CommonSenseEconomics.com1 Common Sense Economics What Everyone Should Know About Wealth & Prosperity...

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Common Sense EconomicsWhat Everyone Should Know About Wealth & Prosperity

byJames Gwartney, Richard Stroup, and Dwight Lee

CommonSenseEconomics.com

10 Key Elements

of Economics


Ten Key Elements of Economics

Build a bridge between common sense and economic applications.

Provide a solid foundation in economic reasoning.

Apply common sense to help readers make strategic consumption, savings, investment, career, and voting choices.

Explain why people cooperate in order to help themselves prosper and their nations grow.


1.Incentives matter.

10 Key Elements of Economics


What Are Incentives? Incentives are factors that encourage or

discourage various types of behaviors, actions or activities.

Changes in incentives alter the way people behave.

Incentives influence behavior at all levels- personal, familial, business, government, and national.


Gasoline Prices…

When gas prices rise, do you have an incentive to change your behavior?

When do you stop talking and start acting?

How can you change your behavior in the short-run?

How can you alter it in the long-run?


Incentives: Producers and Consumers What is the main incentive of the producer?

Provide consumers with what they value the most while covering their costs of production and making a profit.

What is the incentive of the consumer? Get the most of what they value from their

expenditures.


Volunteerism… Incentives matter to

everyone, including volunteers and charitable organizations.

What incentives do volunteers have? Are they only monetary?

Describe some incentives offered to encourage people to volunteer, donate blood and assist Habitat for Humanity in the building of houses.


2.There is no such thing as a free lunch.10 Key Elements of Economics


The Condition of Scarcity

Our resources are limited…but our desires for goods and services are NOT.

Something is scarce if it has more than one valuable use. Consider your time.

When resources are used to do one thing, they are unavailable to do others.


To Choose Is To Sacrifice

Scarcity forces us to make choices.

Choosing an action means we sacrifice doing something else.

The opportunity cost of a choice is the value of what is given up.


There Is No Such Thing As A Free Lunch

What if a financial planner offers to buy you lunch?

You incur no money cost but you sacrifice time that could have been used to do something else.

The value of your next best option is the opportunity cost of going to the “free” lunch.


3. Decisions are made at the margin.10 Key Elements of Economics


Marginalism…

Few, if any, decisions are “all-or-nothing”. Marginal means additional or one more. We are constantly facing marginal choices. To get the most out of our resources, we

should only take an action when the additional benefits are greater than the additional costs.


Marginal Decision Examples… How much do you clean your

house or room? Do you clean until 100% of the

dirt and clutter has been removed when its just you and no company is expected?

Do you clean until 100% of the dirt and clutter has been removed when you expect company?

You clean as long as the marginal costs are less than the marginal benefits!


Apply Marginal Thinking To

Weeding an overgrown garden Cleaning up a polluted stream Picking up litter along the highway Eating pizza Eating at an “All You Can Eat” buffet


4. Trade promotes economic progress.



People Gain When They Trade

Trade (Voluntary Exchange) Moves goods and services from people who value

them less to people who value them more.

Makes larger output and consumption possible by allowing us to specialize in doing what we do best.

Makes larger output and lower per-unit costs possible as a result of mass production.

Trade leads to larger output and higher income levels.


Discuss how trade effects the well being of the trading partners in the following scenarios. Flea Market

eBay

Garage sales

International trade between the U.S. and Mexico


5. Transaction costs are an obstacle to trade.



Transaction Costs Transaction costs: resources spent when

making an exchange or transaction. Buyers and sellers spend scarce resources

when they Search for exchange partners Locate product information Negotiate the terms of trade Finalize and formalize contracts and agreements


Why are there transaction costs? Physical obstacles

Movement of goods from sellers to buyers

Scarcity of information Locate buyers and sellers; assess

their reputation; and find best deals Political obstacles

Taxes, tariffs, quotas, licensing requirements, and other regulations

Middlemen List a few types. Describe how they impact the costs

of transacting in a complex world.


6. Profits direct business toward activities that increase wealth.10 Key Elements of Economics


Profits: Friend or Foe? People are better off if their resources are

directed toward the production of goods and services valued highly relative to costs.

Users should be encouraged to undertake productive projects.

Profits and losses perform this function. Profits provide rewards to those who

transform resources into goods and services that are valued more than costs.

Losses impose a penalty on the unproductive use of resources.


Losses Are Important! A T-shirt factory has total production

cost of $20,000. 1,000 T-shirts can be sold at $22 each.

This production results in a $2,000 profit.

Consumers value the T-shirts more than the resources required for their production.

What if these shirts could be sold for only $17 each? What is the total sale price? Is there loss or a profit?

This loss of $3000 indicates that the T-shirts are worth less to consumers than the resources required to produce them.


7. People earn income by helping others.10 Key Elements of Economics


Earning Income What do you have to do to earn a high

income? Explain why you need others to earn a high

income? How do you know that others value the

services or goods you provide? Explain why high earnings come from

providing goods and services that others value.


Income Variation College students are

rewarded for studying. Star athletes and

entertainers are rewarded for their specialized skills.

Entrepreneurs are rewarded for their productive innovations and risk-taking.

Why does Tiger Woods earn more than a nurse?


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

economic institutions. 10 Key Elements of Economics


What is Economic Progress?

Americans produce and earn THIRTY TIMES more now than colonists did in 1750.

What contributed to this economic progress? Why is this progress important?


Sources of Economic Growth Investments in productive assets

Physical capital (tools, machines, computers, and buildings) and human capital (education, vocational training, and professional development)

Entrepreneurial discoveries and improvements in technology Cotton gin, assembly line, refrigerators, telephone, polio

vaccine, microwave, minicomputer, and artificial heart

Improvements in economic organization Rule of law, even handed enforcement, competitive markets,

limited government and money of stable value


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



Invisible What?

Adam Smith, The Wealth of Nations (1776)

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


What Is the Invisible Hand?

Through price signals, the primary function of markets is to provide information to buyers and sellers.

The invisible hand of market prices directs millions of self-interested individuals into cooperative action and brings their choices into line with each other.

Friedrich von Hayek


Price Signals and the Invisible Hand By pursuing self-interests in markets, individuals

help others and everyone is made better off. Who is made better off when consumers buy MP3 players? How do consumers indicate how much they value MP3

players? How do MP3 manufacturers relate production costs to

consumers? Do the MP3 consumers and producers ever meet to swap

information on consumer preferences and production costs? What makes this possible?


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



Secondary Effects or Long Range ConsequencesA person

“…must trace not merely the immediate results but the results in the long run, not merely the primary consequences but the secondary consequences, and not merely the effects on some special group but the effects on everyone.”

- Henry Hazlitt [1979]

Economics in One Lesson


Unintended Consequences

Well intended actions have secondary effects that impact others. Discuss the secondary effects of: Rent controls designed to make housing

affordable for the poor. Tariffs and quotas designed to protect domestic

industries. Government projects designed to increase

employment in construction.


If policymakers have good intentions

Will their actions lead to desirable outcomes?

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