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Economics For Dummies has supplied hundreds of thousands of students with an approachable reference book while also providing an informational outlet for anyone curious about how businesses, consumers, and governments interact to produce and distribute all the goods and services that we enjoy today.

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We also do not have links that lead to sites DMCA copyright infringement. If You feel that this book is belong to you and you want to unpublish it, Please Contact us. Economics For Dummies 3rd Edition. I spend the next few sections of this chapter expanding on the three-step economic choice model and addressing the objections to it.

Pursuing Personal Happiness Economists like to think of human beings as free agents with free wills. To economists, people are fully rational and capable of deciding things on their own. But that begs the question of what motivates people and, in turn, of what sorts of things people will choose to do given their free wills.

In a nutshell, economists assume that the basic motivation driving most people most of the time is a desire to be happy. This assumption implies that people make choices on the basis of whether or not those choices will make them as happy as they can be given their circumstances.

This section examines how the pursuit of happiness affects consumer behavior. Using utility to measure happiness If people make choices on the basis of which ones will bring them the most happiness, they need a way of comparing how much happiness each possible thing brings with it.

Along these lines, economists assume that people get a sense of satisfaction or pleasure from the things life offers. Sunsets are nice. Eating ice cream is nice. Friendship is nice. And I happen to like driving fast. Economists suppose that you can compare all possible things that you may experience with a common measure of happiness or satisfaction that they call utility. Things you like a lot have high utility. Things that you like only a little have low utility.

And things you hate like toxic waste or foods that cause you to have allergic reactions have negative utility. Utility acts as a common denominator that allows people to sensibly compare even radically different things. The concept of utility is very broad. For a hedonist, utility may be the physical gratification of experiencing sensual pleasures. But for a morally conscientious person, utility may be the sense of moral satisfaction received when doing the right thing in a particular situation.

The important idea for economists is that people are able to sort out and compare the utilities of various possible activities. This viewpoint immediately raises objections because people are often willing to endure great personal suffering in order to help others. The same can be said about people who donate to charities. If people give because doing so makes them feel good, their selfless action is motivated by selfish intention.

Because economists see human motivation as selfish, economics is often accused of being immoral; however, economics is concerned with how people achieve their goals rather than with questioning the morality of those goals. For instance, some people like honey, but others do not. Economists make no distinction between these two groups regarding the rightness or wrongness of their preferences.

Rather, what interests economists is how each group behaves given its preferences. Consequently, economics is amoral rather than immoral. They just tend to interpret the desire to pursue morality and equity as an individual goal that maximizes individual happiness rather than as a group goal that should be pursued in order to achieve some sort of collective good. Yet because they want your money, they end up producing for you everything that you need to have a nice meal.

When you trade them your money for their goods, everyone is happier. You think that not having to prepare all that food is worth more to you than keeping your money. And they think that getting your money is worth more to them than the toil involved in preparing all that food.

Time, for instance, is always in limited supply, as are natural resources. The second stage of the economic choice model looks at the constraints that force you to choose among your happy options. For example, oil can be used to manufacture pharmaceuticals that can save many lives. But it can also be used to make gasoline, which can be used to drive ambulances, which also save lives. This section outlines the various constraints, as well as the unavoidable cost — opportunity cost — of getting what you want.

For more on how markets use supply and demand to allocate resources in the face of constraints, please see Chapter 4. Resource constraints The most obvious constraints on human happiness are the physical limitations of nature.

Not only are the supplies of oil, water, and fish limited, but so are the radio frequencies on which to send signals and the hours of sunshine to drive solar-powered cars. The limited supply of natural resources is allocated in many different ways. In some cases, as with some endangered species, laws guarantee that nobody can have any of the resource.

With the electromagnetic spectrum, national governments portion out the spectrum to broadcasters or mobile phone operators. But for the most part, private property and prices control the allocation of natural resources. Under such a system, the use of the resource goes to the highest bidder. Technology constraints You have a much higher standard of living than your ancestors did. You have a cushier life because of improvements in the technology of converting raw resources into things people like to use.

As technology improves over time, people are able to produce more from the limited supply of resources on the planet. Or, put slightly differently, as technology improves, individuals have more and better choices. In the last years, people have figured out how to immunize children against deadly diseases, how to use electricity to provide light and mechanical power, how to build a rocket capable of putting people on the moon, and how to dramatically increase farm yields to feed more people.

In just the last 20 years, the Internet and cheap mobile phones have revolutionized everything from entertainment to how governments communicate with their citizens. Time constraints Time is a precious resource. Worse yet, time is a resource in fixed supply. Therefore, the best that technology can do for people is to allow them to produce more in the limited amount of time that they have or to grant them a few more years of life through better medical technology.

But even with a longer life span, you can only be in one place at a time so that you only have a finite amount of time to work with. This means that you must choose how to allocate your limited amount of time between leisure and labor, and between taking time to do things you like and selling your time to employers so that you can earn wages to pay for things you like. This trade-off implies that time is a precious commodity about which people must make serious choices.

Opportunity cost: The unavoidable cost The economic idea of opportunity cost is closely related to the idea of time constraints. I chose to chat with my friend because that made me happiest. So the opportunity cost of chatting on the phone was not getting to spend the time working on this chapter.

Opportunity cost depends only on the value of the best alternative option because you can always reduce a complicated choice with many options down to a simple choice between two things: Option X versus the best alternative option out of all the other options you can choose from.

Simplifying a decision down to only two options makes choosing easy. You should go with option X rather than the best alternative option only if the pleasure you will receive from option X exceeds the opportunity cost of not getting to enjoy the best alternative option. And you should select the best alternative option only if the opportunity cost of forgoing it exceeds the pleasure you would get from consuming option X.

Suppose that you can choose only one item from a selection of desserts that includes pecan ice cream, doughnuts, chocolate chip cookies, and peach cobbler. Select one of these at random — say, pecan ice cream. Then, out of all the other desserts, identify the one that you like best out of that group. My decision about which dessert to eat now comes down to simply comparing how I feel about pecan ice cream with how I feel about chocolate chip cookies.

To select the ice cream means enduring the opportunity cost of not eating the chocolate chip cookies. In the third stage, you simply choose the option for which the benefits outweigh the costs by the largest margin. The cost-benefit model of how people make decisions is very powerful in that it seems to correctly describe how most decisions are made.

But this version of cost-benefit analysis can tell you only whether people choose a given option. To see how marginal utility works, recognize that the amount of utility that a given thing brings usually depends on how much of that given thing a person has already had. The third, in turn, brings less utility than the second.

And if you keep forcing yourself to eat, you may find that the 12th or 13th slice of pizza actually makes you sick and brings you negative utility. Economists refer to this phenomenon as diminishing marginal utility. Each additional, or marginal, unit that is consumed brings less utility than the previous unit so that the extra utility, or marginal utility, brought by each successive unit diminishes as you consume more and more units. Here, each successive slice of pizza brings with it less additional, or marginal, utility than the previous slice.

And for people who choose to have some of each, the optimal quantities of each depend on their feelings about the two goods and how fast their marginal utilities decrease. Check out Chapter 5 for more detail on diminishing marginal utility and how it causes demand curves to slope downward. Marginal utility is for the birds! For instance, scientists can train birds to peck at one button in order to earn food and another button to earn time on a treadmill.

If scientists increase the cost of one of the options by increasing the number or clicks required to get it, the birds respond rationally by not clicking so much on the button for that option. But even more interesting is that they also switch to clicking more on the button for the other option. The birds seem to understand that they have only a limited number of clicks they can make before they get exhausted, and they allocate these clicks between the two options to maximize their total utility.

It tells you not only what people will choose but how much of each thing they will choose. For example, it assumes that people have a clear sense of the utility of various things, a good idea of how fast marginal utilities diminish, and no trouble making comparisons. I discuss these substantial criticisms in the next section.

You may think that gives people way too much credit, but models based on those assumptions work surprisingly well much of the time. In this section, I note some of the limitations of the choice model and explain why they may not matter all that much in the long run.

Understanding uninformed decision-making When economists apply the choice model, they assume a situation in which a person knows all the possible options, knows how much utility each will bring, and knows the opportunity costs of each one. But how do you evaluate whether it would be better to sit on top of Mount Everest for five minutes or hang-glide over the Amazon for ten minutes? Politicians with novel new programs often ask voters to make similarly uninformed choices.

They make their proposals sound as good as possible, but in many cases, nobody really knows what they may be getting into. Things are similarly murky with respect to choices involving luck or uncertainty. People buying lottery tickets in state lotteries have no idea about the eventual possible gain because the size of the prize depends on how many tickets are sold before the drawing is made.

Economists account for this reality by assuming that when faced with uninformed decisions, people make their best guesses about not only uncertain outcomes but also about how much they may like or dislike things with which they have no previous experience. Although this may seem like a fudge, because people in the real world are obviously making decisions in such situations they do, in fact, buy a whole lot of lottery tickets , the people in those situations must be fudging a bit as well.

Whether people make good choices when they are uninformed is hard to say. Obviously, people would prefer to be better informed before choosing. And some people do shy away from less certain options. Making sense of irrationality Even when people are fully informed about their options, they often make logical errors in evaluating costs and benefits.

I go through three of the most common errors in the following subsections. Sunk costs are sunk! Economists refer to costs that have already been incurred and which should therefore not affect your current and future decision-making as sunk costs.

Rationally speaking, you should consider only the future, potential marginal costs and benefits of your current options. How much should you eat? More specifically, when deciding how much to eat, should you care about how much you paid to get into the restaurant?

Of course not. Mistaking a big percentage for a big dollar amount Costs and benefits are absolute, but people make the mistake of thinking of the costs and benefits as percentages or proportions. Instead, compare the total costs against the total benefits, because the benefit of, say, driving to the next town to get a discount is the absolute dollar amount you save, not the percentage you save.

Suppose you decide to save 10 percent on a mobile phone by making a one- hour round trip to a store in another town. You do the math, and because you would save only 0. In the second, you were not. Should you believe him? Who cares what costs and benefits all the previous bridges brought with them? You have to compare the costs of that extra, marginal bridge with the benefits of that extra, marginal bridge.

If the marginal benefits exceed the marginal costs, you should build the bridge. And if the marginal costs exceed the marginal benefits, you should not. For example, suppose that an independent watchdog group hires an engineer to estimate the cost of building one more bridge and an economist to estimate the benefits of building one more bridge.

The engineer finds that because the three shortest river crossings have already been taken by the first three bridges, the fourth bridge will have to be much longer. By telling voters only about the average costs and benefits of past bridges, the politician supporting the project is grossly misleading them. So watch out anytime somebody tries to sell you a bridge. In fact, thanks to advanced technologies, people are spoiled for choices.

This chapter explains how economists analyze the process by which societies choose exactly what to produce in order to maximize human happiness. For every society, the process can be divided into two simple steps: 1. Figure out all the possible combinations of goods and services that it could produce given its limited resources and the currently available technology. Choose one of these output combinations — presumably, the combination that maximizes happiness.

I give you the lowdown on diminishing returns, production possibilities frontier graphs yeah, graphs! If resources were unlimited, goods and services would be as well. Diminishing returns: Basically, diminishing returns means that the more you make of something, the more expensive it becomes to produce.

Even with mass production, after some level of output the cost of producing additional units will begin to rise. Eventually, the increasing cost exceeds the benefit of producing additional units. In such situations, resources should be reallocated to producing units of other products for which the benefits still outweigh the costs.

A key result of diminishing returns is that societies are usually better off when they devote their limited resources to producing moderate amounts of many goods rather than producing a huge amount of just one thing. This section gives you the lowdown on how limited resources and diminishing returns determine production possibilities.

It also shows you how to represent these possibilities graphically. Land includes the weather, plant and animal life, geothermal energy, and the electromagnetic spectrum. Labor: Labor is the work that people must do in order to produce things. For instance, a car that you drive for pleasure is a consumption good, but an identical car that you use to haul around bricks for your construction business is capital.

Capital includes factories, roads, sewers, electrical grids, the Internet, and so on. In addition to these three traditional inputs, economists now often speak of human capital, which is the knowledge and skills that people use to help them produce output. For instance, I have a lot of human capital with regard to teaching economics, but I have extremely low human capital with regard to painting and singing. An important consequence is that skilled workers high human capital get paid more than unskilled workers low human capital.

Therefore, a good way for societies to become richer is to improve the skills of their workers through education and training. However, building up human capital is costly, and at any given instant, you should think of the level of human capital in a society as being fixed. Combined with limitations on the amount of land, labor, and capital, the limitation on human capital means that the society will be able to produce only a limited amount of output.

And along these same lines, the decisions about where to best allocate these limited resources become crucial because the resources must be used for production of the goods and services that will bring the greatest amount of happiness.

It refers to the fact that for virtually everything people make, the amount of additional output you get from each additional unit of input decreases as you use more and more of the input.

Diminishing returns is sometimes referred to as the low-hanging fruit principle. Imagine being sent into an apple orchard at harvest time to pick apples. During the first hour, you pick a lot of apples because you go for the low-hanging ones that are the easiest to reach. During the third hour you pick even fewer apples; you now have to jump off the ground every time you try to pick an apple because the only ones left are even farther away.

Table demonstrates how your productivity — your output for a given amount of input — diminishes with each additional hour you work. Another way to see the effect of diminishing returns is to note the increasing costs for producing output. Only get picked in the third hour, so the labor cost per apple rises to five cents. Eventually, the effects of diminishing returns drive prices so high that you will stop devoting further labor resources to picking additional apples.

Virtually all production processes show diminishing returns and not just for labor. Additional amounts of any particular input usually result in smaller and smaller increments of output, holding all other inputs constant. A little here, a little there: Allocating resources Because diminishing returns guarantees that a production process will eventually become too costly, a society normally allocates its limited resources widely, to many different production processes.

Imagine that you can allocate workers to either picking apples or picking oranges. Allocating all your workers to picking oranges, for example, is unproductive because the output you get from the last worker picking oranges will be much less than the output you get from the first worker picking oranges. The smart thing to do is to take a worker away from picking oranges and reassign him to picking apples.

You may also want to reassign a second worker, and perhaps a third or a fourth. Each additional worker assigned to picking apples produces less than the previous worker picking apples.

The Production Possibilities Frontier, which is sometimes referred to as the production possibilities curve, also shows how limited resources limit your ability to produce output. Figure shows a PPF graph that corresponds to the data in Table Table shows how the total output of apples and oranges changes as you make different allocations of five available workers to picking apples or oranges.

For instance, if you put all five people to work picking only apples for one whole day, you get apples picked and zero oranges picked. If you move one worker to oranges so four workers are picking apples and one worker is picking oranges , you get apples picked and oranges picked. Because of diminishing returns, taking one worker away from apples reduces apple output by only But moving that worker to oranges increases orange production by because that worker is the first one picking oranges and can get the low-hanging fruit.

Graphing the combinations You can graph your production possibilities by plotting on a graph the various combinations of two output goods that can be produced as you vary the amount of a resource that is allocated between them.

Figure plots the six output combinations that result from varying the allocation of workers in Table , thereby graphing all your production possibilities.

Point B corresponds to the output you get from four workers picking apples and one worker picking oranges, and so on.

On the other hand, a point like C is not attainable. Imagine that instead of allocating labor by worker, you allocate it by time. The five workers each work for one day, so you have 5 worker-days of labor to allocate.

You can now allocate, for instance, 3. This arrangement allows you to fill in the graph and draw a line connecting the six points that correspond to the output combinations that you get when allocating labor by worker. A line passing through the points that represent various output combinations is called the production possibilities frontier, or PPF, because it divides the area of the graph into two parts: The combinations of output that are possible to produce given your limited supply of labor are under the line, and those that are not possible to produce are above it.

In this way, the PPF graph captures the effect of scarce resources on production. Some output combinations are just not producible given the limited supply of labor.

The PPF is a simplification of the real world, derived by allocating one input between just two outputs. The real world is, of course, more complicated, with many different resources allocated among many different outputs. Interpreting the shape of the graph The bowed-out curvature of the PPF graph illustrates the effects of diminishing returns.

In Figure , the changing slope as you move along the frontier shows that the tradeoff between apple production and orange production depends on where you start. In economic jargon, the changing slope of the PPF in the face of diminishing returns is due to the fact that the opportunity costs of production vary depending on your current allocation of resources. On the other hand, the opportunity costs of devoting that labor to orange production are very low because you have to give up producing only a few apples.

For instance, if you start at Point B, the only way to increase apple production is to slide up along the frontier, which implies reducing orange production. All the points below the line are productively inefficient. Consider Point E in Figure , which corresponds to producing apples and oranges. In fact, you can see from Table that you can produce these numbers by sending only one worker to pick apples and another worker to pick oranges.

In the real world, you end up at points like E because of inefficient production technology or poor management. Any manager who has five workers to allocate but produces only output combination E should be fired!

Reaching new frontiers with better technology One simplification of the PPF is that other than the particular input you are allocating, you are implicitly holding all other productive inputs, including technology, constant. Economists represent this increase in productivity by shifting the PPF outward. In Figure , the shaded area represents new combinations of output that, thanks to better technology, can now be produced using the same amount of resources as before.

Even with a better technology, if you start increasing the amount of a particular input, you get successively smaller additional increases in output. In Figure , the new technology shift is balanced in the sense that it increases your ability to produce more of both goods. An example of a balanced technological change would be improvements in fertilizers or pesticides that increase crop yields of both apples and oranges.

But most technological innovations are biased. An improvement in steel-making technology obviously allows you to make more steel from your limited resources but has no effect at all on your ability to make wheat. Consequently, as Figure shows, the PPF does not shift out evenly.

Rather, it shifts out at the end where all your particular input say, labor is devoted to steel, but remains fixed at the end where all your particular input is devoted to wheat production.

Figure A technologically balanced outward shift of the PPF. Figure A technologically biased outward shift of the PPF. Deciding What to Produce After a society locates the frontier of efficient output combinations see the preceding sections , the next step is choosing the point along the frontier that produces the combination of goods and services that makes people most happy.

Choosing only from among frontier combinations guarantees productive efficiency. Choosing the single frontier combination that maximizes happiness assures allocative efficiency.

Because determining where the frontier lies is mostly a matter of engineering and applying current technology to available resources, it creates little controversy. But deciding which particular combination of outputs a society as a whole should choose is much more complicated.

People have preferences both as individuals and as groups about which products make them happiest. An individual choosing a point along his own personal PPF encounters no conflict; he just determines what combination of outputs makes him happiest and then he produces and consumes it. For instance, your neighbor may not mind all the pollution produced by the fact that he likes driving his SUV day and night. Similarly, the government argues over what it should produce with its limited resources: Some people favor farm subsidies while others favor defense spending or programs to aid the poor.

Because of competing priorities, some sort of decision-making process must be established to determine what will actually get produced and to try to make sure that it pleases most of the people most of the time. In most modern economies, this process is the result of both private and public decisions acting through a combination of free markets and government action.

The process is not always smooth, but it has delivered the highest standards of living in world history. In this section, I discuss the pros and cons of free markets and government interventions and why it is that most nations have opted for mixtures of the two rather than attempting to rely exclusively on one or the other. Comparing market results and government interventions When analyzing the ways in which modern economies and societies select a combination of goods and services to produce, realize that current laws and institutions are the result of conflicting pressures to either Leave markets to their own devices when turning resources into output.

Keep the following three factors in mind when considering the fight between leaving the markets alone and intervening: Complexity: Modern economies are hugely complicated, with literally millions of goods and services produced using limited supplies of land, labor, and capital.

These negative consequences bring forth substantial pressure for government intervention in the economy because markets, if left alone, will produce a lot of these goods and services and, consequently, a lot of negative consequences for third parties.

Inequality: Some people end up consuming a very large proportion of the goods and services produced, and others end up with very little. Such unequal distribution also brings forth a great deal of pressure for government intervention in the economy in order to equalize living standards. These factors are both a consequence and a cause of the fact that modern economies are largely a mix of market production and government intervention.

For the most part, what to produce, how much of it to produce, and who gets it is decided by voluntary transactions made by individuals and businesses. In both cases, a huge apparatus of law and tradition governing economic transactions helps society produce a combination of output that is, hopefully, both productively efficient so resources are not wasted and allocatively efficient so the economy is producing the things that people want most.

Next, I outline the benefits and the drawbacks that both markets and governments bring to the economic table. The magic of markets: Directing resources automatically Market economies are simply collections of billions of small, face-to-face transactions between buyers and sellers.

In markets, the allocation of resources is facilitated by the fact that each resource has a price, and whoever is willing to pay the price gets the resource. In fact, market economies are often called price systems because prices serve as the signals that direct resources.

Holding supply constant, products in high demand have high prices, and products in low demand have low prices. Because businesses like to make money, they follow the price signals and produce more of what has a high price and less of what has a low price. In this way, markets tend to take limited resources and use them to produce what people most want — or at least, what people are most willing to pay for.

The factory, in turn, increases production, taking resources away from the production of other things. Markets have the benefit of figuring out, automatically, the things that people want. To grasp why this is so amazing, consider that you live in a world of nearly 7 billion people. It would be very hard for any single person to gather enough information to figure out what each of them most wants to buy. It would take several lifetimes to speak with each of them, even just to find out what they want for dinner, let alone all the other things they would most like to purchase on a typical day.

Communism, long lines, and toilet paper In a command economy, all economic activity is done on the orders of the government. Shortages of everything from sugar to clothing to toilet paper were constant.

Rather, because everyone in a communist country is ideologically equal, the government attempted to give everyone an equal share of the goods and services made. The lines were so long that people often stood in line for an entire day just to get one roll of toilet paper.

What caused this mess? It was an impossible task! To see why, consider toilet paper. First, you estimate how many millions of rolls of toilet paper are needed.

At the same time, you have to try to balance the production of toilet paper against the other zillion things that also require trees, railcars, and workers. The entire problem is far too complex and requires far too much information to be solved. The result was that resources were constantly being misdirected and wasted.

In a price system, the farmers would have simply paid to bid the railcars away from other uses. In a competitive market, many sellers compete against each other to attract customers, and the market tends to be very efficient. Because competition is ongoing, the pressure to be efficient is constant. Sellers also have a big incentive to improve efficiency in order to undersell their rivals and steal their customers.

As long as profits are to be made, you can be pretty certain that a supply will arise to satisfy any demand. The fact that illegal drugs are widely and cheaply available — despite vigorous government programs to stop their production and distribution — is probably the best example of the robustness of markets.

Child labor and sweatshop labor are primary examples. The other big problem with markets is that they cater to those who have money to spend. The price system gives an incentive to produce only the things that people are willing and able to pay for.

A related problem with markets is income and wealth inequality. This invariably leads to large inequalities in wealth that many people find offensive. Government interventions in the economy usually take one of three forms: Penalties or bans on producing or consuming goods or services considered dangerous or immoral: These bans often work only partially because the market still has large incentives to provide such goods and services.

Subsidies to encourage the production of goods and services considered desirable: For instance, most governments heavily subsidize the education of children and the provision of medical care. They do so because of the fear that insufficient education and inadequate medical care will be provided without the subsidies. Education and medical care also often provide large spill over benefits to the wider public.

Consider immunizations. Taxes on the well-off to provide goods and services to the less fortunate and to reduce inequalities in income and wealth: These taxes are put toward things like good parks, clean air, and art, as well as goods and services for the poor.

Governments tax individuals and businesses in order to raise the money to provide such things. In terms of the PPF graph, each of these government interventions causes the economy to produce and allocate an output combination different from the one that society would have ended up with if the markets had made all the production and allocation decisions.

Depending on the situation, the output combination produced by a government intervention may be better or worse than the market combination in terms of productive efficiency, allocative efficiency, or both. Which combination is, in fact, better depends on the specifics of each case. TAGS download economics for dummies economics book economics for dummies ebook economics for dummies pdf. Leave a Reply Cancel reply Your email address will not be published.

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