Chapter 1: Thinking like and Economist

LO1: Explain and apply the Scarcity Principle, which says that having more of any good thing necessarily requires having less of something else

-AKA: the Know Free Lunch Principle -Although we have boundless needs and wants, the resources available to us are limited. So having more of one good thing usually means having less of another. -economic terms, scarcity means finite or not unlimited. This means almost everything is a scarce resource, even if it's common there is still a price. -everything involves tradeoffs/upside vs. downside

Opportunity Cost

-the value of what you must sacrifice to do something -a higher opportunity cost will have significant effect of cost benefit analysis and make the cost more likely to exceed the benefit -the value of all costs, both explicit and implicit

Micro vs macro economics

By convention, we use the term microeconomics to describe the study of individual choices and of group behavior in individual markets. Macroeconomics, by contrast, is the study of the performance of national economies and of the policies that governments use to try to improve that performance. Macroeconomics tries to understand the determinants of such things as the national unemployment rate, the overall price level, and the total value of national output.

LO2: Explain and apply the Cost-Benefit Principle, which says that an action should be taken if, but only if, its benefit is at least as great as its cost

Economists resolve trade-offs by using cost-benefit analysis, which is based on the disarmingly simple principle that an action should be taken if, and only if, its benefits exceed its costs. We call this statement the Cost-Benefit Principle, and it, too, is one of the Core Principles of economics: -ex/ reducing class size benefit is learning quality but cost is more teachers. Only makes sense if the learning value exceeds additional teacher salaries and other costs -Fundamental tool for how rational people make choices -usually won't have clear quantitative costs/benefits, which is okay -goal is to take actions that yield the largest economic surplus (the benefit minus the cost) -opportunity costs play factor

implicit vs explicit costs

Explicit: dollars given up Implicit: anything given up not measured in dollars

Normative vs. Positive Economic Principles

The Cost-Benefit Principle is an example of a normative economic principle, one that provides guidance about how we should behave. For example, according to the Cost-Benefit Principle, we should ignore sunk costs when making decisions about the future. As our discussion of the various decision pitfalls makes clear, however, the Cost-Benefit Principle is not always a positive, or descriptive, economic principle, one that describes how we actually will behave. As we saw, the Cost-Benefit Principle can be tricky to implement, and people sometimes fail to heed its prescriptions.

Explain and apply the Incentive Principle, whcih says that if you want to predict people's behavior, a good place to start is by examining their incentives.

The Incentive Principle: A person (or a firm or a society) is more likely to take an action if its benefit rises, and less likely to take it if its cost rises. In short, incentives matter. The Incentive Principle is a positive economic principle. It stresses that the relevant costs and benefits usually help us predict behavior, but at the same time does not insist that people behave rationally in each instance. For example, if the price of heating oil were to rise sharply, we would invoke the Cost-Benefit Principle to say that people should turn their thermostats down, and invoke the Incentive Principle to predict that average thermostat settings will in fact go down.

What does "marginal" mean

relevant to the decision

Discuss three important pitfalls that occur when applying the Cost-Benefit Principle inconsistently

researchers have identified situations in which people tend to apply the Cost-Benefit Principle inconsistently. In these situations, the Cost-Benefit Principle may not predict behavior accurately. But it proves helpful in another way, by identifying specific strategies for avoiding bad decisions. PITFALL 1: MEASURING COSTS AND BENEFITS AS PROPORTIONS RATHER THAN ABSOLUTE DOLLAR AMOUNTS -The cost of walking downtown for a cheaper price should be the same, regardless of the price of the object, should be measured objectively rather than proportionally PITFALL 2: IGNORING IMPLICIT COSTS implicit costs are the forgone opportunities to do something. Often people will just look at the cost of walking downtown, but won't measure what they miss, such as finishing the end of a movie. phrase not as "should I walk downtown" but as "should I walk downtown or finish the movie". PITFALL 3: FAILURE TO THINK AT THE MARGIN the only costs that should influence a decision about whether to take an action are those we can avoid by not taking the action. Similarly, the only benefits we should consider are those that would not occur unless the action were taken.As a practical matter, however, many decision makers appear to be influenced by costs or benefits that would have occurred no matter what. Thus, people are often influenced by sunk costs—costs that are beyond recovery at the moment a decision is made. For example, money spent on a nontransferable, nonrefundable airline ticket is a sunk cost. If you are letting sunk costs influence your decisions, you can do better by changing your behavior. n addition to paying attention to costs and benefits that should be ignored, people often use incorrect measures of the relevant costs and benefits. This error often occurs when we must choose the extent to which an activity should be pursued (as opposed to choosing whether to pursue it at all). We can apply the Cost-Benefit Principle in such situations by repeatedly asking the question "Should I increase the level at which I am currently pursuing the activity?" In attempting to answer this question, the focus should always be on the benefit and cost of an additional unit of activity. To emphasize this focus, economists refer to the cost of an additional unit of activity as its marginal cost. Similarly, the benefit of an additional unit of the activity is its marginal benefit. When the problem is to discover the proper level for an activity, the cost-benefit rule is to keep increasing the level as long as the marginal benefit of the activity exceeds its marginal cost. Knowing average cost vs avg benefit isn't enough, need to know cost/benefit ratio of each additional unit. The cost-benefit framework emphasizes that the only relevant costs and benefits in deciding whether to pursue an activity further are marginal costs and benefits—measures that correspond to the increment of activity under consideration. Think about the strip mall example - don't consider sunk costs and only think about marginal cost. Some costs and benefits, especially marginal costs and benefits and implicit costs, are important for decision making, while others, like sunk costs and average costs and benefits, are essentially irrelevant.

Economic Naturalist/naturalism

someone who uses insights from economics to help make sense of observations from everyday life.