Common Sense Economics
What Everyone Should Know About Wealth & Prosperity
by
James Gwartney, Richard Stroup, and Dwight Lee
CommonSenseEconomics.com
10 Key Elements
of Economics
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Ten Key Elements of Economics

Build a bridge between common sense and
economic applications.

Provide a solid foundation in economic reasoning.

Apply common sense to help readers make
strategic consumption, savings, investment,
career, and voting choices.

Explain why people cooperate in order to help
themselves prosper and their nations grow.
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1. Incentives matter.
10 Key Elements of Economics
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What Are Incentives?

Incentives are factors that encourage or
discourage various types of behaviors,
actions or activities.

Changes in incentives alter the way people
behave.

Incentives influence behavior at all levelspersonal, familial, business, government,
and national.
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Gasoline Prices…




When gas prices rise, do
you have an incentive to
change your behavior?
When do you stop talking
and start acting?
How can you change
your behavior in the
short-run?
How can you alter it in
the long-run?
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Incentives: Producers and Consumers

What is the main incentive of the producer?


Provide consumers with what they value the most
while covering their costs of production and
making a profit.
What is the incentive of the consumer?

Get the most of what they value from their
expenditures.
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Volunteerism…

Incentives matter to
everyone, including
volunteers and charitable
organizations.

What incentives do
volunteers have? Are they
only monetary?

Describe some incentives
offered to encourage
people to volunteer, donate
blood and assist Habitat for
Humanity in the building of
houses.
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2. There is no such
thing as a free lunch.
10 Key Elements of Economics
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The Condition of Scarcity

Our resources are limited…but our desires
for goods and services are NOT.

Something is scarce if it has more than
one valuable use. Consider your time.

When resources are used to do one thing,
they are unavailable to do others.
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To Choose Is To Sacrifice

Scarcity forces us to make
choices.

Choosing an action means we
sacrifice doing something
else.

The opportunity cost of a
choice is the value of what is
given up.
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There Is No Such Thing As A Free Lunch



What if a financial planner
offers to buy you lunch?
You incur no money cost
but you sacrifice time that
could have been used to
do something else.
The value of your next best
option is the opportunity
cost of going to the “free”
lunch.
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3. Decisions are made
at the margin.
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Marginalism…




Few, if any, decisions are “all-or-nothing”.
Marginal means additional or one more.
We are constantly facing marginal choices.
To get the most out of our resources, we
should only take an action when the
additional benefits are greater than the
additional costs.
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Marginal Decision Examples…

How much do you clean your
house or room?



Do you clean until 100% of the
dirt and clutter has been
removed when its just you and
no company is expected?
Do you clean until 100% of the
dirt and clutter has been
removed when you expect
company?
You clean as long as the
marginal costs are less than
the marginal benefits!
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Apply Marginal Thinking To

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Weeding an overgrown garden
Cleaning up a polluted stream
Picking up litter along the highway
Eating pizza
Eating at an “All You Can Eat” buffet
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4. Trade promotes
economic progress.
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People Gain When They Trade
Trade (Voluntary Exchange)

Moves goods and services from people who value
them less to people who value them more.

Makes larger output and consumption possible by
allowing us to specialize in doing what we do best.

Makes larger output and lower per-unit costs
possible as a result of mass production.
Trade leads to larger output and higher
income levels.
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Discuss how trade effects the well being
of the trading partners in the following
scenarios.

Flea Market

eBay

Garage sales

International trade
between the U.S. and
Mexico
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5. Transaction costs are
an obstacle to trade.
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Transaction Costs


Transaction costs: resources spent when
making an exchange or transaction.
Buyers and sellers spend scarce resources
when they




Search for exchange partners
Locate product information
Negotiate the terms of trade
Finalize and formalize contracts and agreements
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Why are there transaction costs?

Physical obstacles


Scarcity of information


Locate buyers and sellers; assess
their reputation; and find best deals
Political obstacles


Movement of goods from sellers to
buyers
Taxes, tariffs, quotas, licensing
requirements, and other regulations
Middlemen


List a few types.
Describe how they impact the costs
of transacting in a complex world.
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6. Profits direct business
toward activities that
increase wealth.
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Profits: Friend or Foe?





People are better off if their resources are
directed toward the production of goods and
services valued highly relative to costs.
Users should be encouraged to undertake
productive projects.
Profits and losses perform this function.
Profits provide rewards to those who
transform resources into goods and
services that are valued more than costs.
Losses impose a penalty on the
unproductive use of resources.
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Losses Are Important!



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
A T-shirt factory has total production
cost of $20,000.
1,000 T-shirts can be sold at $22 each.
This production results in a $2,000
profit.
Consumers value the T-shirts more
than the resources required for their
production.
What if these shirts could be sold for
only $17 each? What is the total sale
price? Is there loss or a profit?
This loss of $3000 indicates that the Tshirts are worth less to consumers than
the resources required to produce
them.
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7. People earn income
by helping others.
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Earning Income




What do you have to do to earn a high
income?
Explain why you need others to earn a high
income?
How do you know that others value the
services or goods you provide?
Explain why high earnings come from
providing goods and services that others
value.
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Income Variation




College students are
rewarded for studying.
Star athletes and
entertainers are
rewarded for their
specialized skills.
Entrepreneurs are
rewarded for their
productive innovations
and risk-taking.
Why does Tiger Woods
earn more than a
nurse?
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8. Economic progress comes primarily
through trade, investment, better
ways of doing things, and sound
economic institutions.
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What is Economic Progress?



Americans produce and earn THIRTY TIMES more
now than colonists did in 1750.
What contributed to this economic progress?
Why is this progress important?
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Sources of Economic Growth

Investments in productive assets


Entrepreneurial discoveries and improvements in
technology


Physical capital (tools, machines, computers, and buildings)
and human capital (education, vocational training, and
professional development)
Cotton gin, assembly line, refrigerators, telephone, polio
vaccine, microwave, minicomputer, and artificial heart
Improvements in economic organization

Rule of law, even handed enforcement, competitive markets,
limited government and money of stable value
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9. The “invisible hand” of market
prices directs buyers and
sellers toward activities that
promote the general welfare.
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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.”
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What Is the Invisible Hand?


Through price signals, the primary
function of markets is to provide
information to buyers and sellers.
The invisible hand of market prices
directs millions of self-interested
individuals into cooperative action and
brings their choices into line with each
other.
Friedrich von Hayek
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Price Signals and the Invisible Hand

By pursuing self-interests in markets, individuals
help others and everyone is made better off.

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Who is made better off when consumers buy MP3 players?
How do consumers indicate how much they value MP3
players?
How do MP3 manufacturers relate production costs to
consumers?
Do the MP3 consumers and producers ever meet to swap
information on consumer preferences and production costs?
What makes this possible?
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10. Too often long-term
consequences, or the
secondary effects, of an
action are ignored.
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Secondary Effects or Long Range
Consequences
A person
“…must trace not merely the immediate results
but the results in the long run, not merely the
primary consequences but the secondary
consequences, and not merely the effects on
some special group but the effects on
everyone.”
- Henry Hazlitt [1979]
Economics in One Lesson
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Unintended Consequences

Well intended actions have secondary effects
that impact others. Discuss the secondary
effects of:



Rent controls designed to make housing
affordable for the poor.
Tariffs and quotas designed to protect domestic
industries.
Government projects designed to increase
employment in construction.
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If policymakers have good
intentions
Will their actions lead to desirable
outcomes?
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