Principles of Economics - Week 2

Economics

A systematic approach to thinking about the world

Marginal Principle

Evaluate the extra benefit and extra cost from adding or buying one more unit to make "how many" decisions

Marginal Benefit (MB)

The additional benefit gained from buying or consuming one more unit of a good or service

Marginal Cost (MC)

The additional cost incurred from producing or buying one more unit of a good or service

Rational Rule

If something is worth doing keep doing it until Marginal Benefit equals Marginal Cost (MB = MC) to lead to good decisions

Cost-Benefit Principle

Costs and benefits are incentives shaping decisions so evaluate the full set of financial and non-financial consequences and choose if Benefit >= Cost

Willingness to Pay (WTP)

The maximum dollar amount you would pay to receive a benefit or avoid a cost

Economic Surplus

The net surplus or net benefit from decisions where both buyers and sellers benefit from voluntary exchange

Framing Effect

How a decision is framed or presented can lead people to make different choices even if options are identical

Opportunity Cost Principle

The idea that you must give up the next best alternative in EVERY choice because of limited resources and unlimited wants

Opportunity Cost Formula

Opportunity Cost = (Cost of choice) - (Cost of next best alternative)

Types of Opportunity Costs

Opportunity costs are not always out-of-pocket financial costs

non-financial trade-offs are real opportunity costs

Sunk Costs

Costs already incurred that cannot be reversed and must be ignored when making decisions

Production Possibility Frontier (PPF)

A curve illustrating alternative output combinations of two choices on two axes that reveals opportunity costs

PPF Shift - Technology in Both Goods

A technological advance that improves both goods shifts the entire PPF outward to the right

PPF Shift - Technology in One Good

A technological advance in only one good changes the slope of the PPF by rotating outward on that good's axis

PPF Shift - Productivity Gains

Overall productivity gains shift the entire PPF forward

Interdependence Principle

Your best choice depends on four types of interdependencies asking "what else does my decision affect?"

Dependencies Between Individual Choices

Limited resources mean every choice made affects available resources for other decisions such as income time attention and production capacity

Dependencies Between People or Businesses

Competition between participants in the same market for society's scarce resources including employees jobs proposal vs proposal and buyers' attention

Dependencies Between Markets

Cross-market connections where price changes in one market affect opportunities in another (housing depends on credit market

Dependencies Through Time

Asking whether it is better to act today or tomorrow because expectations about the future influence your best choice today

4-Step Decision Process

1) Marginal choice for how many choices into similar choices 2) Cost-benefit assessing relevant MB and MC 3) Opportunity cost principle asking or what? 4) Interdependence principle seeing how changes in factors affect decision

Perspective-Taking Rule

Put yourself in someone else's shoes when making a decision to anticipate their choices and incentives