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.

Broken window fallacy Example of the indirect effect. See: The broken window fallacy was described by Frederic Bastiat: „That Which Is Seen and That Which Is Unseen“ ( en,_and_That_Which_Is_Not_Seen) en,_and_That_Which_Is_Not_Seen

Peltzman effect Another example of the indirect effect. See: OA 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 da3CFh5g

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)