101 Econ Lecture 1 Should there be twelve sections of Econ 101 or only one? Students learn more effectively in smaller classes. But smaller classes are also more expensive. Some relevant costs: Faculty salary: $60,000 per "course" Per student faculty salary cost: one section: $60,000/300 = $200 twelve sections: $60,000/25 = $2400 If you were currently in a class with 300 students, would you be willing to pay $2200 to switch to one with only 25 students? The Scarcity Principle (Also called the No-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. Microeconomics entails the study of how people choose under conditions of scarcity. The Rationality Assumption: People have goals and try to fulfill them as best they can. Cost-benefit analysis Should I do activity x? C(x) = the costs of doing x B(x) = the benefits of doing x If B(x) > C(x), do x; otherwise don't. Example 1.1. Should I turn down my stereo? You have settled into a comfortable chair and are listening to your stereo when you realize that the next two tracks on the album are ones you dislike. If you had a compact disc player, you would have programmed them not to play. But you don't, and so you must decide whether to get up and turn the music down, or to stay put and wait it out. Suppose C(x) = $1.00 = the minimum amount it would take to get you out of your chair. B(x) = the maximum you would be willing to pay someone to turn down the volume. If B(x) > $1, then turn your stereo down. If B(x) < $1, then don't. The Cost-Benefit Principle An individual (or a firm, or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs. Can cost-benefit analysis help you make better decisions? Example 1.2 You are about to buy a $20 alarm clock at the campus store when a friend tells you that K-mart has the same alarm clock on sale for $10. Do you drive down to K-mart? Example 1.3 You are about to buy a $2510 laptop computer from the campus store when a friend tells you that K-mart has the same computer on sale for $2500. Do you drive down to K-mart? Should I drive down to K-mart? B(x) = benefit of driving down to K-mart = $10 in both C(x) cases = cost of driving down to K-mart = the same amount in both cases.
2 So your answer should be the same in both cases. Example 1.4. Choosing a public health program. A rare disease will claim 600 lives if we do nothing. We must choose between these two programs: Program A: save 200 lives with certainty Program B: save 600 lives with probability 1/3 save zero lives with probability 2/3 Example 1.5. Same disease as in Example 1.4 Program C: 400 people will die with certainty Program D: 1/3 chance that no one will die 2/3 chance that all 600 will die Example 1.6. Losing a $20 bill You have just arrived at the theater to buy your ticket and discover that you have lost a $20 bill from your wallet. Do you buy a ticket and see the play anyway? Example 1.7. A lost theater ticket. You have just arrived at the theater and discover that you have lost the $20 ticket you purchased earlier that day. Do you buy another ticket and see the play anyway? In both cases, you are $20 poorer than before. In both cases, the benefit of seeing the play, as measured by what you are willing to pay, may therefore be slightly smaller, but this benefit is the same in both cases. In both cases, the additional cost you must incur to see the play is exactly $20. Since the relevant costs and benefits are the same in both cases, your decision should also be the same. Example 1.8. How much memory should your computer have? Suppose that random access memory can be added to your computer at a cost of $0.50 per megabyte. Suppose also that the value to you, measured in terms of your willingness to pay, of an additional megabyte of memory is as shown in the diagram.
Dollars per megabyte MB 2.00 Value of an additional megabyte Cost of an additional megabyte
1.00 0.50 0.25 1000 2000 Megabytes of memory
How many megabytes of memory should you purchase?
MC 3000 4000
3 "Should I do X?" "How much X should I buy?" "Should I buy an additional unit of X?" The optimal amount of memory to purchase is the quantity for which the benefit of an additional megabyte (its marginal benefit) is just equal to its cost (marginal cost). Here, that equality occurs for 3000 megabytes of memory.
Dollars per megabyte MB 2.00
Optimal amount of memory
1.00 Price= 0.50 0.25 1000 2000 Megabytes of memory 3000 MC 4000