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Unformatted text preview: Chapter 1 - Thinking Like an Economist Economics: Studying Choice in a World of Scarcity Scarcity is a fundamental fact of life. Economics - the study of how people make choices under conditions of scarcity and of the results of those choices for society. Scarcity 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. No-Free Lunch Principle - somebody, somehow, always has to pay for everything. Cost-Benefit Principle : An action should be taken if, and only if, its benefits exceed its costs. The economic definition of "best" takes into account both the benefits and the costs Applying The Cost-Benefit Principle Rational Person - someone with well-defined goals who tries to fulfill those goals as best he or she can. Often the only real difficulty in applying the cost-benefit rule is to come up with reasonable measures of the relevant benefits and costs. o Economic Surplus Economic Surplus - difference between the benefit and its cost o Opportunity Cost Opportunity Cost - the value of the nest-best alternative that must be forgone in order to undertake the activity. o The Role of Economic Models Economists use the cost-benefit principle as an abstract model of how an idealized rational individual would choose among competing alternatives. All the cost-benefit principle really says is that a rational decision is one that is explicitly or implicitly based on a weighing of costs and benefits. Four Important Decision Pitfalls o Pitfall I: Measuring Costs and Benefits As Proportions Rather Than Absolute Dollar Amounts The benefit is not the proportion you save, rather it is the absolute dollar amount you save. o Pitfall II: Ignoring Opportunity Costs Many of us tend to overlook the implicit value of activities that fail to happen. Intelligent decisions require taking the value of forgone opportunities properly into account Opportunity cost of an activity is the value of the next-best alternative that must be forgone in order to engage in that activity. The key to using the concept of opportunity cost correctly lies in recognizing precisely what taking a given action prevents us from doing....
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