Four Principles of Economics

Sunk Cost

A cost that has been incurred and cannot be reversed. A sunk cost exists whatever choice you make, and hence it is not an opportunity cost. Good decisions ignore sunk costs.

someone else's shoes technique

By mentally "trading places" with someone so that you understand their objectives and constraints, you can forecast the decisions they will make.

Voluntary Exchanges

Sellers get money, buyers get the stuff they want. Both are better off.

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.

Marginal Principal

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.

Rational Rule

If something is worth doing, keep doing it until your marginal benefits equal your marginal 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)?"

As a consumer: How many cups of coffee should you buy today?

Keep buying coffee until the marginal benefit (your willingness to pay for that last cup of coffee) is equal to the marginal cost (the price and, if it's late, how much it would stand in the way of getting a good night's rest).

As an export company: How many tons of coffee should you export?

Keep exporting until the marginal benefit (the price you can get for the coffee overseas) is equal to the marginal cost (the price at which domestic producers will sell you one more ton, plus the price of shipping it overseas).

As an employer: How many workers should you hire?

Keep hiring until the marginal benefit of an extra worker (the rise in revenues you get from selling more coffee) is equal to the marginal cost (the wages of that last worker and the cost of that extra coffee).

As an investor: How much should you invest in a new chain of specialty coffee shops?

Keep investing until the marginal benefit (your return on the last dollar invested) is equal to the marginal cost. (This includes the opportunity cost of that last dollar: How else could you invest that dollar, and how could you spend it now?)

As a producer: How many tons of coffee should you produce?

Keep producing coffee until the marginal benefit of producing an extra ton (the wholesale price you can sell it for) is equal to the marginal cost of producing another ton.

As a job-seeker: How many coffee shops should you send your résumé to?

Keep sending job applications until the marginal benefit (the value of the increased chance of finding a job) is equal to the marginal cost of an application (the time and hassle of filling out one more application).

As a worker: How many hours should you work as a barista?

Keep working until the marginal benefit (your hourly wage) is equal to the marginal cost of working (the value of the marginal hour of leisure time that you are missing).

When you confront a problem use MCOI

Marginal, Cost benefit, opportunity, interdependence

Marginal Benefit

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

Marginal Cost

The extra cost from one extra unit.

Economic Surplus

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

Opportunity Cost Principle

The true cost of something is the next best alternative you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs.

Framing Effect

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

Interdependence Principal

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 change, your best choice might change.