Common Sense EconomicsCommon Sense EconomicsWhat Everyone Should Know About Wealth & ProsperityWhat Everyone Should Know About Wealth & Prosperity

by James Gwartney, Richard Stroup, and Dwight Leeby James Gwartney, Richard Stroup, and Dwight Lee

10 Key Elements

of Economics

CommonSenseEconomics.com

Ten Key Elements of Ten Key Elements of EconomicsEconomics

Provide an introductory flavor for the courseProvide an introductory flavor for the course

Bridge between common sense & basic Bridge between common sense & basic principles of economics principles of economics

Begin to help you “think like an economist”Begin to help you “think like an economist”

Provide some explanation as to why our Provide some explanation as to why our economy and our world work the way they doeconomy and our world work the way they do

Terms for 10 Key Elements of Terms for 10 Key Elements of Economics:Economics:

Incentives: A reward offered for increased Incentives: A reward offered for increased productivity.productivity.

Free Lunch: There is a price to be paid for Free Lunch: There is a price to be paid for everything in life.everything in life.

Margin: The point at which the return from Margin: The point at which the return from economic activity barely covers the cost of economic activity barely covers the cost of production, below which production is production, below which production is unprofitable.unprofitable.

Trade: The act or process of buying, selling, or Trade: The act or process of buying, selling, or exchanging commodities at either wholesale or exchanging commodities at either wholesale or retail within a country or between countries. retail within a country or between countries.

Terms for 10 Key Elements of Terms for 10 Key Elements of Economics:Economics:

Obstacles to Trade: Tariffs, quotas, or Obstacles to Trade: Tariffs, quotas, or non-tariff barriers that restrict free trade.non-tariff barriers that restrict free trade.

Growth: Increase in a country’s Growth: Increase in a country’s productive capacity as measured by productive capacity as measured by comparing a country’s Gross National comparing a country’s Gross National Product.Product.

Invisible Hand: Market Forces that Invisible Hand: Market Forces that influence our economic decisions. influence our economic decisions.

1.1. Incentives Incentives matter.matter.

What are Incentives?What are Incentives?

Incentives are the costs and benefits of Incentives are the costs and benefits of making specific decisions.making specific decisions.

Changing incentives alters people’s Changing incentives alters people’s behavior.behavior.

Incentives operate on all levels- personal, Incentives operate on all levels- personal, familial, industry and societal level.familial, industry and societal level.

Gasoline Prices…Gasoline Prices… When the price of gas When the price of gas

rises, do you change rises, do you change your behavior?your behavior?

Do you Do you reallyreally??

What’s the difference What’s the difference between short-run between short-run changes and long-run changes and long-run changes in behavior?changes in behavior?

Volunteerism…Volunteerism… Incentives don’t Incentives don’t

matter only to the matter only to the greedy and selfish.greedy and selfish.

What incentives do What incentives do volunteers have, if volunteers have, if not monetary?not monetary?

Why do you Why do you volunteer?volunteer?

Seat belts save lives…Seat belts save lives…

Does wearing a seat Does wearing a seat belt create any belt create any incentives?incentives?

Why do people get in Why do people get in more accidents now more accidents now that cars are safer?that cars are safer?

2.2.There is no such There is no such thing as a free thing as a free lunch.lunch.

The condition of scarcityThe condition of scarcity Our resources are limited…but our desire Our resources are limited…but our desire

for goods & services is for goods & services is NOTNOT..

When production costs are high, it is When production costs are high, it is because the resource in question is because the resource in question is desired for other purpose(s) as well.desired for other purpose(s) as well.

A resource is scarce if A resource is scarce if it has more than it has more than one valuable useone valuable use..

To Choose is to RefuseTo Choose is to Refuse Because we are constantly Because we are constantly

faced with scarcity, we must faced with scarcity, we must make make choiceschoices..

Every time we choose one Every time we choose one thing (material or not) we thing (material or not) we refuse something else.refuse something else.

We constantly make We constantly make trade-trade-offsoffs in our decisions. in our decisions.

But, but, but…But, but, but…

What if someone else What if someone else buys your lunch?buys your lunch?

Merely a Merely a shiftingshifting of cost, of cost, not an not an eliminationelimination

And is it And is it reallyreally free? free?

3. Decisions are 3. Decisions are made at the made at the margin.margin.

Marginalism…Marginalism… Few, if any, decisions are “all-or-nothing”.Few, if any, decisions are “all-or-nothing”. Marginal means Marginal means additionaladditional…… Marginalism is seldom ignored in our Marginalism is seldom ignored in our

personal decisions, but frequently in our personal decisions, but frequently in our conversations and in politics.conversations and in politics.

To get the most out of our resources, we To get the most out of our resources, we should should only take an action when the only take an action when the marginal benefits are greater than the marginal benefits are greater than the marginal costsmarginal costs..

Marginal Decision Examples…Marginal Decision Examples…

How clean is your house?How clean is your house? Do you clean to 100% Do you clean to 100%

cleanliness?cleanliness? How about when company How about when company

is coming?is coming? How about when selling How about when selling

your house?your house? You clean to the point You clean to the point

where the where the marginal costs marginal costs outweigh the expected outweigh the expected marginal benefitsmarginal benefits!!

4. Trade promotes 4. Trade promotes economic economic progress.progress.

People gain when they trade…People gain when they trade…

Trade moves goods from people who Trade moves goods from people who value them less to people who value value them less to people who value them more.them more.

Trade makes larger outputs/consumption Trade makes larger outputs/consumption possible as we specialize.possible as we specialize.

Voluntary exchange allows production Voluntary exchange allows production costs to fall through mass production.costs to fall through mass production.

Trade exists at many Trade exists at many levels…levels…

Enrolling in this classEnrolling in this class

Shopping at SafewayShopping at Safeway

Having a garage saleHaving a garage sale

Taking a vacationTaking a vacation

Buying imports from Buying imports from China & MexicoChina & Mexico

5. Transaction costs 5. Transaction costs are an obstacle to are an obstacle to trade.trade.

Transaction CostsTransaction CostsSpending resources onSpending resources on::

Searching out trading partnersSearching out trading partners Searching out product informationSearching out product information Negotiating terms of tradeNegotiating terms of trade Closing salesClosing sales

Why do we experience Why do we experience transaction costs?transaction costs?

Physical objectsPhysical objects Can’t get there from here!Can’t get there from here!

Lack of informationLack of information Finding sellers/ best dealsFinding sellers/ best deals

Political obstaclesPolitical obstacles Taxes, tariffs, licensing Taxes, tariffs, licensing

requirements, regulations, requirements, regulations, etc.etc.

Role of middlemen?Role of middlemen? Increase or decrease TC?Increase or decrease TC?

6. Profits direct 6. Profits direct business toward business toward activities that activities that increase wealth.increase wealth.

Why profits are not the Why profits are not the enemy…enemy…

People of a nation are better off if their People of a nation are better off if their resources produce valuable goods & resources produce valuable goods & services.services.

Less productive use of resources should Less productive use of resources should thus be discouraged.thus be discouraged.

ThisThis is the function of profits and losses. is the function of profits and losses. Profit Profit is a reward for transforming is a reward for transforming

resources into something of greater resources into something of greater value.value.

Losses just as important!Losses just as important! A T-shirt factory has total A T-shirt factory has total

production costs of $20,000.production costs of $20,000. 1,000 T-shirts sold at $22 each = 1,000 T-shirts sold at $22 each =

$2,000 in profit.$2,000 in profit. Wealth has been created for the Wealth has been created for the

producer producer andand consumer. consumer. What if shirts can only be sold for What if shirts can only be sold for

$17 each?$17 each? T-shirts are worth less to T-shirts are worth less to

consumers than the resources consumers than the resources required to produce them.required to produce them.

What’s the trade-off if firms continue What’s the trade-off if firms continue to operate at a loss?to operate at a loss?

7. People earn 7. People earn income by helping income by helping others.others.

Earning IncomeEarning Income People are different in many ways…This People are different in many ways…This

is our greatest asset!is our greatest asset! Differences in income arise because they Differences in income arise because they

affect the value of goods and services affect the value of goods and services individuals are willing to provide.individuals are willing to provide.

There is a direct link (ceteris paribus) There is a direct link (ceteris paribus) between helping others & income.between helping others & income.

If you want a large income- figure out If you want a large income- figure out how to help others!!!how to help others!!!

Income VariationIncome Variation

College students are College students are rewarded for rewarded for studyingstudying

Star athletes and Star athletes and entertainers are entertainers are rewarded for their rewarded for their special skillsspecial skills

Entrepreneurs are Entrepreneurs are rewarded for their rewarded for their innovations.innovations.

8. Economic progress 8. Economic progress comes primarily comes primarily through trade, through trade, investment, better investment, better ways of doing ways of doing things, and sound things, and sound economic economic institutions. institutions.

What is Economic Progress?What is Economic Progress?

Americans produce and earn Americans produce and earn THIRTY TIMESTHIRTY TIMES as much as they did in 1750.as much as they did in 1750.

Why are Americans so much more productive Why are Americans so much more productive today than they were 250 years ago?today than they were 250 years ago?

Why is economic progress important?Why is economic progress important?

Sources of Economic GrowthSources of Economic Growth

Investments in productive assetsInvestments in productive assets Tools, machines, “human capital”Tools, machines, “human capital”

Improvements in technologyImprovements in technology Internal combustion engine, electricity, Internal combustion engine, electricity,

computers, by-pass surgeries, etc.computers, by-pass surgeries, etc.

Improvements in economic organizationImprovements in economic organization Legal system, competitive markets, etc. Legal system, competitive markets, etc.

9. The “invisible hand” 9. The “invisible hand” of market prices of market prices directs buyers and directs buyers and sellers toward sellers toward activities that activities that promote the general promote the general welfare.welfare.

Invisible What?Invisible What? Adam Smith, Adam Smith, The Wealth of The Wealth of

NationsNations (1776) (1776) ““It is his own advantage, indeed, and It is his own advantage, indeed, and

not that of society which he has in not that of society which he has in his view. But the study of his own his view. But the study of his own advantage naturally, or rather advantage naturally, or rather necessarily, leads him to prefer that necessarily, leads him to prefer that employment which is most employment which is most advantageous to society…He advantageous to society…He intends only his own gain, and he is intends only his own gain, and he is in this, as in many other cases, led in this, as in many other cases, led by an invisible hand to promote an by an invisible hand to promote an end which was not part of his end which was not part of his intention.”intention.”

Friedrich von HayekFriedrich von Hayek Primary function of markets is to provide Primary function of markets is to provide

information (both to buyers and sellers)information (both to buyers and sellers) Consider the price of apples…Consider the price of apples…

Price indicative of what consumers are willing and Price indicative of what consumers are willing and able to pay, but also incorporates costs of able to pay, but also incorporates costs of production/bringing to marketproduction/bringing to market

Things constantly happen to make both consumer Things constantly happen to make both consumer value & production costs vary…value & production costs vary…

10. Too often long-10. Too often long-term consequences, term consequences, or the secondary or the secondary effects, of an action effects, of an action are ignored.are ignored.

Unintended Unintended ConsequencesConsequences

Perhaps the most common source of Perhaps the most common source of economic error.economic error.

Actions often promote secondary effects.Actions often promote secondary effects. Tariffs & quotas to protect domestic Tariffs & quotas to protect domestic

industriesindustries Paying for pencils in the 2Paying for pencils in the 2ndnd grade class grade class