Microeconomics / Section 1 / Scarcity, Choice, Opportunity Cost

Incentive

An incentive could be either a reward or a penalty

Choice

Choice Scarcity requires choice. Choice refers to people having to choose which of their desires they will satisfy and which they will leave unsatisfied. When we, either as individuals or as a society, choose more of something, scarcity forces us to take less of something else.

Cost Associated with Next Best Alternative

Cost Associated with Next Best Alternative Making decisions requires comparing the costs and benefits of alternative choices. The opportunity cost of any item is whatever must be given up to obtain it. It is the cost associated with the next best alternative only. It is the relevant cost for decision making.

Cost Associated with Next Best Alternative Examples:

Cost Associated with Next Best Alternative Examples: The opportunity cost of going to graduate school for two years is not just cost of the tuition, books, and fees, but also the cost of foregone wages. The opportunity cost of seeing a play is not only the price of the ticket and any concessions, but also the value of the time you spend at the theatre.

Rational people only take action

If an only if MB > MC

People Face Tradeoffs

People Face Tradeoffs Society faces an important tradeoff in efficiency vs equality. Efficiency is when society gets the most from its scarce resources. Equality is when prosperity is distributed uniformly among society's members. The tradeoff is that to achieve greater equality by redistributing income from higher wage earners to the poor. But this redistribution reduces the incentive to work and produce, and it shrinks the size of economic prosperity. Note: The redistribution of income from the wage earners to poorer people is accomplished through a progressive tax system and well-defined social programs like food stamps and unemployment insurance that try to provide a safety net for people at the low end of the income distribution. But, a progressive tax system reduces the incentive to work. The reward for working hard is a high income. Taxes reduce this reward and therefore reduce the incentive to work hard.

Rational People Respond to Incentives

Rational People Respond to Incentives An incentive is something that induces a person to act, such as the prospect of a punishment or a reward. Because rational people make decisions by comparing costs and benefits, they respond to incentives. Examples: When fuel prices rise, consumers buy more hybrid cars and fewer less fuel efficient SUVs or trucks. When cigarette taxes increase, teen smoking falls.

Rational People Think at the Margin Examples:

Rational People Think at the Margin Examples: When a student considers whether to go to college for an additional year, he compares the fees and foregone wages to the extra income he could earn with the extra year of education. When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue.

Rational People Think at the Margin

Rational People Think at the Margin Rational people Systematically and purposefully do the best they can to achieve their objectives. Often make decisions by comparing the marginal benefit (MB) and the marginal cost (MC) of a proposed action. Rational decision makers take action if and only if MB > MC.

Scarcity

Scarcity Scarcity refers to the limited nature of society's resources. People have unlimited wants and needs but there are limited resources so all human demands cannot be satisfied. Scarcity limits us both as individuals and as a society. As individuals, limited income (and time and ability) keep us from having and doing everything we would like. As a society, limited resources (such as manpower, machinery, and natural resources) constrain the amount of goods and services that can be produced.

fter much consideration, you have chosen Cancun over Ft. Lauderdale as your Spring Break destination this year. However, Spring Break is still months away, and you may reverse this decision. Which of the following events would prompt you to reverse this decision?

The marginal cost of going to Ft. Lauderdale decreases.

Opportunity cost

The opportunity cost of any item is whatever must be given up to obtain it. It is the cost associated with the next best alternative only.

Trade-offs

Trade-offs All decisions that people make involve trade-offs of one goal against another. To get one thing that we like, we usually have to give up another thing that we like. Examples: Going to the club or bar the night before your final exam leaves less time for a college student to study. Having more money to buy stuff requires working longer hours, which leaves less time for rest and relaxation. Protecting the environment requires resources that could otherwise be kept as savings for a company or used to produce more products.

People respond to incentives

by calculating their individual costs and benefits and determining which is greater.

A tradeoff exists between a clean environment and a higher level of income in that

laws that reduce pollution raise costs of production and reduce incomes

he optimal amount of studying is determined by comparing the

marginal benefit and the marginal cost of studying

In economics, the cost of doing something is

the value of the next best opportunity not taken