principles of economics

cost benefit principle

before you make a decision:

1. evaluate the full set of costs and benefits

2. only make that choice if benefits are at least as big as the costs

willingness to pay

convert non-financial costs or benefits into their monetary equivalent → “what is the most i am willing to pay to get this benefit (or avoid that cost)?

economic surplus

the total benefits minus the total costs flowing from a decision

• measures how much a decision has improved your well-being

• you generate economic surplus every time you make a decision in accordance with the cost-benefit principle

• maximized when marginal benefit equals the marginal cost

opportunity cost principle

the opportunity cost of choosing any one alternative is the value of the next best alternative that is given up

limited resources

• land - natural endowments

• labour - physical and mental human resources

• capital - manufactured aids to production

• also - attention, time, money, etc.

scarcity

our wants outweigh our ability to produce those wants with our resources

• thus, scarcity makes opportunity costs (trade-offs) inescapable

• economics is the study of the use of scarce resources to satisfy unlimited human wants, and how people make decisions

production possibilities frontier (PPF)

shows the different sets of output that are attainable with your scarce resources, reveals your opportunity costs

• illustrates the trade-offs you confront when deciding how to allocate your scarce resources (like your time)

sunk costs

a cost that has been incurred and cannot be reversed. exists in whatever choice you make

• irrelevant to current decision at hand because these costs are associated with every alternative moving forward

marginal principle

decisions about quantities are best made incrementally

• to break “how many” decisions down into a series of smaller (marginal) decisions

• ex. instead of “how many workers should i hire?” → “should i hire one more worker?”

  • apply cost-benefit principle to this marginal decision to answer this question

  • hire additional worker is marginal benefit exceeds marginal cost

marginal benefit

benefit derived from one more unit (of goods purchased, hours of studying, etc.)

marginal cost

the extra cost from one more unit

rational rule

if something is worth doing, keep doing it until your marginal benefits equal your marginal costs

• every additional unit acquired use it the marginal principle will increase your economic surplus (surplus = benefit costs)

interdependence principle

your best choice depends on:

1. your other choices

2. the choices others make

3. developments in other markets

4. expectations about the future

• when any of these factors change, your best choice might change

MCOI

when confronting problems:

• Marginal principle by breaking down how many choices into simpler marginal choices

• Cost-benefit principle by assessing relevant costs and benefits

• Opportunity cost principle to ask “or what?”

• Interdependence principle to help identify how changes in factors might lead you to a different decision