Chapter 1. About Economics. About Economics. Economics is often referred to as the “dismal science.” Purpose of this Chapter: Introduction to field of economics. Defining economics and the questions economics address Discussing how economists think
For example: 1960’s—Numerous automobile safety regulations, including the mandatory use of seat beats, padded dashboards, and penetration-resistant windshields were issued.
Figure 1.2 The Three I’s of Economic Theory : Incentives, Interactions and Indifference
Figure 1.3. Wren is indifferent between farming and industry labor
Figure 1.5. The government subsidy raises land rent, leaving Wren indifferent once again.
Full Price = Transaction Price + Transaction Cost
For example: Purchasing a car in Raleigh (your hometown) or Charlotte, North Carolina.
Figure 1.6. Price differences for wheat in selected Midwest states. All differences are relative to river ports in Eastern Kansas and Oklahoma ( a negative difference means the price is lower relative to river ports).
Map made available by Agmanager, Department of Agricultural Economics at Kansas State University. Available at http://www.agmanager.info. Accessed September 20, 2005.
Adam Smith is considered the Father of Economics
Image made available by the Adam Smith Institute. Available at http://www.adamsmith.org/.
For example: After Exxon Valdez, many states created laws placing unlimited liability on tanker operations. This caused many companies to cease shipping oil across seas or hiring other companies to do it for them.
For example: Poultry Production
Poultry production produces water pollution. When you purchase chicken at the grocery store, it makes you better off. The sale of the chicken makes the grocery better off. However, the users of the surface waters are made worse by the raising of chicken leads to water pollution. THIS IS CALLED A NEGATIVE EXTERNALITY, because of the negative harm to the third party.
A researcher sells her services to a pharmaceutical company, both the buyer and seller are better off. The researcher discovers a better means of health care, down the road it will benefit the third party—society. Because the pharmaceutical company can not capture all the benefits to the third party, the end result is too little research. The solution is to have the government subsides research.
Example: If you were offered $100 today or $101 in one year, you would take the $100 today. You could take the $100 today and invest it in a interest-earning instrument and have more than $101 in one year.
You could put that $100 in a CD or savings account at the bank that pays i = 3% interest. At the end of the year you will have your $100 plus earn $100 x i = $100 x 0.03 = $3. (This can be written as $100(1+i) = $100(1+0.03) = $103)
This means that $100 today is worth more than $101 next year, but $100 today is worth the same as $103 next year, at the interest rate of 3%.
Example: You have the choice of $1,000 today or $1,050 next year and you choose $1,000 today. Then give you the choice of $1,00 today or $1,100 next year, and you say you are indifferent. You are given the choice of $1,000 today or $1,101 next year, you prefer the money next year.
The discount rate (r) that makes you indifferent between money today and next year is then $1,000(1+r)=$1,100. Solve for r. r=1100/1000-1= 0.1 or 10%. The rate at which you discount money in the future is 10%.
The discount rate of 10% means that as long as you can use money today to purchase a financial instrument that yields 10% or more in interest you will forgo the money today , purchasing the instrument, and earning interest.
In the example: $1,000 today is the Present Value (money today). $1,100 next year is the Future Value (money paid out later).
The discount rate is just a number that converts present values to future values.
(Present Value)(1+r)=Future Value OR Present Value=(1+r)-1(Future Value)
It is clear the upgrade should be made. Accounting for the opportunity costs of money, the expenditure of $150,000 today yields more profits than investing in the next best alternative.