Economic 101 Lecture 1 PDF

Economic 101 Lecture 1 Thinking Like an Economist Brandt, Economics 101: Thinking Like an Economist 1 The Economics Way of Thinking 1. The Economic Problem: Scarcity Requires Choices 2. Economic Decision-making: 2.1 Opportunity Cost What one forgoes (gives up) by...

Economic 101 Lecture 1 Thinking Like an Economist Brandt, Economics 101: Thinking Like an Economist 1 The Economics Way of Thinking 1. The Economic Problem: Scarcity Requires Choices 2. Economic Decision-making: 2.1 Opportunity Cost What one forgoes (gives up) by not taking the best alternative action 2.2 Marginal Analysis Compare Additional Benefits with Additional Costs Ignore Sunk Costs 2.3 Behavioral Rule Do things if benefits exceed costs 3. People Respond to Incentives Brandt, Economics 101: Thinking Like an Economist 2  def : The demand for a Scarcity good/service is greater than the availability of the good/service Individual to must allocate limited resources individual Limited Budget - > satisfy their needs Limited Time Society Limited resources to produce goods Choices Economics – Study of how rational people make choices Brandt, Economics 101: Thinking Like an Economist 3 Economics: the study of how rational people make choices You buy, in advance, a ticket for a hockey game at a discounted price of $75. As planned, you take an Uber to the game, which costs $40. Unfortunately, when you arrive, you discover that you have lost the ticket. Question: If you have the funds, should you buy a new ticket, which costs $100? Observations: Ticket : 75$ 1. This is an “economics” problem. Uber : 40x2 : = 80$ 2. If you are rational, there is a “correct” answer. New ticket : 100$ Will revisit this problem later in the lecture. Brandt, Economics 101: Thinking Like an Economist 4  Rational (economic) Decision Making Two key building blocks business of option not taken when a 1. Opportunity Cost > - The value make a decision of activity 2. Marginal Analysis > - an examination of the additional benefits an compared to the costs incurred by that same activity Ex 1 : A student spends three hours and $20 at the movies the night before an exam. The opportunity cost is time spent studying and that money to spend on something else Ex 2 : The marginal benefit of an additional cookie is $5 while the marginal cost of that cookie is $3. Net benefits = $5 - $3 = $2. Since net benefits are positive, it would be in the favor of the consumer to purchase an additional cookie. Brandt, Economics 101: Thinking Like an Economist 5 Opportunity Cost The opportunity cost of taking an action is what one gives up by not taking the next best alternative. Examples: 1. 2. Insight: If the opportunity cost of taking an action is high, one is less likely to take the action. Brandt, Economics 101: Thinking Like an Economist 6 The Importance of Opportunity Cost (Intuition) To make a rational decision whether to take an action, one must know what one “gives up” by taking the action. Opportunity costs: - Formalizes the concept of what one “gives up” - Highlights the need to identify the next best alternative Brandt, Economics 101: Thinking Like an Economist 7  no Example The price of a concert ticket is $50, but you are given a free ticket (which you cannot resell). You value the opportunity to attend the concert at $100. What is the opportunity cost of attending the concert? a. Zero (since the ticket is free) b. $50 (the price of the ticket) We need to k w best opp. c. $100 (the benefit to you of attending) the next O d. Not enough information Brandt, Economics 101: Thinking Like an Economist 8 Answer: D – Not enough information to determine Remember: To identify the opportunity cost of taking an action, one must identify the next best alternative Example # 1: If your next best alternative is to work for two hours and earn $40, the opportunity cost is $40. Example # 2: If your next best alternative is to walk in the park, which you value at $60, the opportunity cost is $60. Remember: The opportunity cost of taking an action is what you give up by taking the action (and does not reflect the benefit you derive from taking the action. Brandt, Economics 101: Thinking Like an Economist 9  You bought a rare wine for $50, and you could sell it for $100. If you give the wine to a friend, you receive a benefit of $150, while your friend receives a benefit of $200. What is the opportunity cost if you choose to keep the wine? a. $50 b. $100 O c. $150 d. $200 e. $350 Answer in class Brandt, Economics 101: Thinking Like an Economist 10 In 2014, the US (and Canadian) economy recovered from a deep recession, and unemployment fell sharply. Question: opp cost of going to uni ? and how is it related Would you predict that the number of students enrolling in university increased, fell, or was unchanged in September 2014 compared to September 2013? Insights: 1. One must identify the opportunity cost of attending university and how the opportunity cost changes if unemployment falls (and job opportunities increase) 2. If the opportunity cost of taking an action increases, the action is less likely to be taken. Brandt, Economics 101: Thinking Like an Economist 11 Student Question: What are the benefits of attending university? Highest Education T Average Earnings (Full Time) Less than High school $44,002 High School Diploma $51,994 College Diploma $61, 176 Bachelor’s Degree $82, 735 Master’s Degree $102, 342 Ph.D. $111, 626 Source: 2016 Census Brandt, Economics 101: Thinking Like an Economist 12 Opportunity cost of attending university for one year? 1. If next best alternative is full time work at $30,000 per year Tuition/books $15,000 Foregone Earnings $30,000 Total $45,000 2. If next best alternative is to work full-time, but no work is available (due to high unemployment) Tuition/books $15,000 Foregone Earnings Nil Total $15,000 Brandt, Economics 101: Thinking Like an Economist 13 The benefit (and cost) to attend university differs across individuals Benefits Suppose the benefit (higher future earnings) of attending university for one year is: Student A: $200,000 Student B: $100,000 Student C: $35,000 If the opportunity cost increases from $15,000 to $45,000, should all the students attend university? Brandt, Economics 101: Thinking Like an Economist 14 Should you operate a hotdog stand? Revenue (per 8-hour day) 100 hot dogs @ $4 = $400 Costs (per 8-hour day) Rent, for stand $150 Hotdogs, buns … $100 Your next best alternative: Work in a different job Brandt, Economics 101: Thinking Like an Economist 15 Rational Decision Making Undertake activity if marginal (additional) benefit exceeds marginal (additional) cost Insights 1. Include all opportunity costs 2. Ignore sunk costs Brandt, Economics 101: Thinking Like an Economist 16 What are sunk costs? non-recoverable Definition Costs that are incurred regardless of the action is taken Insight Only relevant costs are those that can be avoided if action is not taken Brandt, Economics 101: Thinking Like an Economist 17 Rational Decisions: Ignore Sunk Costs Benefit of attending concert: Francis: $100 Megan: $100 Ticket Price: $75 Francis buys one week in advance (cannot be resold) Megan plans to buy on day of concert Each has a subway pass, which allows unlimited use. The subway breaks down on the day of the concert, so each faces an unexpected cost of $50 for an Uber Should Francis attend the concert? Should Megan attend the concert? Follow up question: Should Francis attend the concert if he could sell his ticket for $60? For $40? Brandt, Economics 101: Thinking Like an Economist 18 Answer Francis should attend: MB = 100 MC = 50 MB > MC Key: For Francis, the ticket price is a sunk cost, and does not influence his decision Megan should not attend: MB = 100 MC = 75 + 50 = 125 MB < MC Key: For Megan, who has not yet purchased her ticket, the price is NOT a sunk cost. ↑ Brandt, Economics 101: Thinking Like an Economist 19 Rational Decision-Making * OCnoice = Value - cost + cost choice Marginal Benefit: MB give up giveup Marginal Cost: MC If MB>MC, take action If MB MC What is MC? What is MB? Brandt, Economics 101: Thinking Like an Economist 24  * Incentives Alter marginal benefit or marginal cost of an action (and can thus affect whether an action is taken) Brandt, Economics 101: Thinking Like an Economist 25 Examples When economists review proposed policy initiatives, they draw attention to the incentives so created, some of which are unintended. Brandt, Economics 101: Thinking Like an Economist 26 The unintended consequences of public policy: An example To protect workers, Italy and France make it very difficult for employers to fire employees Response of employers: Hire few new workers, usually with temporary contracts, thereby reducing the opportunity for young people to find jobs. Brandt, Economics 101: Thinking Like an Economist 27 The unintended consequences of public policy: an unusual example A province requires that all drivers use seatbelts in order to reduce injuries from motor vehicle accidents. Question: After this legislation, the number of motor vehicle accidents will: Fall? Be unchanged? Increase? Brandt, Economics 101: Thinking Like an Economist 28 The optimal amount of “Care” -- attention to safety -- when driving an automobile An economic decision, which can be influenced by incentives Economic analysis 1. Before legislation, each driver chooses the optimal amount of “care” by weighing MB and MC of driving safely Marginal benefit of taking more “care”: reduced accidents, injuries Marginal cost of taking more “care”: longer to reach destination (driver slower), pay more attention (no mobile devices) 2. After legislation, the marginal benefit of “care declines. Why? 3. Incentive: After mandatory seatbelt legislation, drivers will choose less “care”, since the marginal benefit of taking “care” declines. Brandt, Economics 101: Thinking Like an Economist 29 Putting it all together Economics The study of how “agents" make decisions on the allocation of scarce resources Microeconomics: the study of how individuals, households, and firms make decisions and interact in markets Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth Brandt, Economics 101: Thinking Like an Economist 30 Putting it all together Economics The study of how “agents" make decisions on the allocation of scarce resources Microeconomics: the study of how individuals, households, and firms make decisions and interact in markets Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth Brandt, Economics 101: Thinking Like an Economist 30