Presentation Transcript

1. Economics for Leaders

   Lesson 2: Opportunity Cost, Incentives & Markets
2. Joke Of The Day An economist and an accountant are walking along a large pond and see a frog jumping on the mud. The economist says: "If you eat the frog I'll give you $20,000!"The accountant checks his budget and figures out he's better off eating it, so he does and collects money.Continuing along they see another frog. The accountant says: "Now, if you eat this frog I'll give you $20,000."After evaluating the proposal the economist eats the frog and gets the money.
3. Joke Of The Day They go on. The accountant starts thinking: "Listen, we both have the same amount of money we had before, but we both ate frogs. I don't see us being better off."The economist says:
4. Joke Of The Day "Well, that's true, but you overlooked the fact that we've just been involved in $40,000 of trade."
5. True or False?
6. Economic Reasoning Principle #1: People choose, and individual choices are the source of social outcomes. Scarcity necessitates choices: not all of our desires can be satisfied. People make these choices based on their perceptions of the expected costs and benefits of the alternatives.
7. Economic Reasoning Principle # 2: Choices impose costs; people receive benefits and incur costs when they make decisions. The cost of a choice is the value of the next-best alternative foregone, measurable in time or money or some alternative activity given up. What did you give up to be here? Should you go to college?
8. choices → TRADE-OFFS → forgone alternatives OPPORTUNITY COST! choosing is REFUSING! the cost of something is what you give up. OPPORTUNITY COST!
9. Economic Reasoning Principle # 3: People respond to incentives in predictable ways. Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, behavior changes in predictable ways. People do what makes them better off. Marginal Cost, Marginal Benefit
10. Eau Claire to MuskegonSummer 2009 Drive or drive & ride the ferry? What matters for this choice? People do what makes them better off. Marginal Cost, Marginal Benefit
11. Price of gasoline $2.79/gal
12. What About 2008? xx The price of gasoline is $4.09/gal
13. The Cost of Something Is What You Give Up to Get It Should Tiger Woods do his own yard work? Should Roger Federer do his own house-work? What else could they do? …
14. The Cost of Something Is What You Give Up to Get It Should Kobe Bryant, LebronJames and Dwight Howard have gone to college? What about you? What else could they/you do? …
15. More Examples Why attend college right after high school? Getting bumped from a flight? Another Rolo, a second washing machine More oranges, more automobiles and buildings auto industry bailout? financial industry bailout? health care reform? Afghanistan/Iraq wars? BP oil spill? Bush era tax cuts? Free Dave Matthews concert?
16. Policy Conundrum There are no SOLUTIONS. There are just TRADE-OFFS.
17. Should We Ration? Given that we MUST ration, what is the best mechanism?Let’s do an activity!
18. Rationing Scarce Goods How much do you like it? Rank how much you value the item. 1 to 10 10 = TOTALLY AWESOME :>) 1 = PATHETIC :<(
19. Rationing STUFF!
20. Rationing Scarce Goods How much do you like it? Rank how much you value the item. 1 to 10 10 = TOTALLY AWESOME :>) 1 = PATHETIC :<(
21. Rationing STUFF!
22. Rationing Scarce Goods How much do you like it? Rank how much you value the item. 1 to 10 10 = TOTALLY AWESOME :>) 1 = PATHETIC :<(
23. Rationing STUFF!
24. Given the method of allocation just used to ration the STUFF… How could we improve this outcome? Methods of Allocation
25. Allow Trade Set up a market Voluntary Trade Creates Wealth! Methods of Allocation
26. Rationing STUFF! Do you want to trade?
27. Rationing STUFF! Do you want to trade?
28. Rationing STUFF! Do you want to trade?
29. Rationing STUFF! Do you want to trade?
30. Rationing STUFF! Do you want to trade?
31. Rationing STUFF! Do you want to trade?
32. Lottery Contest Arbitrary criteria Force Share equally First-come, first serve Need Merit Market Transactions (exchange/prices) Methods of Allocation
33. Goods go to those with the highest value. Goods are produced by those with the lowest opportunity cost. Voluntary trade increases well-being. It makes people better off! What do markets look like? Markets Typically Do A Good Job Of Rationing
34. What is a Market? Buyers Sellers specific product information property rights competition voluntary trades well-being
35. Households Develop resources to their fullest potential and offer them for sale in factor markets. Earn income from sale of resources and purchase goods & services to maximize well-being (utility). Firms Employ resources in their most useful capacity to produce goods and services. Sell goods and services to maximize well-being (profit). Markets: Circular Flow
36. How Do Markets Work? Buyers Buyers and sellers each perform cost/benefit analysis. Price is a measure of relative scarcity. Price represents opportunity cost. Price sends signals/incentives to players. Sellers
37. Law Of Demand consumers could purchase other things price → opportunity cost high price → purchase less higher price means less incentive to consume this good relative to what else you could do demand represents value (compared to alternatives) willingness to pay (gasoline) Buyers
38. Law Of Supply sellers could produce other things price → opportunity cost high price → produce more higher price means more incentive to produce this good relative to what else you could do supply represents marginal (opportunity) cost willingness to sell (corn/ethanol) Sellers
39. D = MB = WTP (value) Diminishing marginal benefit Rolos, washing machine S = MC = WTS (opportunity cost) Rising marginal cost wheat/oranges Markets: Supply & Demand
40. Big Ideas choices → TRADE-OFFS → forgone alternatives OPPORTUNITY COST! choosing is REFUSING! the cost of something is what you give up. OPPORTUNITY COST!
41. People do things that make them better off. People respond to incentives in predictable ways. The rules of the game shape how decisions are made. Decisions determine outcomes. Big Ideas
42. Voluntary trade creates well-being. Markets do a good job of allocating scarce resources to meet society’s many and often competing wants/desires. Big Ideas
43. Policy Conundrum There are no SOLUTIONS. There are just TRADE-OFFS.
44. Fire Department Auction