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Unformatted text preview: Economics
Studying Choice In a World of Scarcity Outline
Scarcity Principle Cost-Benefit Principle Micro vs. Macro Main Sources of Mistakes This Semester The Scarcity Principle
Boundless wants cannot be satisfied with limited resources. Therefore, having more of one thing usually means having less of another. Because of scarcity we must make choices. Wants vs. Resources Scarcity Choices So What Is Economics?
The study of how people make choices under conditions of scarcity and of the results of those choices for society. 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 Example: Class Size
What is the Optimal Class Size? To maximize learning without consideration of cost? How would considering costs change our answer?
A personal tutorial course in economics might cost $40,000 A class of 300 students might cost $200/student Question
What is the Optimal Class Size? What trade-offs must university administrators and students consider when choosing class size? What do we need to compare to answer this question? Bring in Assumptions and apply Cost-Benefit Principle
Assumptions: Two class sizes: 90 and 19 Large introductory economics classes currently have 90 students Question Should the class size be reduced to 19 students for all introductory classes? What we Observe:
The "best" class from an economic point of view will generally not be the same as the "best" size from the point of view of an educational psychologist. People will feel differently about the value of smaller classes. But at what cost?
Assume: The cost of a class with 19 students is more expensive per student than a class of 90 students
Electricity costs per student will increase Hiring more instructors will be expensive Example: 1 instructor for all 90 students versus multiple instructors for each of the smaller classes That means tuition will rise What do you think: Would it be a good idea to reduce the class size? Applying The Cost-Benefit Principle
Rational Person Someone with well-defined goals who tries to fulfill those goals as best he or she can What about an irrational person? Example
Should you walk downtown to save $10 on a $25 DVD? The benefit of going downtown = $10 The cost of going downtown is the dollar value of everything you give up to go downtown Estimate the costs:
Should you walk downtown to save $10 on a $25 DVD? Estimating the cost:
How much would someone have to pay you to walk downtown? If you would walk downtown for $9; the trip's cost is $9 The benefit ($10) exceeds the cost of ($9) of buying the DVD downtown Will everyone make the same choice? Why do individual people each make unique decisions?
Economic Surplus The benefit of taking any action minus its cost The goal of economic decision makers is to maximize their economic surplus So each person acts to maximize personal economic surplus What types of costs do people face?
1. Time Costs 1. Monetary Costs 1. Opportunity Costs The value of the next-best alternative that must be forgone to undertake an activity Back to the example
If the monetary cost of walking downtown is $9 (the amount you'd be willing to pay someone to walk for you), what is the Opportunity Cost? OC = next best alternative (like going to class or working for an hour) If you could earn $7 at work in that time, then your cost is really $16! Conclusion
The cost-benefit principle suggests that we take only those actions that create additional economic surplus. If that's economics, what's the difference between micro and macro?
Microeconomics The study of individual choice under scarcity and its implications for the behavior of prices and quantities in individual markets Macroeconomics The study of the performance of national economies, and of the policies that governments use to try to improve that performance Four Common Mistakes
1. Always measure costs and benefits in dollar amounts, not as percentages
Examples: Should you walk downtown to save $20 on a $2,020 laptop computer? Which is more valuable, saving $100 on a $2,000 plane ticket to Tokyo or saving $90 on a $200 plane ticket to Chicago? Mistake 2: Don't Ignore Opportunity Costs
Example: Should you use your US frequent-flyer coupon to fly to Fort Lauderdale for spring break? Assume: Round trip airfare is $500 and is equal to your frequent flyer coupon Other costs equal $1,000 The most you would be willing to pay for your trip is $1350 (i.e. the benefit you get from it) Mistake #2 Continued
Benefits = $1350+$500 Costs = $500 + $1000 + OC of using the FF ticket If the OC is greater than $350, should you use the ticket? What if the FF ticket expires right after spring break? Mistake 3: Failing to Ignore Sunk Costs
The only costs that should influence a decision about whether to take an action are those that we can avoid by not taking the action Sunk cost A cost that is beyond recovery at the moment a decision must be made Example: How much should you eat at a buffet? Mistake 4: Average and Marginal Are Different Concepts
Marginal Benefit The increase in total benefit that results from carrying out one additional unit of an activity Marginal Cost The increase in total cost that results from carrying out one additional unit of an activity Average Benefit The total benefit of undertaking n units of an activity divided by n Average Cost The total cost of undertaking n units of an activity divided by n Mistake 4 Example: How many NASA launches should there be each year?
# of Launches 0 1 2 3 4 5 Total Cost
($ billion) Average Cost
($ billion/launch) Marginal Cost
($ billion/launch) 0 3 7 12 20 32 0 3 3.5 4 5 3 4 5 8 12 Assume: Average Benefit = Marginal Benefit = $6 billion
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This note was uploaded on 04/13/2008 for the course ECON 190 taught by Professor Belasen during the Fall '08 term at Saint Louis.
- Fall '08