Economic LogicAssumptions, Rational Behavior, & Incentives
• Economists make many assumptions to analyze problems– Ceteris paribus: Latin for “all other things being equal”
• The art in economic analysis is deciding which assumptions to make…– wrong assumptions => poor Gov’t policy => poor outcomes
The Role of Assumptions
ScientistEconomist
Important Economic Assumptions:
• People make decisions based at the margin
• People make rational decisions
• People respond to incentives
Marginal Analysis
Selling Airline Tickets Diamonds vs. Water
Lesson: A consumer’s willingness to pay for any good is basedon the marginal benefit of an extra unit (the last unit sold)
Economic Decision Making
Economics assumes people are rational– Make decisions where MB ≥ MC
Is this rational?
11 min. Rational Behavior Video http://video.pbs.org/video/1479100777
Incentives Matter!
– Taxes encourage less activity
– Subsidies encourage more activity
Market System
Command System
Taxes & subsidies alter the behavior of consumers & producers by providing an incentive or disincentive
How would Gov’t ↑ taxes on gasoline $3.00 per gallon change the behavior of both consumers and producers?
CONSUMERS PRODUCERS
USA vs. Europe
Cost of Gasoline
USA: $3.70 per gallonEngland: $7.25 per gallon
Average tax per gallon: USA = $0.50 tax per gallon Europe = $3.50 tax per gallon
Gov’t incentivescan drastically change behavior
Economic Lesson:
End Result of High Gasoline TaxesCommon European Car in 2004!
Scooters almost as common as cars
Incentive Reading
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