Econ 101 - Chapter 2.1 - Tradeoffs, Budget Constraint, Opportunity Cost & Marginal Utility.

Tradeoffs

Giving up what you have in exchange for something you need

Budget Constraint

• One of the mathematical models that try to capture ideas of scarcity and tradeoffs

• Describes all possible consumption combinations of goods that someone can afford given the prices of the goods when ALL income is spent

• Each point on graph represents the maximum amount of one good one can afford given some amounts of the other available goods

Opportunity set

• One of the mathematical models that try to capture the ideas of scarcity and tradeoffs

• Describes all possible combinations of consumption that someone can afford given the prices of goods and given the individual’s income

• Does not require all income to be spent

How does opportunity set and budget constraint relate to each other?

• A budget constraint is the boundary of the opportunity set it defines

• When looking at a budget line graph, the opportunity set includes every point on (or inside) the budget constraint which someone can afford.

Opportunity Cost

• resources that are sacrificed, such as money or time which cannot be used for another purpose

• Every choice has an opportunity cost

• Reasonable to refer opportunity cost as price, but it sometimes does not measure the true opportunity cost when looking at a broader topic → costs of time

Graphs

• what happens when price 1 increases? → budget becomes steepers

• What happens when there’s an increase to price 2? → the budget line lowers

• What happens when there’s an increase to income? → there’s more room in opportunity cost

• No changes happen when there’s a proportional increase to two prices and income

Thinking at the Margin

• Economic principle

• Decisions are most often made at the margin

• Economists use concept of utility to describe one’s level of satisfaction

Marginal Utility

• A concept made by economists that humans tend to like extra units if a good or service is less, and less the more they have it.

  • A poor person valuing an extra dollar more than a rich person does

• Utility is a measure of satisfaction or value one obtains from consuming goods and services

• Marginal utility is increase in utility when the amount of good consumed increases by one small unit while the quantities of all other good remain unchanged

Marginal Analysis

• people rarely make binary decisions

• People most likely make decisions in increments: should i buy more fruits this week, or more burgers?

• Ponders the benefits and costs of choosing a little more or a little less of a good

Sunk Cost

• Money, time, or effort already spent that cannot be recovered

• Sunk cost (Concorde) fallacy: letting past investments influence them to continue a losing endeavour

  • Watching a bad movie just because you’ve paid for it is irrational