Week 1.docx - Economics is the study of how people make...

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Economics- is the study of how people make choices in order to attempt to satisfy their unlimited wants with scarce, limited resources. Economic Analysis-is an approach that makes use of economic reasoning in order to gain insights into problems faced by decision makers Foundational themes: People are rational People respond to incentives Optimal decisions are made at the margin Choices require tradeoffs Benefits are what are gained; costs are what is given up People are rational: People use all available information to act to achieve their goals They compare benefits to costs and choose the optimal level of particular behavior relative to their goals Whichever option makes the best use of available resources in the interest of the decision maker is called a rational choice People Respond to Incentives Incentives can be rewards or penalties associated with a particular choice People and firms consistently respond to incentives It is crucial to understand the incentive structure if you want to be able to predict how people will behave Often we focus on price incentives which are key to the function of markets. Optimal Decisions are Made at the Margin: When we say choices are made “at the margin” we simply mean that alternatives have been compared systematically and incrementally. The term marginal simply means “additional” Ex. A person lying in bed contemplating hitting the snooze button compares the marginal costs and marginal benefits associated with another 15 minutes of sleep If ΔQ represents ‘a change in the amount of the behavior under consideration’, When the marginal benefit exceeds the marginal cost, the decision maker should engage in the additional action i.e. MB>MC ---- ΔQ > 0 When the marginal benefit is the smaller than the marginal cost, the decision maker should reduce the level of her action i.e. MB<MC ---- ΔQ < 0 When the marginal b enefit is equal to the marginal cost, the decision maker should maintain the current level of the behavior
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i.e. MB=MC----- ΔQ=0 Choices Require Tradeoffs No resources can be simultaneously put toward two different uses, hence there are trade-offs. When a choice is made, it comes at the cost of being able to pursue other alternatives An opportunity cost is the next best use of the resource given up to pursue the activity under consideration Ex. The opportunity cost of hitting the snooze button for 15 minutes is the value o. f that time e.g. when used to eat breakfast before leaving Ex. The opportunity cost of not hitting the snooze is the value of that time spent sleeping Benefits Are What Are Gained; Costs Are What Is Given Up Benefits represent the pleasure or gain from a particular action People’s benefits to an activity are determined by personal preferences which are hard to quantify Benefits are measured in terms of what a decision maker is willing to give up for that action i.e. $ Relative to buyers we define a reservation price or willingness to pay for a particular item which represents the maximum price at which the good is purchased.
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