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I have with me at this EFL program a new Dell Vostro 13 Notebook I have with me at this EFL program a new Dell Vostro 13 Notebook computer. It has 13” screen, DVD drive, 500 GB hard drive, 4 GB Ram, i 5 processor, windows 7, internal wireless, etc. Questions: It is mine. How much money would you give me for the computer? (You have until the end of the week to come up with the cash) ____ I have applied for a grant to study cigarette tax policies across the different states of the United States. To perform this project punctually, I will probably have to hire some research assistants. This work will have to be performed during the next 30 days. (at your home) The work will include data collection, research, and data coding. Questions: 2. How many hours would you work total over that time period? (next 30 days) if I paid you $35 per hour 3. I will probably undertake the project even if I do not get the grant. How many hours would you be willing to work if I paid you $10 per hour? Economics for Leaders

Economics for Leaders Lesson 2: Opportunity Cost & Incentives Economics for Leaders Economics for Leaders Lesson 2: Opportunity Cost & Incentives Economics for Leaders

Economic Reasoning Principle #1: People choose, and individual choices are the source of social Economic Reasoning Principle #1: People choose, and individual choices are the source of social outcomes. Scarcity necessitates choices Economics for Leaders

How Do You Know When Something Is Scarce? Scarcity Forces You to CHOOSE SCARCITY How Do You Know When Something Is Scarce? Scarcity Forces You to CHOOSE SCARCITY Economics for Leaders CHOICE

Economic Reasoning Principle # 2: Choices impose costs; people receive benefits and incur costs Economic Reasoning Principle # 2: Choices impose costs; people receive benefits and incur costs when they make decisions. The cost of a choice is the value of the next-best alternative foregone. Economics for Leaders

Opportunity Cost: the value of the next best or foregone alternative Think: “next-best” Economics Opportunity Cost: the value of the next best or foregone alternative Think: “next-best” Economics for Leaders

Opportunity Cost =the value of the Next-Best Alternative – What are the considered alternatives? Opportunity Cost =the value of the Next-Best Alternative – What are the considered alternatives? • What would you do – not what could you do? • What does the decision-maker perceive to be the benefits of each alternative? Economics for Leaders

Opportunity Cost Analysis What was the 1 st decision you made this morning? Economics Opportunity Cost Analysis What was the 1 st decision you made this morning? Economics for Leaders

Opportunity Cost Analysis Decision Maker: YOU Alternatives: Perceived Benefits Choice Opp. Cost Benefits Refused Opportunity Cost Analysis Decision Maker: YOU Alternatives: Perceived Benefits Choice Opp. Cost Benefits Refused Economics for Leaders Get Up Now Don’t Get Up Now

Opportunity Cost Analysis Decision Maker: YOU Alternatives: Perceived Benefits Choice Opp. Cost Benefits Refused Opportunity Cost Analysis Decision Maker: YOU Alternatives: Perceived Benefits Choice Opp. Cost Benefits Refused Economics for Leaders Get Up Now Shower bkfst don’t rush On time coffee Don’t Get Up Now More sleep

Opportunity Cost Analysis Decision Maker: YOU Alternatives: Perceived Benefits Choice Opp. Cost Benefits Refused Opportunity Cost Analysis Decision Maker: YOU Alternatives: Perceived Benefits Choice Opp. Cost Benefits Refused Economics for Leaders Get Up Now Shower bkfst don’t rush On time coffee Don’t Get Up Now More sleep X X

Choosing is Refusing Every time we choose we pay a cost. Economics for Leaders Choosing is Refusing Every time we choose we pay a cost. Economics for Leaders

People’s Choices are always RATIONAL Rational choice = choosing the alternative that has the People’s Choices are always RATIONAL Rational choice = choosing the alternative that has the greatest excess of benefits over costs. If ALL choices are rational, then the challenge is to understand the decisionmaker’s perception of costs and benefits. Economics for Leaders

Economics for Leaders Economics for Leaders

Characteristics of Costs are the results of ACTIONS Costs are TO people; things have Characteristics of Costs are the results of ACTIONS Costs are TO people; things have no cost All costs lie in the FUTURE (past costs are “sunk” costs) Costs are frequently not monetary (although we may value them in dollar terms) Economics for Leaders

What Determines Your Opportunity Cost? Alternatives Tastes and preferences (values) Rules of the Game--Institutions What Determines Your Opportunity Cost? Alternatives Tastes and preferences (values) Rules of the Game--Institutions Economics for Leaders

Do Gov’t actions have opportunity costs? Government Debt Economic Stimulus Package War in Iraq Do Gov’t actions have opportunity costs? Government Debt Economic Stimulus Package War in Iraq Limiting Carbon Emissions Universal Healthcare All alternatives have cost and benefits Individuals perceive the value of costs and benefits differently Economics for Leaders

Back to Scarcity: What’s the Question? (And what does opportunity cost have to do Back to Scarcity: What’s the Question? (And what does opportunity cost have to do with it? ) Should we Allocate? ration? Given that we MUST ration, what is the best mechanism? Economics for Leaders

Allocating/Rationing DVDs Economics for Leaders Allocating/Rationing DVDs Economics for Leaders

Methods of Rationing Scarce Goods and Services prices command (someone decides) majority rule contests Methods of Rationing Scarce Goods and Services prices command (someone decides) majority rule contests by force voting Economics for Leaders first-come-firstserved sharing equally lottery personal characteristics need or merit

Why is price rationing the most common method of allocating scarce goods, services, and Why is price rationing the most common method of allocating scarce goods, services, and resources in our economy? 1. The outcome is clear 2. Individuals can affect the outcome based on their desire for the product 3. It directs resources to their most highly valued uses 4. Individuals’ power and freedom is enhanced 5. It provides incentives for both consumers and producers to reduce scarcity. Economics for Leaders

Where do Prices Come From? The market interaction of buyers and sellers in open Where do Prices Come From? The market interaction of buyers and sellers in open and competitive markets! Economics for Leaders

Prices: POWERFUL Incentives When prices change, opportunity costs change – that’s an incentive! Both Prices: POWERFUL Incentives When prices change, opportunity costs change – that’s an incentive! Both consumers and producers react to prices in ways that help us to deal with scarcity. Economics for Leaders

Economic Reasoning Principle # 3: People respond to incentives in predictable ways. Choices are Economic Reasoning Principle # 3: People respond to incentives in predictable ways. Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, behavior changes in predictable ways. Economics for Leaders

When incentives (Prices) change, behavior changes in predictable ways. When prices go up consumers When incentives (Prices) change, behavior changes in predictable ways. When prices go up consumers demand a larger/smaller quantity? Demand The willingness and ability to purchase goods and services at various prices. Economics for Leaders

When incentives (Prices) change, behavior changes in predictable ways. When prices go up consumers When incentives (Prices) change, behavior changes in predictable ways. When prices go up consumers demand a larger/smaller quantity? Smaller When prices go down consumers demand a larger/smaller quantity? Larger Always? Law of Demand P Q Economics for Leaders

When incentives (Prices) change, behavior changes in predictable ways. When prices go up producers When incentives (Prices) change, behavior changes in predictable ways. When prices go up producers supply a larger/smaller quantity? Supply Producers willingness and ability to produce goods and services at various prices. Economics for Leaders

When incentives (Prices) change, behavior changes in predictable ways. When prices go up producers When incentives (Prices) change, behavior changes in predictable ways. When prices go up producers supply a larger/smaller quantity? Larger When prices go down producers supply a larger/smaller quantity? Smaller Always? Law of Supply P Q Economics for Leaders

What does Opportunity Cost have to do with supply and demand? Everything! Economics for What does Opportunity Cost have to do with supply and demand? Everything! Economics for Leaders

Choices are made at the Margin Our only choice is the next choice Marginal Choices are made at the Margin Our only choice is the next choice Marginal = additional, next, a little more or a little less Economics for Leaders

How much should we do? Work Play Study Sleep Buy Sell Economics for Leaders How much should we do? Work Play Study Sleep Buy Sell Economics for Leaders

As long as the marginal benefit is greater than the marginal cost you should As long as the marginal benefit is greater than the marginal cost you should continue the activity MB=MC Economics for Leaders

The “Big Ideas” from Lesson 2: 1. Scarcity forces us to choose and every The “Big Ideas” from Lesson 2: 1. Scarcity forces us to choose and every choice has an opportunity cost. 2. When opportunity costs change, incentives change, and choices change. 3. Because costs lie in the future, the important costs and benefits occur at the margin. 4. Money price rations goods in markets. 5. Consumers and producers respond to changes in price in predictable ways. Economics for Leaders