AnnouncementsAnnouncements

• First assignment due next Tuesday. Post to discussion board and turn in on Assignments page!

Critical concepts in economicsCritical concepts in economics

Points to CoverPoints to Cover

• Desirable ends, scarce resources, human behavior, how do we allocate?

• Opportunity cost: micro and macro• Marginal analysis• Cost benefit principle and its limitations

The Definition of Economics The Definition of Economics (again)(again)

• Economics is the allocation of scarce resources among alternative desirable ends, within and between generations

What are the desirable ends?What are the desirable ends?

• Is this a question for economists?

• For science?

• What is the conventional answer from economists?– Preference satisfaction

• How do we know what people prefer? • Who’s preferences matter?

– Maximization of monetary value– Ever greater consumption of market goods– What about non-market goods?

What are the desirable ends?What are the desirable ends?• Does sustainability matter?

– Do future generations have any say in today’s markets?

• Does distribution matter?– Who should own goods and services created by

nature?

– by society as a whole?

• Is stability desirable?– Is job security important?

– Is food/energy security important?

• Other desirable ends?

What are the scarce resources?What are the scarce resources?• What does ‘scarce’ mean?

• The Scarcity principle: – Resources are limited. If we use a resource to do one thing, we

cannot use it to do something else.

• “Scarcity characterizes virtually everything”?– Is this true about information?

– About oxygen?

– About ecosystem services?

– What happens to GNP when abundant resources become scarce?

• Economics is all about choosing how to use scarce (and non-scarce) resources.

What are the scarce resources?What are the scarce resources?

• 4 capitals– Natural– Built– Human– Social

• What is scarcer, forests or sawmills? Fish or boats? Cars and roads, or more clean water and wilderness?

• Have there been changes in relative scarcity?

What are the properties of the What are the properties of the available resources?available resources?

• Can they be owned?

• If one person uses it, does it prevent others from using it?

• Does one person’s use have a negative impact on others (negative externality)?

• Are they created by nature, society or individuals?

How do people behave?How do people behave?

• Homo economicus – Self interest

• Always wants more• Purely competitive• “self contained globules

of desire”

– Rational actor• What is rational?• Are people purely

rational, or also emotional and spiritual?

How do people behave?How do people behave?

• Or are we cooperative, social animals, concerned about the future that differ across cultures?– e.g. H. comunicus, concern for fairness

and community preferences– H. naturalis, concern for sustainability

and whole system preferences• Evidence from behavioral economics and

sciences– E.g. oxytocin

How do we allocate resources?How do we allocate resources?• Markets and price theory

– Decentralized free choice that under certain conditions maximizes monetary value

• Is maximizing monetary value a suitable goal?– Maximize value by selling to whoever can pay the

most

• Do markets maximize monetary value?– Green technologies more valuable the more they

are used

How do we allocate resources?How do we allocate resources?

• Other allocative mechanisms– Participatory democracy?– State ownership?

• The atmosphere?• Natural resources, e.g. water, oil?

– Common ownership?• Vermont Common Assets Trust

– Citizen activism and the role of civil society

• What is appropriate depends on the answers to the other questions

AnnouncementsAnnouncements

• Assignment due dates are posted on blackboard– Must click on assignment

• Neither I nor TAs are obliged to answer questions already answered in the syllabus

Thinking Like an EconomistThinking Like an Economist

• Opportunity Costs• Marginal Costs• Cost Benefit analysis

Opportunity cost: micro levelOpportunity cost: micro level

• The best alternative you sacrifice when you do something else.

• Allocating resources• Allocating income• Allocating time

You could be here…

How much does it cost to attend How much does it cost to attend UVM?UVM?

A. Tuition paymentsB. Tuition payments plus housing and foodC. Tuition payments plus the money I could

have made working if I was not attending UVM

D. Tuition payments, housing, food and income I could have made working

E. Negligible, because higher education is heavily subsidized in the US, same as in the other rich countries

Opportunity cost: macro levelOpportunity cost: macro level

Marginal analysisMarginal analysis

• What does ‘marginal’ mean?

• Why does it matter?

Marginal values: Marginal values: diamond water paradoxdiamond water paradox

• Why do diamonds cost more than water?

• Use value = total value

• Exchange value = marginal value

• How much is a glass of water worth to you right now? How much is all the water you drank this month worth?

• BASIC RULE OF ECONOMICS:Optimum occurs when MARGINAL BENEFIT = MARGINAL COST

Non-marginal impactsNon-marginal impacts

• Thresholds• Irreversible change• Positive feedback loops

What investments should we prioritize AT What investments should we prioritize AT THE MARGIN to achieve our desirable ends?THE MARGIN to achieve our desirable ends?

• Invest in built capital: More GNP, more material consumption? Stand up and face left

• Invest in natural capital: stable climate, clean air, clean water, forests, etc.? Stand up and face right

• Invest in social capital: More time with family, friends, community? Stand up and face backwards

• Invest in human capital: better education, better health care.Stand up and face forwards

Cost Benefit PrincipleCost Benefit Principle

• If the benefits are greater than the costs, do it.

• Sounds easy, BUT…– Can all costs be measured in the same units,

and compared?– How do we treat C&B in the future?– C&B that affect different people?– Is that how people behave?

• E.g. would Carlos Slim Helú pick up a $100 bill?

Decision pitfalls in CBADecision pitfalls in CBA

• Ignoring opportunity costs

• Failure to ignore sunk costs– All you can eat restaurant

• Failure to understand the average-marginal distinction– If the marginal benefit is greater than the

marginal cost, do it.

• Ignoring social costs and benefits

ReviewReview

• Desirable ends, scarce resources, human behavior, how do we allocate?

• Opportunity cost: micro and macro• Marginal analysis

– MC=MB

• Cost benefit principle and its limitations