Chapter 1: Four Core Principles

Economics

the study of people “in the ordinary business of life”

The Four Core Principles of Economics

cost-benefit principle, opportunity cost principle, marginal principle, interdependence principle

Cost-benefit principle

Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice, and only pursue those whose benefits are at least as large as their costs.

Willingness to pay

In order to convert nonfinancial costs or benefits into their monetary equivalent, ask yourself: “What is the most I am willing to pay to get this benefit (or avoid that cost)?”

Economic surplus

The total benefits minus total costs flowing from a decision; it measures how much a decision has improved your well-being.

Voluntary exchange

Both the buyer and the seller benefit.

Framing effect

When a decision is affected by how a choice is described, or framed. You should avoid framing effects altering your own decisions.

Opportunity cost

The true cost of something is the next best alternative you have to give up to get it.

costs of the choice - costs of the next best alternative

Scarcity

Resources are limited, therefore any resource you spend pursuing one activity leaves fewer resources to pursue others. Scarcity implies that you always face a trade-off.

Marginal principle

Decisions about quantities are best made incrementally. You should break “how many” questions into a series of smaller, or marginal decisions, weighing marginal benefits and marginal costs.

Marginal benefit

The extra benefit from one extra unit (of goods purchased, hours studied, etc.).

Marginal cost

The extra cost from one extra unit.

Rational Rule

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

Interdependence principle

Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors changes, your best choice might change.