The Economic Way of

Thinking

Basic Foundations of the Economic Way of Thinking:

1. Everything Has a Cost2. People Choose for Good Reasons3. Incentives Matter4. Systems Matter … and Influence Incentives5. People Gain from Voluntary Trade6. Economic Thinking is Marginal Thinking7. The Value of a Good or Service is Affected by

People’s Choices8. Economic Actions Create Secondary Effects

1. Everything Has a Cost

• “There is no such thing as a free lunch” (TINSTAAFL)

• Opportunity cost = the cost of the next best alternative

2. People Choose for Good Reasons

• People always face choices

• Cost-benefit analysis

• Different people have different values choices vary from person to person

• Business and government decisions are made by people

3. Incentives Matter

• When incentives change, people’s behavior changes in predictable ways.

4. Systems Matter … and Influence Incentives

• Economic systems are governed by rules

• As rules change, incentives and behavior change

• The success of market systems and the failure of communism are rooted in incentives

5. People Gain From Voluntary Trade

• Voluntary trade is mutually beneficial

• If a trade is not beneficial to both parties, the trade would not take place

6. Economic Thinking is Marginal Thinking

• Marginal choices involve the effects of additions and subtractions from current conditions

• Marginal analysis is similar to cost-benefit analysis (weighing additional costs and additional benefits)

7. The Value of a Good or Service is Affected by People’s Choices

• Goods and services do not have intrinsic value

• Value is determined by the preferences of buyers and sellers (supply and demand)

8. Economic Actions Create Secondary Effects

• Most economic actions cause secondary effects that are often unintentional

• Secondary effects can be positive or negative

• Must be analyzed when making a decision

Economic Economic Mysteries:Mysteries: The The

Law of Unintended Law of Unintended ConsequencesConsequences

1. Three strikes law

• Several states have enacted laws requiring judges to impose tough sentences for a third felony conviction. The result? An increase in the murder rate. Explain this phenomenon.

2. Seat belt laws

• There’s no question that wearing seat belts helps protect drivers and passengers. But seat belts have led to an increase in pedestrian and cyclist deaths. Why?

3. Saving horses from slaughter

• Thanks to the efforts of animal rights activists, horse slaughter is now banned in Texas and Illinois, home to the last three horse slaughterhouses in the United States. Some argue that this was bad news for horses. Why?

4. Reduced logging in National Forests• To protect the threatened northern spotted

owl, a federal judge issued an injunction in 1991 that greatly reduced logging in the national forests in the Pacific Northwest. Yet this policy may have resulted in more, not fewer, acres of forest being harvested worldwide. Why?

5. Steel tariffs

• In 2002, President Bush imposed a tariff on steel imports in order to protect the steel industry from foreign competition. He ended the tariff in 2003, partly because of evidence that the tariff was costing more American jobs than it was saving. Explain how that could happen.

6. Banning triple-trailer trucks

• Trucks with 3 trailers are 35% more likely to be involved in an accident than trucks with 2 trailers. Knowing this, many states have banned trucks with 3 trailers. The result . . . More accidents. What went wrong?

If we switched to triple-trailered trucks, each truck would have 135% as many accidents, but we'd need only 67% as many trucks.  This means we'd have 1.35 × .67 = 90.45% as many accidents with triple-trailered trucks as with double-trailered trucks.

7. Infant seats on airplanes

• Some politicians suggested requiring infant seats on airplanes, just as we do in cars. Economists intervened and explained that more infants would be killed as a result of this regulation. How can that be?