Chapter One: The Four Core Principles of Economics

What are the Four Core Principles of Economics?

The Cost-Benefit Principle, The Opportunity-Cost Principle, The Marginal Cost Principle, The Interdependence Principle.

What Order Should We Apply the Four Principles?

1. The Marginal Principle

2. The Cost-Benefit Principle

3. The Opportunity-Cost Principle

4. The Interdependence Principle

MCOI

What does the Cost-Benefit Principle State?

The Costs and Benefits of something is what shapes our decisions.

What should we do before making a decision according to the Cost-Benefit Principle?

1. Evaluate the full set of cost and benefits associated with that choice

2. Pursue the choice only if benefits are greater than or equal to the costs.

What is ones Willingness to Pay (WTP)?

The most one is willing to ay to receive a certain benefit

How do we quantify costs and benefits?

Convert the costs and benefits into dollars by evaluating ones Willingness to Pay.

What is Economic Surplus?

The “extra” benefit one gains from an exchange

What is the formula for Economic Surplus?

Benefits - Costs

Is ones Willingness to Pay (WTP), a benefit or a cost?

It is a Benefit

What does the Opportunity-Cost Principle state?

The true cost of something is what you must give up to get it; “what you must give up for an opportunity.”

What are examples of something you might give up using the Opportunity Cost Principle?

Money, Time, Labor

How do you calculate Opportunity Costs?

Ask 2 Questions:

1. What happens if you pursue your choice?

2. What happens under your next best alternative?

What is the formula for Opportunity Costs?

Costs of your choice - Cost of your Alternative

What is a sunk cost?

A cost that you have already paid and cannot get back (you do NOT include this in your calculations)

e.g. An application fee

What is the Product Possibility Frontier (PPF)?

• A visualization of Opportunity costs

• Shows the different outputs(possibilities of how to use your resources) with your scarce resources

What shifts the Product Possibility Frontier (PPF)

1. Increase in Inputs/ resource

   1. Moves the line towards or away from origin

2. Change in technology/ efficiency

   1. Changes the slope of the PPF

What are the Intercepts of the Product Possibility Frontier (PPF)

• y-intercept → maximization of output A

• x-intercept → maximization of output B

What does the line in a PPF Graph mean?

The most efficient combinations of outputs with current resources

What does the space over the line in a PPF Graph represent?

The unattainable combinations with the current resources

What does the pace under the lin of a PPF repersent?

Inefficient combinations of outputs with current resources

What does the Marginal Principle State?

• We should break down the decisions that involve quantity into smaller decisions

• “Should I do ONE more.."?”

What is the Marginal Benefit?

The benefit from buying/getting ONE more of something

What is the Marginal Cost?

The Cost of buying/getting ONE more thing

What is the Marginal Principle rule?

Buy “one more” IF Marginal Benefit > Marginal Cost

What is the Rational Rule?

If something is worth doing, keep doing it until the Marginal Benefit = Marginal Cost

When is Economic Surplus maximized?

When the marginal benefit is equal to the marginal cost

What does the Interdependence Principle State?

Out Best Choices depedn on:

1. Our Other choices

2. The Choices of others

3. Developments in our market

4. Expectations about the Future