Economics: Incentives, Markets, and Key Concepts (Lecture Notes)
Incentives: Something that encourages a person or organization to achieve something or do it.
Economists believe that people and businesses act on incentives (rewards and punishments);
Most decisions are influenced by costs vs. benefits.
Example: A robber wants money, but the cost is the risk of jail.
When punishments get harsher (e.g., longer jail times), people commit fewer crimes.
Example/statistic: “the requirement to submit a DNA sample reduces the likelihood of a new conviction within five years by … 17 percent for serious violent offenders.”
Big Idea (Policy Incentive): Lower-class loan borrowers will have easier access to getting loans cancelled.
This incentive causes college students to expect only to pay 50% of the amount borrowed.
Looney argues that students and their parents will have an incentive to borrow more because they will only need to pay back half.
As a consequence, colleges will increase tuition, leaving taxpayers footing more of the bill.
Tariffs: A tax imposed by a government on imports.
Scarcity, Market, and Rational Behavior
Scarcity: Our wants are unlimited, the resources available to fulfill those wants are limited.
Market: Group of buyers and sellers of goods and services and the institution or arrangement by which they come together and trade.
Rational: Consumers and firms use all available information as they act to achieve their goals.
Marginal Cost: the extra cost of doing one more thing; e.g., making one more pizza costs 3
Marginal Benefit: the extra happiness or value you get from one more unit; e.g., it gives you worth of enjoyment.
Marginal Benefit (example): Apple produces 300,000 phones for more revenue.
Marginal Cost (example): wages and parts to produce the phones.
In many decisions, MB = MC is the target condition to optimize.
Economic Systems and Allocation
Important: Consumers, firms, and the government determine what goods and services will be produced by the choices they make.
Important: Who receives the goods and services produced depends largely on how income is distributed.
Centrally Planned Economy: The government decides how economic resources will be allocated.
Example: The Soviet Union; government officials controlled the goods and who received them.
Consequence: they failed to produce low-cost, high-quality goods and services, leading to low standard of living; typically associated with dictatorships; North Korea cited as an example.
Market economy: Firms and households interact in markets which determine the allocation of economic resources.
Most high-income democracies tend to be market economies, e.g., the United States.
Market economies rely on privately owned firms to produce goods and services, usually to meet the wants of the consumers or they’ll go out of business.
Mixed Economy:
Economists argue that places like the United States, Canada, Japan, and Western Europe aren’t fully market economies; the government sometimes steps in.
Example: social security system for disabled and retired workers.
Voluntary Exchange: In market economies, both buyer and seller are made better off by the transaction.
Productive Efficiency: Occurs when a good or service is produced at the lowest cost.
Guiding principle: We want MB = MC to maximize efficiency.
Page 3: Models, Analysis, and Key Concepts
Allocative Efficiency: Occurs when production is in accordance with consumer preferences.
Economic Models: simplified representations that are useful to analyze real-world economic situations.
Economic Variable: something that can be measured and can take on different values (e.g., the amount of people employed).
Positive Analysis: describes what is and explains/predicts economic events without judgement.
Example: “An increase in money supply will increase inflation.”
Normative Analysis: describes what ought to be; value-based and includes opinions or judgement.
Example: “The government should raise the minimum wage to ensure living standards for people.”
Human Capital: a college-educated worker who has more skills and is more productive than those with only a high school diploma.
Capital: manufactured goods used to produce other goods and services (e.g., machine tools, trucks, factory buildings).
Opportunity Cost: what you are trying to get vs. what you are giving up; the foregone alternative when a choice is made.
Trade-offs: a decision-making concept where gaining one aspect requires giving up another.
Emphasizes that every choice involves costs in terms of foregone alternatives.