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Basic Principles

Lecture 1
Gneezy & Rustichini, Quarterly Journal of Economics (2000)
“A fine is a price.”
Israeli daycares introduced a small fine for parents who picked up their children late. Late pickups immediately increased and stayed high even after the fine was removed. The fine turned a social norm into a transaction, parents stopped feeling guilty and started comparison-shopping. Incentives shape behavior in ways we don’t always predict.

What is Economics?

What is Economics?

A way of thinking about the world.

What is Economics?

A way of thinking about the world.
Focus on individual choice and action.
  • What incentives do individuals face?
  • Do they have information to act consistent with those incentives?

What is Economics?

A way of thinking about the world.
Focus on individual choice and action.
  • What incentives do individuals face?
  • Do they have information to act consistent with those incentives?
Managerial decision-making:
  • Who made the bad decision?
  • Did they not face the right incentives?
  • Did they not have the information needed to act on them?

What do economists assume about individual choice and action?

What do economists assume about individual choice and action?

Individuals are rational.
  • They employ means that they believe will be effective towards desired ends.
  • When the expected costs/benefits of particular means change, individuals change their behavior.

What do economists assume about individual choice and action?

Individuals are rational.
  • They employ means that they believe will be effective towards desired ends.
  • When the expected costs/benefits of particular means change, individuals change their behavior.
Individuals are self-interested.
  • Their desired ends are subjective.
  • Individual tastes and preferences.
  • De gustibus non est disputandum!

What do economists assume about individual choice and action?

Individuals are rational.
  • They employ means that they believe will be effective towards desired ends.
  • When the expected costs/benefits of particular means change, individuals change their behavior.
Individuals are self-interested.
  • Their desired ends are subjective.
  • Individual tastes and preferences.
  • De gustibus non est disputandum!
Individuals make choices at the margin.
  • Trading off a bit more of this at the cost of a bit less of that.
  • Is the marginal individual changing his/her behavior?
Marginal analysis means thinking in terms of opportunity cost.
Marginal analysis means thinking in terms of opportunity cost.
Opportunity cost is the value of the next best alternative action an individual sacrifices by acting in a particular way.
Marginal analysis means thinking in terms of opportunity cost.
Opportunity cost is the value of the next best alternative action an individual sacrifices by acting in a particular way.
The price of a good is only one component of its cost.
Marginal analysis means thinking in terms of opportunity cost.
Opportunity cost is the value of the next best alternative action an individual sacrifices by acting in a particular way.
The price of a good is only one component of its cost.
  • Lost wages are only one component of the cost associated with losing one’s job.
  • Interest is only one component of the cost of capital.
Marginal analysis means thinking in terms of opportunity cost.
Opportunity cost is the value of the next best alternative action an individual sacrifices by acting in a particular way.
The price of a good is only one component of its cost.
  • Lost wages are only one component of the cost associated with losing one’s job.
  • Interest is only one component of the cost of capital.
Cost is subjective to the individual.
What’s the cost of your college education?
Marginal analysis acknowledges tradeoffs are everywhere
“I’ve been in public service for many years on every level of public service. I’ve managed dozens of emergencies. The philosophy that’s always worked for me is prepare for the worst, hope for the best… This is about saving lives and if everything we do saves just one life, I’ll be happy.” Gov. Andrew Cuomo, signing “New York State on Pause” executive order, March 20, 2020
The economic critique: “If everything we do saves just one life, I’ll be happy” explicitly rejects marginal analysis. Every policy has costs. Economists insist tradeoffs be made expliciteven when uncomfortable.
Economics is positive (rather than normative) analysis.
Economics is positive (rather than normative) analysis.
How individuals will (rather than ought to) act when they face certain incentives.
Economics is positive (rather than normative) analysis.
How individuals will (rather than ought to) act when they face certain incentives.
“[T]he role of the managerial economist when consulting, is to leave their own ethical opinions at the door.” Anthony J. Evans, Market for Managers: A Managerial Economics Primer
Economics is positive (rather than normative) analysis.
How individuals will (rather than ought to) act when they face certain incentives.
“[T]he role of the managerial economist when consulting, is to leave their own ethical opinions at the door.” Anthony J. Evans, Market for Managers: A Managerial Economics Primer
Given that employees are self-interested, how do you design incentives so they act in the firm’s interest?

Key Terms

Practice Questions
Question 1 of 5

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