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1-1© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - All
Chapter 1: Thinking Like an Economist
1. The Scarcity Principle: having more of any good thing necessarily requires having less of something else
2. The Cost-Benefit Principle: an action should be taken if and only if its benefit is at least as great as its costs
3. The Incentive Principle: examine people's incentives to predict their behavior
4. Three pitfalls in reasoning
1. Measuring costs and benefits as proportions instead of as dollar amounts
2. Ignoring implicit costs
3. Failing to weigh costs and benefits at the margin
1-2© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 1
The Scarcity Principle
1-3© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 2
The Cost-Benefit Principle
Take an action if and only if the extra benefits are at least as great as the extra costs
Costs and benefits are not just money
1-4© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 2
Economic Surplus
Benefit of an action minus its costs
1-5© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 2
Opportunity Cost
The value of what must be foregone in order to undertake an activity Consider explicit and implicit costs
Examples: Give up an hour of babysitting to go to the movies Give up watching TV to walk to town
Caution: NOT the combined value of all possible activities Opportunity cost considers only your best alternative
1-6© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 2
Economic Models
Simplifying assumptions Which aspects of the decision are absolutely
essential? Which aspects are irrelevant?
Abstract representation of key relationships The Cost-Benefit Principle is a model
If costs of an action increase, the action is less likely If benefits of an action increase, the action is more
likely
1-7© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 – 4, 5, 6
Three Decision Pitfalls
Economic analysis predicts likely behavior Three general cases of mistakes
1. Measuring costs and benefits as proportions instead of absolute amounts
2. Ignoring implicit costs
3. Failure to think at the margin
1-8© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 4
Pitfall #1
Measuring costs and benefits as proportions instead of absolute amount Would you walk to
town to save $10 on a $25 item?
Would you walk to town to save $10 on a $2,500 item?
1-9© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 5
Pitfall #2 Ignoring implicit costs
Consider your alternatives
The value of a Frequent Flyer coupon depends on its next best use Expiration date Do you have time for
another trip? Cost of the next best
trip
1-10© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 6
Pitfall #3
Failure to think at the margin Sunk costs cannot be
recovered Examples:
Eating at an all-you-can-eat restaurant
Attend a second year of law school
1-11© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO - 6
Marginal Analysis Ideas
Marginal cost is the increase in total cost from one additional unit of an activity Average cost is total cost divided by the number of
units Marginal benefit is the increase in total benefit from one
additional unit of an activity Average benefit is total benefit divided by the number
of units
1-12© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - All
Normative and Positive Economics
Normative economic statements say how people should behave Gas prices are too
high Building a space base
on the moon will cost too much
Positive economic statements predict how people will behave The average price of
gasoline in May 2008 was higher than in May 2007
Building a space base on the moon will cost more than the shuttle program
1-13© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - 3
Incentive Principle
1-14© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - All
Microeconomics and Macroeconomics
Microeconomics studies choice and its implications for price and quantity in individual markets Sugar Carpets House cleaning services
Microeconomics considers topics such as Costs of production Demand for a product Exchange rates
Macroeconomics studies the performance of national economies and the policies that governments use to try to improve that performance Inflation Unemployment Growth
Macroeconomics considers Monetary policy Deficits Tax policy
1-15© The McGraw-Hill Companies, Inc., 2009McGraw-Hill/Irwin
LO 1 - All
Economics Is Choosing
Focus in this course is on a short list of powerful ideas Explain many economic issues Predict decisions made in a variety of circumstances
Core Principles are the foundation for solving economic problems