Economics Notes

Choices and Tradeoffs

In a world of scarcity, choices involve tradeoffs. Opportunity cost is what must be given up to obtain something desired. People make decisions based on budget constraints, which are the limit of spending based on income. Marginal analysis involves comparing the benefits and costs of choosing a little more or less of a good. The law of diminishing marginal utility states that as a person receives more of a good, the additional utility from each additional unit declines.

Budget Constraints and Opportunity Cost

Budget constraints show the tradeoff between two goods. For example, Alphonso has $10 to spend on burgers ($2) and bus tickets ($0.50). The budget constraint illustrates all possible combinations he can afford. Opportunity cost is the value of the next best alternative. For Alphonso, the opportunity cost of one burger is four bus tickets.

Production Possibilities Frontier (PPF)

The PPF illustrates the constraints faced by society due to limited resources. It shows the tradeoff between two goods, like healthcare and education. The PPF's shape reflects the law of diminishing returns, where additional resources yield smaller marginal benefits. Comparative advantage arises when a country can produce a good at a lower opportunity cost than another country.

Efficiency

Productive efficiency means it's impossible to produce more of one good without decreasing the quantity of another. Allocative efficiency means the mix of goods represents what society desires most. Scarcity impacts all the choices we make.

Confronting Objections to the Economic Approach

The economic approach to decision-making assumes rationality, which critics argue is unrealistic. However, it provides a useful framework for analyzing tradeoffs. Economics distinguishes between positive statements (describing the world as it is) and normative statements (how the world should be). The assumption of self-interest is a simplification and does not negate altruism or the importance of personal freedom.