Big Idea of the Day--



Big Idea of the Day-- TANSTAAFL & Opportunity Cost

I. Big idea of the day: TANSTAAFL and Opportunity Cost

A. TANSTAAFL(There Ain’t No Such Thing As A Free Lunch.

1. For every choice made, something is given up (opportunity cost).

B. Opportunity Cost( The highest-valued alternative action foregone for a given choice or activity.

II. What is Economics?

A. Ask for student ideas of what economics is.

B. Book definition: “economics is the science of choice—the science that explains the choices that are made by individuals, firms, and societies and how those choices change in reaction to scarcity.”

C. My definition: the science that seeks to explain the distribution of scarce resources by individuals, firms, and governments, and the science that studies the interactions between these three groups to distribute those resources.

D. All economic questions arise from scarcity, the fact that wants exceed the resources available to satisfy the wants.

E. Because resources are scarce, people must make choices.

II. Big Economic Questions

A. What? What goods and services are produced and in what amounts?

B. How? How are goods and services produced?

C. When? When are goods and services produced?

D. Where? Where are goods and services produced?

E. Who? Who consumes the goods and services produced?

III. Big Ideas of Economics

A. A choice is a tradeoff, and the highest valued alternative given up is the opportunity cost of the activity chosen.

1. The opportunity cost of a choice is the highest alternative foregone, not all the alternatives foregone.

B. Choices are made in small steps, at the margin; these choices are influenced by incentives.

1. Marginal analysis, which compares the marginal cost of an activity (the added cost from making a small change) to the activity’s marginal benefit (the additional benefit from the small change), is how people make decisions. If the marginal benefit exceeds the marginal cost, the activity is undertaken; if it is short of the marginal cost, the activity is not undertaken.

2. Changes in the opportunity cost (the marginal cost), or in the marginal benefit of an activity, change the incentives and change the decision made.

C. Voluntary exchange makes both buyers and sellers better off, and markets are an efficient way to organize exchange.

1. People engage in voluntary exchange only if they expect the exchange to make them better off, so everyone gains from voluntary exchange.

2. Most exchange in our economy takes place in markets.

3. Markets are efficient because they send resources to the place where they are most highly valued.

D. The market does not always work efficiently so sometimes government action is necessary to overcome market failure and lead to a more efficient use of resources.

1. Market failure is not when prices rise (or are high) or prices fall (or are low).

2. Market failure may occur when one firm controls the market and restricts the quantity it produces; when producers fail to take into account all the costs of production; or when the good being produced can be consumed by everyone without paying for it.

E. For the economy as a whole, expenditure equals income equals the value of production.

1. Spending money on a product generates income for the producers of the product.

F. Living standards improve when production per person increases.

1. When productivity — production per person — increases, living standards increase because people can buy more products.

G. Prices rise when the quantity of money increases faster than production does.

1. Inflation is the process of rising prices.

2. Inflation results from “too much money chasing too few goods.”

H. Unemployment can result from market failure, but some unemployment is productive.

1. Some unemployment is normal and helpful as people search for good jobs and firms search for good employees.

2. Some unemployment is wasteful because it results from swings in total production.

IV. What Economists Do

A. Economics is divided into two areas: microeconomics and macroeconomics.

1. Microeconomics studies the decisions of individual households and firms, the way individual markets work, and how individual regulations and taxes affect markets.

2. Macroeconomics examines national and global economies. It looks at the determination of the overall level of economic activity, such as the amount of total employment, and also studies how government actions affect the aggregate economy.

B. Economic science attempts to understand the economic world. The distinction between “what is” and “what ought to be” is important.

1. Positive statements describe how the world actually is; they can be tested and possibly refuted. Positive statements tell “what is.”

2. Normative statements tell how the world should be; they depend on value judgments and cannot be tested. Normative statements tell “what ought to be.”

C. In their pursuit of economic science, economists observe and measure economic variables and then build and test models designed to help explain the observed facts.

1. Economic models are abstract and are used to make predictions about the real world. A model must contain assumptions about what is important and what can be ignored.

D. In developing economic models, the ceteris paribus (Latin for “other things equal”) clause is used to concentrate on the effect from a single variable in isolation from all others.

E. Two pitfalls can occur in the construction of economic theories:

1. The fallacy of composition is the false assertion that what is true of the parts must be true for the whole or, alternatively, what is true for the whole must be true for the parts.

2. The post hoc fallacy is the claim that one event caused another simply because the first event occurred before the second.

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