History of economic thought
The principles of economic thinking
Petr Wawrosz
Some principles that is economics
based on
People face trade-off
• There is no such thing
as free lunch.
• Making decision
requires trading off one
goal against another.
• Production possibility
frontier
The cost of something is what you give
up to get it
• Opportunity cost
• All costs are subjective!
The value of goods is subjective.
• Peoples, preferences differ.
• Example: the indifferent curve of gourmand and
the indifferent curve of person preferring clothes
(or the indifferent curve of skinflint and the
indifferent curve of spendthrift person).
• The good has no objective value!
• Economics does not place any inherent moral
judgment on value on one personal person´s
preference over another´s – in economics all
individual preferences are counted equally.
People are rational
• An economic subjects
- systematically and purposefully do their best
they can to achieve his/her objectives (goals)
- uses all available information
- weighs benefits and costs of each action
• People do not intentionally make decision that
would leave them worse off.
Rational people think at the margin
• Marginal change = small incremental
adjustment to a plan of action
• Rational subject compares marginal benefits
and marginal costs (benefits and costs of
additional activity).
• Marginal benefit depends on amount of units
that is available (water-diamond paradox)
People respond to incentives
• Incentives = something that induce a person
to act
• Examples: price, norms, law, behavior of other
people
• Change of incentives generate direct as well as
indirect effects.
• Example: G. Depardieu and his choice to give
up French citizenship.
Human behavior has both direct and
indirect effects
• Direct = visible, clear effects. It is easy find
connection between behavior and effects.
• Indirect = invisible, unclear effects. Effects can
happen after time, at different place ….
• Between a good and a bad economist this
constitutes the whole difference—the good one
takes account of the visible effect; the bad one
takes account both of the effects which are seen
and also of those which it is necessary to foresee.
Peltzman effect
• Another example of the indirect effect.
• See:
http://www.youtube.com/watch?v=7IB2xRfRH
OA
Invisible hand
• The most classic example of indirect effect.
• Adam Smith: An Inquiry into the Nature and
Causes of the Wealth of Nations (1776):
• By directing that industry in such a manner as
its produce may be of the greatest value, 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 no part of his
intention.
Invisible hand
• Smith:
• Every individual is continually exerting himself to
find out the most advantageous employment of
whatever capital he can command. It is his own
advantage, indeed, and not that of the society,
which he has in view. But the study of his own
advantage naturally, or rather necessarily leads
him to prefer that employment which is most
advantageous to society.
Country´s standard of living depends
on its ability to produce goods
• Productivity = amount of goods produced
from one unit of resources.
• If a society wants to be wealthy in long-run it
must increase its productivity.
Trade can make everyone better off
• Economic isolation cannot improve standard
of living
- individual person
- family (household)
- village (town)
- region
- nation (state)
Markets are usually a good way to
organize economic activity
• Decision of any economic subject depends on
their will, skills and possibilities.
• Prices determine supply and demand of
goods.
The importance of property rights
• Property rights
• 1. the right to exclusive use the property (the
owner has sole possession control and use of the
property, including the right to exclude others).
• 2. legal protections against invasion from other
individual who would seek to use or abuse the
property without owner´s permission
• 3. the right to transfer, sell, exchange or mortgage
(lend) the property
The importance of property rights
• Private owners can gain by employing their
ownerships (resources) in ways that are
beneficial to others and they bear the
opportunity cost of ignoring the wishes of
others.
• Private owners have a strong incentive to care
for and properly manage what they own:
otherwise they lose the value of their
property.
The importance of property rights
• Private owners have an incentive to conserve
their property for the future, particularly if the
property is expected to increase in value.
• Private owners have an incentive to lower the
chance that their property will cause damage
to the property of others.
The importance of property rights
• See
http://www.youtube.com/watch?v=gwda3CFh5g
The middleman as a cost reducer
• Middleman = a person who buys and sells goods
or arranges trade.
• Middleman reduces transaction costs.
• Example: car dealer, a grocer, a stockbroker, a
realtor, a merchant
• Transaction cost = cost connecting with finding
part of contract, make a deal, solving problems of
contract (including enforcement of fulfillment).
Trade-off between Efficiency and
Equality
• A system without government intervention
usually promotes efficiency, but on the other
hands results in inequality: some people
(usually with low or insufficient skills) has low
income.
• Government interventions can increase
equality but usually reduce efficiency.
Government can sometimes improve
market outcomes
• Property rights
• Trade off efficiency-equity
• Market failure: public goods, externalities,
information asymmetry, market power,
macroeconomics policy
Prices rise when government print too
much money
• Inflation
• No commodity standard
• Independent central bank
Some names
• Adam Smith (1723 – 1790)
• Thomas Malthus (1766 – 1834)
• Frederic Bastiat (1801 – 1850)