1
Big Ideas in Economics
Incentives Matter
Good Institutions Align Self-Interest with the Social Interest
Trade-offs Are Everywhere
Thinking on the Margin
The Power of Trade
The Importance of Wealth and Economic Growth
Institutions Matter
Economic Booms and Busts Cannot Be Avoided but Can Be Moderated
Prices Rise When the Government Prints Too Much Money
Central Banking Is a Hard Job
The Biggest Idea of All: Economics Is Fun
The prisoners were dying of scurvy, typhoid fever, and smallpox, but nothing was killing them more than bad incentives. In 1787, the British government had hired sea captains to ship convicted felons to Australia. Conditions on board the ships were monstrous; some even said the conditions were worse than on slave ships. On one voyage, more than one-third of the men died and the rest arrived beaten, starved, and sick. A first mate remarked cruelly of the convicts, “Let them die and be damned, the owners have [already] been paid for their passage.”1
The British public had no love for the convicts, but it wasn’t prepared to give them a death sentence either. Newspapers editorialized in favor of better conditions, clergy appealed to the captains’ sense of humanity, and legislators passed regulations requiring better food and water, light and air, and proper medical care. Yet the death rate remained shockingly high. Nothing appeared to be working until an economist suggested something new. Can you guess what the economist suggested?
Instead of paying the captains for each prisoner placed on board ship in Great Britain, the economist suggested paying for each prisoner that walked off the ship in Australia. In 1793, the new system was implemented and immediately the survival rate shot up to 99%. One astute observer explained what had happened: “Economy beat sentiment and benevolence.”2
The story of the convict ships illustrates the first big lesson that runs throughout this book and throughout economics: incentives matter.
Incentives are rewards and penalties that motivate behavior.
By incentives, we mean rewards and penalties that motivate behavior. Let’s take a closer look at incentives and some of the other big ideas in economics. On first reading, some of these ideas may seem surprising or difficult to understand. Don’t worry: we will be explaining everything in more detail.
2
We see the following list as the most important and fundamental contributions of economics to human understanding; we call these contributions Big Ideas. Some economists might arrange this list in a different manner or order, but these are generally accepted principles among good economists everywhere.