The Economic Way of Thinking: Foundational Concepts

Economics

the theory of choice and its unintentional consequences

Methodological Individualism

individuals are units of analysis

• not organizations

ex: google vs. board of directors

Individual’s Aim

choosing to improve their lives

• Before acting, they weigh subjective costs and benefits

Scarcity

Limited resources to satisfy unlimited wants

• Necessitates choices among alternatives, prioritizes goals, and economizes resources

Ex: Money and time

Opportunity Cost

the second highest value use is lost with scarcity

Foundational question

Do the expected benefits outweigh the expected costs?

Institutions

the rules of society, both formal and informal, that shape and constrain human behavior

ex: Laws or HOA agreements vs urinal choices

Private property rights

Exclusive use and transfer rights

• Creates incentives - rewards- for socially beneficial actions

1. Employ resources in ways beneficial to others

2. care for and properly manage what is owned

3. conserve for future, especially if property is expected to increase in value (Tragedy of the Commons)

4. Lower the chance that property will damage other people’s property

Incentives Matter

they’re rewards that affect evaluation of alternative actions

• Many policies fail because they ignore incentives and take good intentions as sufficient for good actions

Welfare Cliff

below to above poverty line →lose benefits and become worse off even though more money

• programs incentivize people to stay in lower income

People are Self-Interested

mix of selfless and selfish values that inform goals

• people are not wholly selfish, “homo economicus”

• assume people are selfish because it accurately predicts public policy results

Day care example

1. social norms are powerful

2. inserting money into situations is risky

3. strength of an incentive matters

People are rational

people act according to their own self interest, and they do what they expect will improve their lives the most

• you cannot superimpose personal values on someone else

Microeconomics

individuals and firms

macroeconomics

economy-wide patterns

• aggregate outcomes

• reflects unintended consequences of many microeconomic decisions

  • all social phenomena, orders, emerge from individuals’ actions