Economics. com 23

Losses Are Important! n n n A T-shirt factory has total production cost of $20, 000. 1, 000 T-shirts can be sold at $22 each. This production results in a $2, 000 profit. Consumers value the T-shirts more than the resources required for their production. What if these shirts could be sold for only $17 each? What is the total sale price? Is there loss or a profit? This loss of $3000 indicates that the Tshirts are worth less to consumers than the resources required to produce them. Common. Sense. Economics. com 24

7. People earn income by helping others. 10 Key Elements of Economics Common. Sense. Economics. com 25

Earning Income n n What do you have to do to earn a high income? Explain why you need others to earn a high income? How do you know that others value the services or goods you provide? Explain why high earnings come from providing goods and services that others value. Common. Sense. Economics. com 26

Income Variation n n College students are rewarded for studying. Star athletes and entertainers are rewarded for their specialized skills. Entrepreneurs are rewarded for their productive innovations and risk-taking. Why does Tiger Woods earn more than a nurse? Common. Sense. Economics. com 27

8. Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions. 10 Key Elements of Economics Common. Sense. Economics. com 28

What is Economic Progress? n n n Americans produce and earn THIRTY TIMES more now than colonists did in 1750. What contributed to this economic progress? Why is this progress important? Common. Sense. Economics. com 29

Sources of Economic Growth n Investments in productive assets q n Entrepreneurial discoveries and improvements in technology q n Physical capital (tools, machines, computers, and buildings) and human capital (education, vocational training, and professional development) Cotton gin, assembly line, refrigerators, telephone, polio vaccine, microwave, minicomputer, and artificial heart Improvements in economic organization q Rule of law, even handed enforcement, competitive markets, limited government and money of stable value Common. Sense. Economics. com 30

9. The “invisible hand” of market prices directs buyers and sellers toward activities that promote the general welfare. 10 Key Elements of Economics Common. Sense. Economics. com 31

Invisible What? n n 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 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. ” Common. Sense. Economics. com 32

What Is the Invisible Hand? Through price signals, the primary function of markets is to provide information to buyers and sellers. n The invisible hand of market prices directs millions of self-interested individuals into cooperative action and brings their choices into line with each other. n Friedrich von Hayek Common. Sense. Economics. com 33

Price Signals and the Invisible Hand n By pursuing self-interests in markets, individuals help others and everyone is made better off. n n n Who is made better off when consumers buy MP 3 players? How do consumers indicate how much they value MP 3 players? How do MP 3 manufacturers relate production costs to consumers? Do the MP 3 consumers and producers ever meet to swap information on consumer preferences and production costs? What makes this possible? Common. Sense. Economics. com 34

10. Too often long-term consequences, or the secondary effects, of an action are ignored. 10 Key Elements of Economics Common. Sense. Economics. com 35

Secondary Effects or Long Range Consequences A person “…must trace not merely the immediate results but the results in the long run, not merely the primary consequences but the secondary consequences, and not merely the effects on some special group but the effects on everyone. ” - Henry Hazlitt [1979] Economics in One Lesson Common. Sense. Economics. com 36

Unintended Consequences n Well intended actions have secondary effects that impact others. Discuss the secondary effects of: q q q Rent controls designed to make housing affordable for the poor. Tariffs and quotas designed to protect domestic industries. Government projects designed to increase employment in construction. Common. Sense. Economics. com 37

If policymakers have good intentions Will their actions lead to desirable outcomes? Common. Sense. Economics. com 38