Common Sense Economics

What Everyone Should Know About Wealth & Prosperity

by James Gwartney, Richard Stroup, and Dwight Lee

10 Key Elements
of Economics

CommonSenseEconomics.com
Ten Key Elements of
Economics
 Provide an introductory flavor for the course

 Bridge between common sense & basic

principles of economics

 Begin to help you “think like an economist”

 Provide some explanation as to why our

economy and our world work the way they do
1. Incentives matter.
What are Incentives?

 Incentives are the costs and benefits of

making specific decisions.

 Changing incentives alters people’s

behavior.

 Incentives operate on all levels- personal,

familial, industry and societal level.
Gasoline Prices…
 When the price of gas
rises, do you change
your behavior?

 Do you really?

 What’s the difference

between short-run
changes and long-run
changes in behavior?
Volunteerism…
 Incentives don’t
matter only to the
greedy and selfish.

 What incentives do
volunteers have, if
not monetary?

 Why do you
volunteer?
Seat belts save lives…
 Does wearing a seat
belt create any
incentives?

 Why do people get in

more accidents now
that cars are safer?
2. There is no such
thing as a free
lunch.
The condition of scarcity
 Our resources are limited…but our desire
for goods & services is NOT.

 When production costs are high, it is

because the resource in question is
desired for other purpose(s) as well.

 A resource is scarce if it has more than

one valuable use.
To Choose is to Refuse
 Because we are constantly
faced with scarcity, we must
make choices.

 Every time we choose one

thing (material or not) we
refuse something else.

 We constantly make trade-

offs in our decisions.
 But, but, but…
 What if someone else
buys your lunch?

 Merely a shifting of cost,

not an elimination

 And is it really free?

3. Decisions are
made at the
margin.
Marginalism…
 Few, if any, decisions are “all-or-nothing”.
 Marginal means additional…
 Marginalism is seldom ignored in our
personal decisions, but frequently in our
conversations and in politics.
 To get the most out of our resources, we
should only take an action when the
marginal benefits are greater than the
marginal costs.
Marginal Decision Examples…
 How clean is your house?
 Do you clean to 100%
cleanliness?
 How about when company
is coming?
 How about when selling
your house?
 You clean to the point
where the marginal costs
outweigh the expected
marginal benefits!
4. Trade promotes
economic
progress.
People gain when they trade…
 Trade moves goods from people who
value them less to people who value
them more.

 Trade makes larger outputs/consumption

possible as we specialize.

 Voluntary exchange allows production

costs to fall through mass production.
 Trade exists at many levels…

 Enrolling in this class

 Shopping at Safeway
 Having a garage sale
 Taking a vacation
 Buying imports from
China & Mexico
5. Transaction costs
are an obstacle to
trade.
Transaction Costs
Spending resources on:
 Searching out trading partners
 Searching out product information
 Negotiating terms of trade
 Closing sales
Why do we experience
transaction costs?
 Physical objects
 Can’t get there from here!
 Lack of information
 Finding sellers/ best deals
 Political obstacles
 Taxes, tariffs, licensing
requirements, regulations,
etc.
 Role of middlemen?
 Increase or decrease TC?
6. Profits direct
business toward
activities that
increase wealth.
Why profits are not the enemy…
 People of a nation are better off if their
resources produce valuable goods &
services.
 Less productive use of resources should
thus be discouraged.
 This is the function of profits and losses.
 Profit is a reward for transforming
resources into something of greater
value.
Losses just as important!
 A T-shirt factory has total
production costs of $20,000.
 1,000 T-shirts sold at $22 each =
$2,000 in profit.
 Wealth has been created for the
producer and consumer.
 What if shirts can only be sold for
$17 each?
 T-shirts are worth less to
consumers than the resources
required to produce them.
 What’s the trade-off if firms continue
to operate at a loss?
7. People earn
income by helping
others.
Earning Income
 People are different in many ways…This
is our greatest asset!
 Differences in income arise because they
affect the value of goods and services
individuals are willing to provide.
 There is a direct link (ceteris paribus)
between helping others & income.
 If you want a large income- figure out
how to help others!!!
Income Variation
 College students are
rewarded for
studying
 Star athletes and
entertainers are
rewarded for their
special skills
 Entrepreneurs are
rewarded for their
innovations.
8. Economic progress
comes primarily
through trade,
investment, better
ways of doing things,
and sound economic
institutions.
What is Economic Progress?

 Americans produce and earn THIRTY TIMES

as much as they did in 1750.
 Why are Americans so much more productive
today than they were 250 years ago?
 Why is economic progress important?
Sources of Economic Growth
 Investments in productive assets
 Tools, machines, “human capital”

 Improvements in technology
 Internal combustion engine, electricity,
computers, by-pass surgeries, etc.

 Improvements in economic organization

 Legal system, competitive markets, etc.
9. The “invisible hand”
of market prices
directs buyers and
sellers toward
activities that
promote the general
welfare.
Invisible What?
 Adam Smith, The Wealth of
Nations (1776)
 “It is his own advantage, indeed, and
not that of society which he has in
his view. But the study of his own
advantage naturally, or rather
necessarily, leads him to prefer that
employment which is most
advantageous to society…He
intends only his own gain, and he is
in this, as in many other cases, led
by an invisible hand to promote an
end which was not part of his
intention.”
Friedrich von Hayek
 Primary function of markets is to provide
information (both to buyers and sellers)
 Consider the price of apples…
 Price indicative of what consumers are willing and
able to pay, but also incorporates costs of
production/bringing to market
 Things constantly happen to make both consumer
value & production costs vary…
10. Too often long-term
consequences, or
the secondary
effects, of an action
are ignored.
Unintended Consequences

 Perhaps the most common source of

economic error.
 Actions often promote secondary effects.
 Tariffs & quotas to protect domestic
industries
 Paying for pencils in the 2nd grade class