01 Five Foundations of Economics

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Misconception - Economics is the dismal science.
The derogatory description of economics was first used by historian and essayist Thomas Carlyle in nineteenth century. He called economics the dismal science after economist Thomas Malthus predicted that population growth combined with the planet's limited resources would ultimately lead to widespread starvation.

What Is Economics?

Scarcity refers to the limited nature of society's resources, given society's unlimited wants and needs.
Economics is the study of how individuals and societies allocate their limited resources to satisfy their nearly unlimited wants and needs.

Microeconomics and Macroeconomics

  • Microeconomics is the study of individual units that make up the economy.
  • Macroeconomics is the study of the overall aspects and workings of an economy, such as inflation, growth, employment, interest rates, and the productivity of the economy as a whole.

Practice what you know
Identify whether the following statements identifies a microeconomics or a macroeconomics?
1. The nation saving rate is less then 2% of income.
2. Jim was laid off from his job and is currently unemployed.
3. Apple decided to open 100 new stores.
4. The government passes a jobs bill designated to stabilize the economy during a recession (an economy downturn).

What Are Five Foundations of Economics

The five foundations of economics are:

  1. Incentives matter.
  2. Live if about trade-offs
  3. Opportunity Cost
  4. Marginal Thinking
  5. Trade

1. Incentives

Incentives are factors that motivate a person to act or exert effort.

Positive and negative incentives

Positive incentives encourage action by offering rewards or payments.
Negative incentives discourage action by providing undesirable consequences or punishment.
Example: Teacher, student, assignment, exams, papers, grades, bonus points

Direct and Indirect Incentives

Direct incentives

  • One gas station lower its prices, it most likely will get business from customers who would not usually stop there.

Indirect incentives

  • welfare programs
  • unintended consequences
Incentives and Innovation
  • In the United States, the patent system and copyright laws guarantee inventors a specific period of time in which they have exclusive right to sell their work.
  • Illegal downloads of books, music and movies are widespread and the incentives to produce new content are reduced. - John Lennon, Jay-Z, Suzanne Collins (Author of The hunger Games), J. K. Rowling
Incentives are everywhere
  • Financial gain almost always plays a prominent role.
  • Incentives matters

Film All the President's Men, "follow the money", President Nixon

Economics in the Media: Incentives: Ferris Bueller's Day off

2. Trade-offs

In a world of scarcity, each and every decision incurs a cost.

Examples
1. Reading books - the Hunger Games or Harry Potter
2. Psy's song "Gangnam Style", 2 billion times on Youtube
3. Dwight Eisenhower in 1953 - The cost one modern heavy-duty bomber is this: a modern brick school in more than 30 cities. It is two electric power plants each serving a town of 60,000 people. It is two fine, fully equipped hospitals. It is some 50 miles of concrete highways. We pay a single fighter with a half million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people.

3. Opportunity Cost

Opportunity Cost is the highest-valued alternative that must be sacrificed to get something else.

Examples

  1. Mick Jagger of Rolling Stone, London School of Economics
  2. The Opportunity Cost of Attending College
  3. How Opportunity Cost Causes a Drop in Hospital Visits When the Red Sox Play - Boston, 2004 Playoff

4. Marginal Thinking

The process of systematically evaluating a course of action is called economic thinking. Economic thinking involves a purposeful evaluation of the available opportunities to make the best decision possible.
Marginal thinking requires decision-makers to evaluate whether the benefit of one more unit of something is greater than its cost.

Economics in the real world
Why Buying and Selling Your Textbooks Benefits You at the Margin

5. Trade

Markets brings buyers and sellers together to exchange goods and services.

The Circular Flow
  1. The circular flow shows how resources and final goods and services flow through the economy. There are two groups in the circular flow, households and firms, which want to trade with each other.
  2. The circular flow contains two markets. The first one is the product market with firms being sellers and households being buyers. The second one is the resource market with firms being buyers and households being sellers.
  3. Barter involves individuals trading a good they already have or providing a service in exchange for something they want. The problem is that barter requires a double coincidence of wants, in which each party in an exchange transaction has what the other party desires.
  4. A double coincidence of wants occurs when each party in an exchange transaction has what the other party desires.

(a) Circular Flow Model
(b) Circular Flow Model with Money

Trade Creates Value
  • Trade is the voluntary exchange of goods and services between two or more parties.
  • Comparative Advantage refers to the situation whether an individual, business, or country can produce at a lower opportunity cost than a competitor can.

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