Economics-Chapter 1-5 - Economics Chapter 1 Approach of an...

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Economics Chapter 1: Approach of an economist: First, based on confronting a hypothesis with evidence before conditionally accepting it. Second, an economist will always have a look at motivation. The economist argues that people tend to behave in a self- interested fashion and respond to incentives → Incentives Matter Third, costs and wether the the cost incurred is warranted by the expected benefits. Lastly, suggesting that things shouldn't be continued beyond the point where marginal costs equal marginal benefits, even if total benefit could be increased → Cost-Benefit Analysis Key part of economic analysis: Identify the relevant trade-offs → tool=models Economics: the study of how people make choices under conditions of scarcity and of the result of those choices for society → studies how scarce resources are or should be distributed Scarcity Principle: (also 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 Cost-Benefit Principle: an individual/firm/society should take an action if, and only if, the extra benefits (the value the action brings to the decision maker) from taking that action are at least as great as the extra costs B-C>/=0 Rational Person: someone with well-defined goals, who fulfills those goals as best as he can (follows cost-benefit principle) Economic surplus: the economic surplus from taking any action is the benefit of taking that action minus its costs → goal as an economic decision maker: choosing the action that generates the largest possible economic surplus Opportunity cost: the opportunity cost of an activity is the value of the next best alternative that must be forgone in order to undertake the activity (not the value of all combined possible activities you could have pursued but only the value of the best alternative) sunk costs: a cost that is beyond recovery at the moment a decision must be made marginal cost: the increase in total cost that results from carrying out one additional unit of an activity marginal benefit: the increase in total benefit that results from carrying out one additional unit of an activity average cost: the total cost of undertaking n units of an activity divided by n average benefit: the total benefits of undertaking n units of an activity divided by n Decision Pitfalls: 1. The pitfall of measuring costs or benefits proportionally → absolute money amounts should be employed to measure costs and benefits 2. The pitfall of ignoring opportunity costs → taking the value of forgone opportunities properly into account 3. The pitfall of not ignoring sunk costs → ignore sunk costs 4. The pitfall of using average instead of marginal costs and benefits → the level of an activity should be increased if, and only if, its marginal benefit exceed its marginal cost Not-All-Costs-and-Benefits-Matter-Equally Principle: some costs and benefits, especially marginal costs and
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