Chapter 1 : Term Review
Opportunity Cost
-The true cost of something is the next best alternative you have to give up to get it -Whenever you choose to do something, you are implicitly choosing not to do something else. -If the opportunity cost of something is what you must give up to get it, then it's the difference between the consequences of making that choice and the consequences of the next best alternative. -If the expense is the same, and if you have to pay for it under either alternative, then it's not an opportunity cost.
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.
The 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. Ask: "Benefit Beat Cost?"
The Marginal Principle
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. -"How Many/One More?"
Production Possibility Frontier(PPF)
Shows the different sets of output that are attainable with your scarce resources.
The 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)?" EX: You are willing to pay $4 for coffee, and coffee is $3. The cost is less than the price you're willing to pay so you should buy it.
Using the Core Principles in Practice
Step one: First, use the marginal principle by breaking "how many" choices down into simpler marginal choices. Ask yourself whether you would be better off doing a bit more of something, or a bit less. Step two: Then apply the cost-benefit principle by assessing the relevant costs and benefits. Since you're analyzing a marginal question, this says you need to assess whether the marginal benefit exceeds the marginal cost. Step three: To evaluate all the relevant costs and benefits, you'll need to apply the opportunity cost principle and ask, "Or what?" This ensures that you take full account of what you give up when you make a choice. You should focus on the relevant opportunity costs, not just financial out-of-pocket costs. Step four: The interdependence principle helps you identify how changes in other factors—in your own choices, other people, other markets, and expectations about the future—might lead you to make a different decision. Remember the order with MCOI : Marginal, Cost-Benefit, Opportunity Cost, and 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.
Scarcity
The problem that resources are limited. EX: Any resources you spend pursuing one activity leaves fewer resources to pursue others.
Economic Surplus
The total benefits minus total costs flowing from a decision. It measures how much a decision has improved your well-being. EX: You are willing to pay $4 for coffee, and paid $3. Your Economic Surplus is $1.
The 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. Always ask: 1. What happens if you pursue your choice? 2. What happens under your next best alternative? -Always ask "Or What"
Framing Effect
When a decision is affected by how a choice is described, or framed. You should avoid framing effects altering your own decisions. EX: Restaurant lists one item in the menu that is the most expensive, and as a result making the rest of the menu items look cheap, which may lead the consumer to buy more (thinking that they are benefiting from not buying that one expensive item).
The Interdependence Principle
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. -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 -Ask "What Else?"