Economics for Leaders I have with me at this EFL program a new Dell Vostro 13 Notebook computer. It...

Economics for Leaders

I have with me at this EFL program a new Dell Vostro 13 Notebook computer. It has 13” screen, DVD drive, 500 GB hard drive, 4 GB Ram, i5 processor, windows 7, internal wireless, etc.Questions:

It is mine. How much money would you give me for the computer? (You have until the end of the week to come up with the cash) ________

I have applied for a grant to study cigarette tax policies across the different states of the United States. To perform this project punctually, I will probably have to hire some research assistants. This work will have to be performed during the next 30 days. (at your home) The work will include data collection, research, and data coding.Questions:

2.How many hours would you work total over that time period?(next 30 days) if I paid you $35 per hour

3. I will probably undertake the project even if I do not get thegrant. How many hours would you be willing to work if I paid you $10 per hour?



Lesson 2: Opportunity Cost & Incentives


Economic Reasoning Principle #1: People choose, and individual choices are the source of social outcomes.

Scarcity necessitates choices


How Do You Know When

Scarcity Forces You to CHOOSE

Something Is Scarce?

SCARCITY CHOICE


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.


Opportunity Cost: the value of the next best or

foregone alternative

Think: “next-best”


Opportunity Cost =the value of the

Next-Best Alternative

– What are the considered alternatives?• What would you do – not what could you

do?• What does the decision-maker perceive

to be the benefits of each alternative?


Opportunity Cost Analysis

What was the 1st decision you made this morning?



Alternatives: Get Up Now Don’t Get Up Now

Perceived Benefits

Choice

Opp. Cost

Benefits Refused

Decision Maker: YOU




Perceived Benefits

Shower bkfst don’t rushOn time coffee

Choice

Opp. Cost

Benefits Refused

Decision Maker: YOU

More sleep




Perceived Benefits

Shower bkfst don’t rushOn time coffee

Choice X

Opp. Cost

Benefits Refused

Decision Maker: YOU

More sleep

X


Choosing is Refusing

Every time we choose we pay a cost.


People’s Choices are always RATIONAL

Rational choice = choosing the alternative that has the greatest excess of benefits over costs.If ALL choices are rational, then the challenge is to understand the decision-maker’s perception of costs and benefits.


Characteristics of Cost

Costs are the results of ACTIONSCosts are TO people; things have no costAll costs lie in the FUTURE (past costs are “sunk” costs)Costs are frequently not monetary (although we may value them in dollar terms)


What Determines YourOpportunity Cost?

AlternativesTastes and preferences (values)Rules of the Game--Institutions


Do Gov’t actions have opportunity costs?

Government DebtEconomic Stimulus PackageWar in IraqLimiting Carbon EmissionsUniversal Healthcare

All alternatives have cost and benefitsIndividuals perceive the value of costs and benefits differently


Should weShould weAllocate?Allocate? ration? ration?

Given that we MUST ration, what is the best mechanism?

Back to Scarcity: What’s the Question? (And what does

opportunity cost have to do with it?)


Allocating/Rationing DVDs


Methods of Rationing Scarce Methods of Rationing Scarce Goods and ServicesGoods and Services

pricesprices

command command (someone decides)(someone decides)

majority rulemajority rule

contestscontests

by forceby force

votingvoting

first-come-first-first-come-first-servedserved

sharing equallysharing equally

lotterylottery

personal personal characteristicscharacteristics

need or meritneed or merit


Why is price rationing the most common method of allocating scarce goods, services, and resources in our economy?

1.1. The outcome is clearThe outcome is clear

2.2. Individuals can affect the outcome based Individuals can affect the outcome based on their desire for the producton their desire for the product

3.3. It directs resources to their most highly It directs resources to their most highly valued usesvalued uses

4.4. Individuals’ power and freedom is Individuals’ power and freedom is enhancedenhanced

5.5. It provides incentives for both consumers It provides incentives for both consumers and producers to reduce scarcity.and producers to reduce scarcity.


Where do Prices Come From?

The market interaction of buyers and sellers in open and competitive markets!


Prices: POWERFUL Incentives

When prices change, opportunity costs change –that’s an incentive!Both consumers and producers react to prices in ways that help us to deal with scarcity.


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.


When incentives (Prices) change, behavior changes in predictable

ways.

When prices go up consumers demand a larger/smaller quantity?

Demand

The willingness and ability to purchase goods and services at various prices.



ways.

When prices go up consumers demand a larger/smaller quantity?

SmallerWhen prices go down consumers demand a larger/smaller quantity?

LargerAlways?Law of Demand P Q



ways.

When prices go up producers supply a larger/smaller quantity?

Supply

Producers willingness and ability to produce goods and services at various prices.



ways.

When prices go up producers supply a larger/smaller quantity?

LargerWhen prices go down producers supply a larger/smaller quantity?

SmallerAlways?Law of Supply P Q


What does Opportunity Cost have to do with supply and demand?

Everything!


Choices are made at the Margin

Our only choice is the next choiceOur only choice is the next choice

Marginal = additional, next, a little Marginal = additional, next, a little more or a little lessmore or a little less


How much should we do?

WorkPlayStudySleepBuySell


As long as the marginal benefit is greater than the marginal cost you should continue the activity

MB=MC


The “Big Ideas” from Lesson 2:

1. Scarcity forces us to choose and every choice has an opportunity cost.

2. When opportunity costs change, incentives change, and choices change.

3. Because costs lie in the future, the important costs and benefits occur at the margin.

4. Money price rations goods in markets.5. Consumers and producers respond to

changes in price in predictable ways.

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