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Important Economic Concepts
• Economists make many assumptions
• People make rational decisions
• People respond to incentives
• Economists make assumptions to analyze the real world– If assumptions are incorrect => analysis is often wrong
• Economics is a social science (not exact), so the result of economic policy is uncertain– we can reach conclusions “holding other factors constant”
The Role of Assumptions
ScientistEconomist
Decision Making
Economists assumes people make rational decisions• meaning the benefits are greater than the costs
Is this rational?
Rational Behavior Video Play 8 min. http://video.pbs.org/video/1479100777
IncentivesPeople respond to incentives
Government uses Taxes or Subsidies to alter behavior
encourage consumer to use less encourage consumer to use more
Incentives Matter Reading
2) “The pocketbook is mightier than the conscience”
4) “Perverse Incentive”
3) The law of unintended consequences
1) private property vs. communal property
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: