Ch. 1 ECON

Sunk Costs

When the time, effort, and other costs you put into the project cannot be reversed, they are referred to as sunk costs. Since sunk costs can't be reversed, you'll incur those costs under either scenario, which means that they are not opportunity costs. Thus, you should ignore sunk costs.

Willingness to pay

Convert costs and benefits into dollars by evaluating your willingness to pay. There's a simple trick that economists use: We convert each cost and benefit into its money equivalent. And that's easier than you may think: Simply assess your willingness to pay. That is, ask yourself: What is the most that you would be willing to pay in order to obtain a particular benefit or to avoid a particular cost?

Rational Rule

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

Production Possibility Frontier

Sometimes you'll find it useful to visualize your opportunity costs. That's what the production possibility frontier is for—it maps out the different sets of output that are attainable with your scarce resources. It illustrates the trade-offs—that is, the opportunity costs—you confront when deciding how best to allocate scarce resources like your time, money, raw inputs, or production capacity. The production possibility frontier illustrates your alternative outputs.

Marginal Cost

The extra cost of that worker is called the marginal cost. Applying the cost-benefit principle to this marginal choice, you should hire one more worker only if the marginal benefit exceeds the marginal cost.

Opportunity Cost

The opportunity cost of something is the next best alternative you have to give up. This principle reminds you that whether you are deciding how to spend your money, your time, or anything else, you should think about its alternative uses. It tells you to assess the consequences of your choice relative to the best of your alternatives. The principle forces you to focus on the real trade-offs you face, and in doing so you will make better decisions.

Scarcity

This opportunity cost arises because of a fundamental economic problem: scarcity. Your resources are limited—that is, they're scarce. It's not just that you have limited income, but you also have limited time (only 24 hours in a day), limited attention, and limited willpower. Any resources you spend pursuing one activity leaves fewer resources to pursue others. Scarcity implies that you always face a trade-off. Whenever you use any scarce resource—your time, money, attention, willpower, or other resources—there's an opportunity cost.

Someone else's shoes technique

To predict what others will do, put yourself in their shoes. They can also be used for the equally important task of understanding and even predicting the decisions of others: your customers, competitors, employees, suppliers, and even friends and family.

Economic Surplus

When you follow the cost-benefit principle, every decision you make will yield larger benefits than costs. The difference between the benefits you enjoy and the costs you incur is called your economic surplus, and it is a measure of how much your decision has improved your well-being. Making good decisions is all about maximizing your economic surplus.

Interdependence Principle

recognizes that 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. There are four types of interdependencies you'll need to think about: 1) Dependencies between each of your individual choices 2) Dependencies between people or businesses in the same market 3) Dependencies between markets 4) Dependencies through time

Cost-Benefit Principle

Costs and benefits are the incentives that shape decisions. This principle suggests that before you make any decision, you should: 1) Evaluate the full set of costs and benefits associated with that choice. 2) Pursue that choice, only if the benefits are at least as large as the costs.

Framing Effect

Psychologists have documented that small differences in how alternatives are described, or framed, can lead people to make different choices. This phenomenon is known as the framing effect. But while the framing effect is common, it is not rational, and you don't want your decision making to be this arbitrary. If you want to make good decisions that aren't affected by how your choices are described, you should follow the cost-benefit principle.

Marginal Principle

That decisions about quantities are best made incrementally. Whenever you face a decision about how many of something to choose (such as, "How many workers should I hire?"), it is always easier to break it into a series of smaller, or marginal, decisions (such as, "Should I hire one more worker?"). The marginal principle suggests that you evaluate whether the extra benefit from hiring one more worker exceeds the extra cost of that extra worker.

Marginal Benefit

The marginal principle suggests that you evaluate whether the extra benefit from hiring one more worker exceeds the extra cost of that extra worker. We call the extra benefit you get from one more worker the marginal benefit.