Let's start by thinking about what economics is. And we're going to start that discussion by thinking about scarcity. So if we think about scarcity, the idea behind scarcity is that society has unlimited wants and limited resources. So it's impossible for us to produce all of the goods and services that people want to consume.
And we'll talk about the fact that that scarcity is going to lead to trade-offs. We'll get into that here in just a second. But that scarcity also is what leads to the field of economics.
So let's talk for a second about what economists do. What is the field of economics? One of the exercises that I go through with my face-to-face classes is something that I used to, when I first started teaching, I would send my students on the first day of class, before we talked about anything, we would meet, we'd talk about the syllabus, we'd talk a little bit about what I expected to have the students do in class and what they could expect from me.
And then we wouldn't really have time to get into the material, so I would send them home with this little survey. And the survey was just designed to get them to think about some of the stuff that we talked about, we're going to talk about in class. and then just gather some information about them. One of the questions I asked on that first day survey was designed to try to get them to understand what economics was.
And so I would give them a list of topics, and the question that I would have them answer was this one. Which of the following subjects do you think economics can help us understand? So I wanted them to put a checkmark.
If this topic was something that... that we would study in an economics class. And so some of them were, some of them weren't. I said here, this isn't a trick question. Economics doesn't help us understand everything.
So let me just read some of these to you, and you just think about whether or not this is something that you believe we would talk about in an economics class. The first one is the business cycle. What I do now is on the first day of class, I just read these off and I have the class raise their hand. So, when I say the business cycle, well, everybody recognizes that. Yeah, that's an economics thing.
Everybody raises their hand. When it was a survey, everybody would check that. The second one, what causes unemployment?
Again, people typically raise their hand. Let me just read some of these others. The freezing point of milk.
What causes inflation? How the human heart works. How fast people drive on the highway.
How to maximize profit. How much people eat at a buffet. How much students study for a test? The cause of earthquakes?
How long a homeowner waits to mow their lawn? How long students pay attention during an economics lecture? How the banking system works? Why stock prices change?
How long parents wait before checking on a crying baby? Why criminals sometimes voluntarily confess to the police? Why gamblers tend to lose money?
When a base runner decides to steal a base? Why fish swim in schools. Why politicians engage in negative campaigns. And there's several more on there.
And of course what happens is, whether it's students checking a box on a survey or whether it's students raising their hand in a classroom, what happens is hands go up when I say something like how to maximize profit or how the banking system works or why stock prices change. Everybody's hand goes up. But then when I say those ones that are the ones like how long a homeowner waits to mow their lawn, hardly anybody would ever raise their hand. Or how fast people drive on the highway. Or when a base runner decides to steal a base.
Hardly any hands ever go up. And of course, if I were to say something like why fish swim in schools, eh. And the reason I do this is to illustrate to people that if your hand went up, Every time I said something like the banking system or I said something like the stock market and your hand didn't go up when I said how long students pay attention during an economics lecture or how fast people drive on the highway, then you don't really understand what economics is. People typically raise their hand when dollars, when the thing that I've just read has something to do with dollars, stock prices, banking systems. Stuff like that.
Inflation. But they skip the stuff like how much people eat at a buffet, how long a homeowner waits to mow their lawn. That's economic. All of those things that you do raise your hand on, the business cycle, that's economics too. But that other stuff that most people don't raise their hand on, a lot of that other stuff I read, that's also economics.
So let's talk about the definition of economics. At its most basic level, it's the study of human behavior. Study of human behavior.
That is what economists do. They study human behavior. So you should, once you understand that, you should raise your hand on everything that involves somebody making a decision. How long a homeowner waits to mow their lawn, that is a human behavior.
How long parents wait before checking on a crying baby. When a base runner decides to steal a base, there's a lot of economics literature devoted to things like that. So, I guess the real reason that I do that in a class, or the real reason that I would do that by sending home a survey, is to get students to realize that economics is not about the financial fate of people. That's not it.
We can talk about that, and economists understand that, and we will spend some time talking about it, but economics is so much more than that. Economics is about human behavior. And if I were to ask a thousand people out there on the street, Where should you go on a college campus to study human behavior?
A vast majority of them would say, well, you should go maybe to the sociology department or maybe you should go to psychology. And those are places where they are studying human behavior. But if you want to study human behavior at its most basic level, the economics department is where that's going on. We typically talk a lot about business types of situations because there are large numbers of dollars on the line.
So if you understand human behavior, then it's natural to talk about human behavior in the context of large dollars, large amounts of dollars being transacted. But at its most basic level, it's the study of human behavior. Turns out, though, that it's actually more general than that.
There's some economics literature where they study the behavior of animals. So if you look at, say, a rat in a cage, and you think about how much food that rat eats, let's suppose that at the end of the cage there's a device there where the rat presses a lever, and if they press the lever once, a piece of food falls out and the rat eats it, and if they press the lever again, another piece of food falls out. If we were to look at the amount of food that the rat consumes in a day, And then change the price of food for the rat. If I were to ask most people out there on the street, what's going to happen if we change the price of food?
Most people will say, it won't matter. The rat won't respond to that because it's just a rat. I mean, they have nothing to do in this cage all day except press the lever and eat food.
So they're just going to eat the same amount of food. Turns out that's not at all what happens. Rats respond to prices the same way we do. If the price of something goes up, all other things equal, price of something goes up, we want to buy less of it. If you raise the price of food for the rat, it will consume less food.
Raising the price of food looks like just making it press the bar more than one time for a piece of food. If you raise the price, it will consume less food. So some economic literature is devoted to just the study of behavior, whether it's a human or whether it's some other animal.
But obviously in this class we're not going to be thinking about the eating habits of rats, so we're going to be thinking about the study of human behavior. But at its most basic level, that's what we study in an economics class. We study how people make decisions.
In this video we're going to talk about ten basic principles of economics. So what these are, are principles that you tend to see in any... economics class that you might take. So the field of economics is very, very broad. Economics is an old discipline, and there are lots and lots of sub-disciplines within the general field of economics.
The kind of big distinction is going to be microeconomics versus macroeconomics. In macro, you're looking at the big picture, how an economy functions. In micro, you're looking at... The small picture, how we understand individual behavior or how an individual business might make its decisions.
But within those two main categories, we've got lots of subdivisions. And so there are all kinds of different... Subfields within economics. There's labor economics and international economics and public choice theory and game theory and econometrics and a subdivision called cleometrics, which is the overlap between history and economics and lots and lots of others. Regardless of whether you're taking a class in this subdiscipline or that subdiscipline or this subdiscipline over here.
There are some basic principles that tend to pop up in all of them, and so what we're going to do here is talk about those basic principles. The first one, and the numbers of these are not important, but let's just kind of run through them. The first one is that people face trade-offs. And so what we mean there, that's one of those things that... You might think, well, that just kind of goes without saying, but it doesn't.
The idea here is that to get something you want, you're always going to have to give up something else you want. So we could be thinking about how you choose to spend your household income. So you have some income that you've earned from working, and then you've got to decide whether you should spend it on pizzas or...
or textbooks for a class, or whether you should spend it going to a movie, or all of the other things that you could spend that money on. And if you spend money on one thing, that's money that can't be spent on something else. So there's a trade-off there.
We could think about, so let's just put here maybe your income. We could think about your time. How do you spend your time?
There's a trade-off there. If you spend one hour studying for a test, that's an hour that you can't spend sleeping or going out with your friends or watching TV or whatever you might be doing with your time. So there are trade-offs that you face in terms of income, time, lots of things, opportunities. It's also the case that society faces trade-offs.
So if we think about a trade-off that society faces, society faces the trade-off between production of consumer goods and services and national defense. Sometimes we refer to that as the guns versus butter trade-off. We like to have both of them.
We like to have national defense and we like to have consumer goods and services. And it'd be great if we could just have more of everything, but we can't. Any resources that we devote to national defense are resources that can't be devoted to building new roads or scholarships to go to school, things like that. There's also a trade-off that society faces between efficiency and equity. Efficiency has to do with the size of the economic pie.
Equity has to do with how fairly the pie is divided. And there's a trade-off there, unfortunately. It would be great if there was not a trade-off, but the reality of it is that if we put more emphasis on equity, If we try to make sure that everybody has an equal slice of the pie, then the economic pie gets smaller.
And the reason for that is that if we're making sure that everybody has the same size pie, or size of the slice of the pie, then that means we're going to be taking resources from people who earned them and providing them to people who didn't earn them. And every economy does that, and that's not an argument that we should do none of that. But we have to recognize the reality that the more of that we do, the less of everything there is to go around.
So society faces tradeoffs just like we individually face tradeoffs. Let's think about the second principle, and that is that the cost of something is what you give up to get it. The cost of something... It's what you give up to get it.
Let's just say what you give up. This word cost, what you see, what you'll learn quickly in this class and in any economics class is that I'm going to use this word cost a little more generally than you've used it in the past. So typically the way that you use... The word cost, or the way that any of us use the word cost when we're interacting with other people, is to refer to the number of dollars that you've given up to get something. So if you have something, let's say you have a cup of coffee and I say, hey, how much did that cost you?
You might say, well, that cost me $2. You would recognize that I'm using the word cost to refer to the number of dollars that you've given up to get it. I'm going to use the word more generally.
I'm going to use the word cost to refer to whatever you give up to get it. It could be that you had to give up $2 plus the effort. to walk over to the place to actually get it. So I'm going to use this word cost more generally. Actually, economists typically use the phrase opportunity cost to remind ourselves that it's more than just the dollars that you have to give up.
The dollars certainly are part of the cost of something. We'll talk more about that here in a little bit. But there's other things that you're giving up, and we have to include...
Whatever it is that you've given up. So if we think about opportunity cost, let's think about the opportunity cost of, say, going to class. If we were to talk about the opportunity cost of going to class, then there's no dollars transacted in going to class. When you walk into a classroom, the professor doesn't require any dollars when you walk in. The tuition, that's been paid.
We're talking about just going to that particular class, walking in that classroom, and sitting down to listen for however long you need to sit there to listen to the professor talk about the material. There's no dollars transacted there. If we think about the opportunity cost of going to class, what you're actually giving up is the time that it takes you to go to class, to sit there, and to get back to your apartment or your dorm room. So it's tempting at first to think that the opportunity cost is that you're giving up your time, but we have to be careful about that because it's not the number of minutes that is actually going to be the cost.
It's whatever you would have done in those minutes. It's whatever your next best alternative use of your time would be. So it could be that if you weren't going to class, you would spend that time sleeping.
So by going to class, what you're giving up is sleeping. Or it could be that your next best use of time, maybe you would be playing video games. And so if you weren't at class, that's what you're giving up. Or it could be that maybe your parents are in town and they're getting ready to leave today and they call you up in the morning and they say, hey, we'd like to take you out to lunch. And you say, oh, you know what?
I've got class at 11 o'clock. I can't go out to lunch with you because I've got to go to class. And so clearly that would be a bigger...
thing that you're giving up than just sleeping. So it's not the number of minutes. It's not the time. It's whatever your next best alternative is. Next best alternative.
So I'm going to just kind of put a line through time because, again, it's not the number of minutes. Let's think about something else. Let's say buying something. So if we were to think about The opportunity cost of purchasing something.
Let's suppose you buy a pizza. Suppose that you call up the pizza place and they say it's $10 and so you pay with your credit card and then they deliver the pizza. Let's think about the cost, the opportunity cost associated with that. In this case there is a dollar component because you will have paid $10. So it's tempting to say that the opportunity cost, that part of it is $10.
But we have to remind ourselves that it's whatever you would have spent the $10 on. That's what you really give up. It's not the $10 itself. It's the other goods and services that you could have bought with the $10.
So there's that. There's the other goods and services that you have to give up. And then there's a little bit of effort, right? You had to make a phone call and maybe when they... knocked on your door with the pizza.
You had to get up off the couch and go get it. And so you had to exert some effort. That's part of the cost.
But the big thing here is that you gave up other goods and services because you used some of your purchasing power for that pizza. So you can see here that when we're talking about the cost of something, we're going to be including the fact that you have to pay dollars. That is part of the cost with a lot of different things. But there are lots of different behaviors that you... engage in, like going to class, where there's not a dollar transaction, but there's still a cost.
And it's whatever your next best alternative is. Let's talk about, for just a second, one common problem that I see students make, one mistake, is that sometimes, let's say we go back to this going to class, sometimes it's tempting for students to say, well if I didn't go to class, then I could be watching TV, and I could be, another thing I could be doing is playing video games, or I could be hanging out with my friends, or I could be... going for a walk, and you can list an infinite number of things that you could be doing if you weren't going to class. And so sometimes students say, well, what I'm giving up is infinite. There's an infinite number of things that I could be doing.
We're always going to think about just your next best alternative. So the cost of something is what you give up. And that leads us to this kind of a basic idea in economics that you've probably heard before, and that is that. There's no such thing as a free lunch. There is nothing that is truly free.
Everything has a cost. If you define the cost as just the dollars, then sometimes you might be able to say this is free because I didn't have to give up dollars. But we're not going to be defining it as just dollars. It's whatever you give up to get it. And in that case, there is no such thing as a free lunch.
There is always going to be a cost associated with everything. Let's talk about principle number three. Principle number three is going to be that people respond to incentives. People respond to incentives. The reason that we're going to be thinking about this, you might think when you first see that, that, well, that's another one that goes without saying.
People respond to incentives, yeah. Well, turns out that's actually really easy to forget. The reason we're going to think about people responding to incentives is because we're interested in understanding human behavior.
And so when we think about how to understand human behavior, incentives are going to be at the root of... all behavior. It's not going to be easy sometimes to see the incentives that change, so you may not be able to understand why somebody engaged in a particular type of behavior.
But you can rest assured that all behavior is a response to incentives. Let's talk about some different types of incentives. We could think about what we're going to call economic incentives.
An economic incentive is typically what we mean if we're talking about, say, dollars. or points in a class. So if I were to give a test, the reason I put points on it is because I want to give you an incentive to try to earn those points to get a good grade in the class.
And so if you are studying in an attempt to do well on the test so that you can earn more points, that's easy to understand why you're responding to that incentive. Or if there's some dollars on the line, if I were to offer you a certain number of dollars to you, do some work for me and you did it, it would be easy to understand why you did that work because of the dollar incentive that I gave to you. So economic incentives a lot of times are really easy to see and it's easy to understand why people respond to those. But there are other types of incentives that are not that easy to see. So if we think about another type, we can talk about social incentives.
Social incentives are created by society. So these are things like the desire for acceptance or the avoidance of ridicule. So if you think about it, a lot of the behavior that we all engage in is driven by our desire to be accepted by people that we respect and our desire to avoid being ridiculed by people that we respect.
And whether or not that's good or bad, we could talk about that all day. That's not what we're interested in. If we want to understand behavior, there are a number of social incentives that we're all responding to. More of our behavior is driven by social incentives than is driven by economic incentives.
And then we could also think about moral incentives. A lot of your behavior is driven by your sense of what's right and what's wrong. And so these two... Types of incentives are much harder to see than economic incentives.
So we can rest assured that behavior is driven by incentives. But that doesn't make it easy to understand all behavior because there are incentives that are very challenging for us to observe in the real world. It's also the case, and this is important, that not everyone responds to the same incentive in the same way. So I might give an incentive, an economic incentive, maybe in the form of points on a test. I might give all my students in a class the exact same economic incentive.
And then what I observe is all of them will react somewhat differently to that incentive. Some students will study really hard and try to scramble for every point they can get, and then other students, for whatever reason, maybe the other students have other time commitments that just keeps them from studying as much, or maybe they just aren't that interested in studying that much, or maybe they don't even realize they need to study that much. But I will observe some students. Not work very hard and therefore not earn very many points on the test and not end up doing that well in the class. And yet I've provided the exact same incentive to all of the students.
So not everyone responds to the same incentive the same way. Let's talk about the fact that it's very easy to forget that people respond to incentives. The way that I typically illustrate this is to talk about...
Our consumption of oil. Let me give you some numbers here. If we were to look at the amount of oil that we've got, I'm going to give you a very big number.
531 with nine zeros after it. That's the number of barrels of crude oil in reserve. And this is a real number. It's not a number that I just made up.
It's a real number. What it means for oil to be in reserve is that we know where it's at. Most of that would be in the ground, but we know that we can get it out of there.
It's not in your best interest, typically, if you have oil in the ground to pull it all out of there, because then once you pull it out, you've actually got to pay to store it, and it turns out that it's already being stored in the ground. So 531, what is that, billion barrels of crude oil in reserve. In the world.
We could also think about world annual usage. It's going to be a smaller number, but still pretty big. World annual usage of crude oil looks like that. 16.5 billion barrels per year. So that's what we've got in reserve.
Let's just pretend like that's all there is. There's oil we haven't found yet, but let's pretend like that's the maximum amount we've got. And then this is the amount we use every year.
If you look at how numbers like that get used by politicians and by activists, what you see is that what they'll do is they'll take this number and they'll divide it by that number, and then they'll come up with a number of years that we've got before we run out of oil. And that would be something probably in the 30s, right? 531 divided by 16 and a half, something in the 30s. We've got, if we use those numbers that way, about 30 years worth of oil.
What if I were to tell you that that's a completely wrong way to use those numbers? What if I were to tell you that the right answer to the question, when will we run out of oil? The right answer is never.
We will never, ever run out of oil. I can say that with 100% confidence. Anybody that tells you otherwise either has never taken an economics class, doesn't understand that people respond to incentives, or I guess they could be lying to you.
But we're never going to run out of oil. Let's talk about why, though. How do I know for sure that we won't?
Well, I know because I know people respond to incentives. Let me give you a different example. Let's suppose that instead of oil, let's suppose that I call you up and it's your birthday and I say, hey, I've got a birthday present for you. The birthday present is this giant room full of peanuts. It's a big room, it's very deep, there's a door at the top, and you walk in and there it's just full of peanuts and it's all yours.
And just for convenience, let's pretend like there's 531 billion peanuts in the room. And that peanut room is yours. And if you are a person who is allergic to peanuts, then the peanut room is probably utterly terrifying for you, I understand that.
And I've thought about maybe changing it to some other type of room like a banana room or something, but that's just gross. So it's easier if you just pretend like you're not allergic to peanuts for right now. So I gave you this peanut room, 531 billion peanuts.
The only requirement is you can't take anything out of the room. So if you eat a peanut, the shell's got to stay in the room. So let's suppose you love peanuts and you call up all of your friends and your friends love peanuts too.
And so you say, hey, come over. Dr. Azevedo just gave me this peanut room. Come on over and let's eat some peanuts.
So your friends go over there and you guys start eating peanuts. And think about the cost of eating a peanut on day one. You can reach anywhere you want.
and there's a new peanut. You don't even have to have your eyes open. You can reach anywhere and there's a new peanut.
And all you've got to do is crack it open, eat it, and let's suppose that that you're smart so you guys all decide that you're going to throw your peanut shells over in one corner because you don't want them on top of your good peanuts. So you're throwing your shells over in one corner. If you think about the cost to you of eating a peanut on that first day, it's practically zero.
It's whatever effort you have to exert to pick it up and and and open it up and eat it. So peanuts are as close to free as they're ever going to be on that first day. And so let's suppose I run into you after maybe a month and I say, hey, how's that peanut room going for you? And let's suppose that you and your friends in that first month have eaten 16 and a half billion peanuts.
Pretend like you never get sick of peanuts, okay? If we were to use these numbers the same way that we used them with oil just a second ago, then what you would do is you would think to yourself, well, I've got 531 billion peanuts. In the first month, my friends and I ate 16.5 billion peanuts. So we've got about 30 months worth of peanuts.
But that would be ignoring that people respond to incentives. So let's talk about what's going to happen as you continue to eat more and more peanuts. So as you eat more and more peanuts, Eventually those shells that you've been throwing back here in this corner of the room are going to start to slide down, spill over onto your new peanuts.
And it's not going to take very long before you're going to have a layer of peanut shells on top of your good peanuts. So now think about what's happening to the cost of eating a peanut. Peanuts are no longer very close to free. Now if you want to consume a peanut, you've got to go into the peanut room, dig through, A layer of shells, some of which might have been in your friend's mouth and are kind of gross. So now you've got to dig through a layer of shells to get down to the good peanuts.
And maybe then you throw some of those good peanuts up on the top. But the point is that the cost of consuming peanuts is going up. And you don't have to have an economics class to know what happens to the amount of something you want to consume as it gets more expensive.
As things get more expensive, we want to consume less of them. And so the number of peanuts that you consume is not going to stay constant. As the cost of consuming peanuts goes up, we consume fewer peanuts.
So this number is going to be falling. And eventually, what would happen is, remember that you can still drive to Walmart and buy a bag of peanuts for something probably around $2.50. So eventually what would happen is you would get so many shells on top of your good peanuts that it's no longer worth it to dig down to the good peanuts. If you call up your friends and you say, hey, come on over and let's eat some peanuts, your friends are eventually going to say, look, if we go over and get into the peanut room, it's going to take us 30 minutes and a lot of effort. To dig down through 10 feet of gross shells to get to the good peanuts.
You know what? I'm just going to drive to Walmart and buy a bag of peanuts. So eventually what would happen is the cost of consuming peanuts would rise enough that you just choose not to consume any more peanuts from the peanut room.
So when are you going to run out of peanuts in the peanut room? When will you consume the last good peanut in the peanut room? Never!
You never would! Eventually it would get so expensive to try to hunt down for those good peanuts, you just voluntarily choose to consume an alternative. That's what will happen with oil.
When will we consume the last barrel of oil? Well, never. Eventually what would happen is the oil will get expensive enough that we will just voluntarily switch to some other alternative source of energy. And when we switch, it won't be because of...
Education that we've provided young people, it won't be because of some overall environmental awareness. It will be because the alternative has become cheaper. So people respond to incentives.
You have to... Keep that in mind when you start thinking about numbers like this. It is not appropriate at all to divide that number by that one and come up with a projection of how much oil we've got. So, let's talk about principle number four. And that is that people think at the margin.
People think at the margin. Let's talk about what that means. So a marginal change, let me give you a couple definitions.
A marginal change is an incremental change to a plan of action. You can kind of think of the margin as the edge of decision making, and that probably doesn't make sense at first. You probably may not be able to understand what I mean by that, but once you think about a couple of examples, it'll probably become clear. So people think at the margin. What that means is you have a plan of action.
But you respond to the incentives as they change. It's very rare to have a plan of action and then to doggedly stick to that plan regardless of what happens to you. That almost never happens. What happens is you have a plan of action, and then you start to execute that plan, and then the incentives, you pay attention to those incentives as they change, and then your plan may switch right in the middle. So let's think about studying.
Let's think about studying and how that is a great example of what it means to think at the margin. So let's suppose that you've got a test that you need to study for, and you know that you need to spend some time this evening studying. And so it comes time to start studying.
Let's think about how you make the decision of how much time to study. Do any of you? Sit there and say, you know what, I'm going to study for exactly 82 minutes and 17 seconds. You don't ever do that, right?
The only time you would even come close to doing something like that is if you know you need to study a whole lot and you've only got a small amount of time. You've only got 30 minutes. Then chances are you're probably going to study for the full 30 minutes. But even that might change.
We'll talk about that here in a second. Instead, what we do is we have a plan of action to study. And what we do is we sit down and we start studying.
And let's suppose that we're sitting there studying and we're not giving up very much. Let's suppose the opportunity cost of studying is very low. None of our friends are doing anything.
So we're not giving up very much, and let's suppose that we are learning a lot about the material that we're studying. Let's think about those incentives, what we're giving up and what we're getting. Turns out that a decision maker takes an action if and only if the marginal benefit of the action is bigger than the marginal cost. So I'm going to abbreviate marginal benefit.
MB and marginal cost MC. You take an action if and only if the marginal benefit is bigger than the marginal cost. Now let's talk about what the marginal benefit is. The marginal benefit is just the change in benefit.
The word marginal in economics you can always substitute the phrase change in and understand better what it means. The marginal benefit is the additional benefit that you get from continuing to take the action. The marginal cost is the additional cost that you incur if you continue to take the action.
So a decision maker takes an action if and only if the marginal benefit is bigger than the marginal cost. That's really, really, really important. That's like a two-star important, maybe even three stars.
Take an action if and only if the marginal benefit's bigger than the marginal cost. Now, let's think about what that means in terms of studying. The marginal benefit of continuing to study is going to be the additional knowledge that you gain from studying, the change in benefit, okay?
The marginal cost is going to be the additional cost that you incur. So, if you continue to study, you're going to be giving up whatever your next best alternative is. But remember, we've said that...
Your friends aren't doing anything and the marginal cost is low. So if the marginal cost is down here and the marginal benefit is right up here, then you continue to study. And then let's suppose that there's a knock on the door. And it's one of your friends, and it's a friend that you like, and they say, hey, you know what, we're going to go out and we're going to do something, you want to go with us.
Now the incentives have changed, and people are going to respond to that change in incentives. That doesn't mean you quit studying. What we have to think about is what's changed.
Well, the benefit of continuing to study at the margin hasn't changed, but the cost has. And if these are friends that you like, the marginal cost has gone up. Does that mean you quit studying?
Well, it depends on how much the marginal cost has gone up. If it goes up, but it's still smaller than the marginal benefit, then you continue to study. But if it goes up and now it's bigger than the marginal benefit, well, then you might say, you know what, I'm going to close my book. I'm going to go out with you guys.
So what's important is to focus on the marginal benefit and the marginal cost. It doesn't matter How big one by itself is or how small it is, what matters is the relative size. Let's change it a little bit.
Let's suppose that you're sitting there studying and you're not giving up very much at all. So the marginal cost is relatively low. And let's suppose that you are really, really learning the material well.
You're having... breakthroughs that are unlike anything you've ever experienced before. So the marginal benefit is huge, tremendously big.
And so when that friend knocks, it doesn't matter what they're doing. You're you're going to continue to study because you're starting to the clouds are parting in your brain and you're starting to understand things like you never have before. Is there any circumstance under which you would ever interrupt that where the marginal benefit is?
tremendously high. Is there any circumstance under which you would stop that? And the answer is of course.
Of course. It doesn't matter if the marginal benefit is just sky-high. If all of a sudden the marginal cost is even higher then you quit.
So if you're sitting there studying and and the clouds are parting and then all of a sudden somebody walks in through the door and sticks points a gun at you and says either stop studying or you're gonna die. then clearly the marginal cost of continuing to study is now huge, right? You die.
So the key here is not how big marginal benefit is or how big marginal cost is. It's how big they are relative to each other. They could both be way up here.
They could both be way down here. But what matters is how do they compare to each other. So that's what it means to think at the margin. You're thinking about the marginal benefit.
the additional benefit, the additional cost, and you're going to respond to those, the comparison of those, you're going to respond to those and incrementally adjust your plan of action. Let's think about the next principle. We'll call it number five, and that is that trade can make everyone better off. Trade can make everyone better off.
We can think about this in terms of trade between two people, or we can think about this in terms of trade between two countries. Let's start by noticing that it doesn't say that trade always makes everyone better off. That's not what it says. What it says is that trade can make everyone better off. And we'll actually spend a whole future video talking about this very principle.
Why do people... voluntarily engage with trade with each other. Let's think for a second about international trade.
It's not uncommon for people to be skeptical of international trade because they think that the world is a zero-sum game. And a zero-sum game is a game where if I win you have to lose. So poker is a zero-sum game.
If we all walk into the room with a hundred dollars and I walk out with $300, then that means some other people had to walk out with less than they walked in with. That's a zero-sum game. Any gains by me are losses by somebody else. Turns out that trade is not that way.
Voluntary trade between people or between countries is not a zero-sum game. It's what we would call a positive-sum game. That means that we can all walk away and have gained from it. So trade can make everyone better off.
An easy way to think about why this has to be true is to think about what would happen if you didn't trade with other people. So let's suppose that you decide, you know what, I'm going to trade less. If you traded less, then that means that you're not going to be buying stuff from other countries.
Let's suppose that you buy only stuff made in the U.S. You buy American. Well, then that's...
you might have reasons for wanting to do that, but that's going to close off several options to you for buying goods and services from people in other countries. If buying American is good, then how about if you just buy Missouri? Well, think about all of the things you won't be able to buy because they're not produced here. Or if buy Missouri is good, then buy Warrensburg.
Well, clearly you start to realize that if I only buy, the less I trade with people, the more stuff I have to produce myself because it's not being produced in my limited circle that I'm going to trade with. And so clearly, the more stuff you have to do for yourself, the... the less time that leads for other things. So trade can make everyone better off. The absence of trade makes people worse off.
We'll talk about that again in an upcoming video. Let's talk about principle number six. Number six is that markets are the best way to organize economic activity.
Markets are the best way to organize economic activity. Now what we mean by this, I'm going to insert the word free here. Free markets are the best way to organize economic activity.
We have to be careful about what we mean by this phrase free markets. We're not saying, when I say the phrase free market, I don't mean a situation where sellers can do whatever they want. Sometimes people define a free market as the complete...
absence of any regulation on sellers. And that's not at all how economists mean that phrase. What we mean is that sellers are free to sell what they want within the bounds of the law, and consumers are free to buy what they want within the bounds of the law. So you can't lie to customers about the quality of your product, and you can't lie to them about other characteristics of the product. And as a consumer, you can't buy things that are deemed illegal.
We're not going to get into whether or not things should be legal or illegal. We're going to say that within the bounds of the law, you're able to consume what you want and produce what you want. That's a free market. And this principle is that free markets are the best way to organize economic activity. The other alternatives, the alternative to a free market is a planned market, or excuse me, a planned economy.
Planned economy, that's the other alternative. So we could think about planned economies like socialism or communism. So what this principle says is that free markets, capitalism, is the best way to organize economic activity.
It is a better way to organize economic activity than communism or socialism. Communism and socialism, for what we're going to do in this class, the key characteristic of those two ways of organizing economic activity is that the means of production... is owned by the government.
So if you look at communism or socialism, both of those are situations where the government controls the means of production, the businesses, what's being produced. It's a basic principle of economics that capitalism beats that. That doesn't mean capitalism is perfect.
So this next principle that we have to think about, we'll call it number seven. Is that sometimes the government can improve the free market outcome. So sometimes, let's just say government can sometimes improve the free market outcome. That happens when there is what we call a market failure.
So free markets are great. We'll talk more about that. in other parts of this class.
If you take a principles of microeconomics class, you spend a lot of time talking about why free markets are good. But sometimes there are situations where the free market doesn't work quite as well. It still works better than planned economies.
So this is not an argument for that. Certainly not. But there are times when we have things that we call an externality. An externality is when one person's behavior imposes a cost on somebody else.
It's a type of market failure. In those cases... Sometimes the government can improve the free market outcome.
Let's talk about the last few principles. Number eight has to do with a country's standard of living. So a country's standard of living depends on its ability to produce other things, to produce things other people want to buy. Standard of living depends...
on its ability to produce things other people want to buy. It's a lot of writing. Country's standard of living depends on its ability to produce things other people want to buy. It's also true for an individual. Your standard of living in the future will depend on your ability to produce goods or services that other people want to buy from you.
That's why it's important to have skills that other people are willing to pay for. We'll talk about how that works in a market. Let's talk about principle number 9 and 10. Number 9 and 10, I'm just going to say.
That's too much writing. Principle number nine is that prices rise when the government prints too much money. So let's just put, let's just write money here.
When the government prints too much money, it drives prices up, causes inflation. We'll spend time talking about that. So that's kind of a basic principle of macroeconomics.
The tenth one. Let's just put here, there's a trade-off between inflation and unemployment in the short run. And that may not mean much right now to you, it doesn't need to, but we'll spend some time talking about that.
In the short run, the government may want to decrease inflation and it will want to decrease unemployment, but the problem is that there's a trade-off. If you decrease one, it's going to drive the other up. So we have to decide which one do we not like the most because that's the one we might want to decrease. So these are the 10 principles.
What we'll do in our next videos, we'll think about some basic... Things that we're going to be thinking about in a principles of macro class or a principles of micro class. We'll kind of think about what economists do, how they do it, and then we'll move on to start talking about this principle that trade can make everyone better off.