GMU Econ Midterm

Economics

The study of human behavior whenever there is choice

Economic Way of Thinking

Applies across people, time, and geographic space

Assumptions of Economics

1. Methodological individualism

2. Purposive, goal-oriented, action

3. Individuals economize by considering costs

   and benefits

Methodological individualism

Economic assumption 1

• The individual is the unit of analysis

• Economics emphasizes that all social phenomena emerge from individuals’ actions and interactions

Cost and benefit analysis

Economic assumption 3

• Individuals seek the desired ends in the least cost way from their perspective

• Does not mean:

  • people never make mistakes

  • people are automatons

  • people are extremely intelligent

Guideposts to economic thinking

1. scarcity

2. competition is ubiquitous

3. opportunity cost

4. marginal analysis

5. incentives matter (utility)

6. seen and unseen (observable and hidden consequences of choices)

7. value of a good/activity is subjective

8. information is costly (no one knows everything = cannot make perfect choices = uncertainty is a fact of life)

Scarcity

There are more human desires than resources for the satisfaction of these desires freely available in nature

Scarcity vs Poverty

• Absence of poverty = some basic level of need has been met

• Absence of scarcity = all desires for goods are fully satisfied

Poverty can be theoretically eliminated — scarcity cannot.

Rationing

How to allocate scarce resources among competing uses in society

• first come, first serve

• lottery

• markets

• government

• violence

Competition

Arises from scarcity, not greed

Having to choose between alternatives creates natural competition

rationing method changes form of competition, but cannot eliminate competition

Opportunity cost

The cost of a choice is the next best alternative foregone

Choosing how to allocate resources is the implication of opportunity cost

Marginal

One additional unit

Marginal benefits

the additional benefit from one more unit of an activity

Marginal cost

the additional cost of one more unit of an activity

Marginal analysis

Individuals engage in an activity when the expected marginal benefit exceeds the expected marginal cost

Individuals refrain from an activity when the expected marginal cost exceeds the expected marginal benefit

Incentives matter

Utility (happiness) is the motivation

Marginal cost increases = marginal benefit decreases = less likely to engage in the activity

Marginal cost decreases = marginal benefit increases = more likely to engage in the activity

Private property

The right to use, control, and obtain benefits from a resource, good, or service

Private property rights

• the right to exclusive use

• legal protection against invaders

• the right to transfer to another

Economists seek to understand current assignment of rights to understand incentives facing relevant actors

Importance of private property rights

• Private owners can gain by using their resources in ways beneficial to others

• Owners have a strong incentive to care for and manage what they own

• They have an incentive to conserve for the future (if valued)

• Owners have an incentive to lower the chance that their property will cause damage to the property of others

• Private property both disperses power and shields us from the coercion of others

Consequences of lacking or poorly defined property rights

• Create problems with resource allocation

• Weaker incentive to conserve and care for resources

  • Tragedy of the commons

• Distorts incentive to produce

  • The free-rider problem

Subsistence production

People produce only enough to survive

No specialization, no trade

Subsistence incentivized by no property rights because it’s risky to produce extra if anyone can steal it

Barter economy

Transition out of subsistence production

Specializing in producing one good (more than they personally need) and trade with others

Barter encouraged by property rights because people can safely trade their surplus

Positive-sum, voluntary trade

• Both parties are better off because each values what they receive more than what they give up (marginal analysis)

• Both parties informed of what they’re receiving

• both parties must own what thyere