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Questions and Answers
What does the Scarcity Principle imply?
What does the Scarcity Principle imply?
Which principle states that no action occurs unless its marginal benefit is at least as great as its marginal cost?
Which principle states that no action occurs unless its marginal benefit is at least as great as its marginal cost?
According to the Principle of Comparative Advantage, what should individuals focus on?
According to the Principle of Comparative Advantage, what should individuals focus on?
What type of costs should be ignored according to economic decision-making principles?
What type of costs should be ignored according to economic decision-making principles?
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Failure to think at the margin typically leads to which of the following?
Failure to think at the margin typically leads to which of the following?
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What does economic surplus represent?
What does economic surplus represent?
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Which decision pitfall involves measuring costs and benefits as proportions instead of absolute amounts?
Which decision pitfall involves measuring costs and benefits as proportions instead of absolute amounts?
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What can be concluded about a market in equilibrium according to the Equilibrium Principle?
What can be concluded about a market in equilibrium according to the Equilibrium Principle?
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Study Notes
Scarcity Principle
- Having more of one good thing usually means having less of another.
Cost-Benefit Principle
- No action takes place unless its marginal benefit is at least as great as its marginal cost.
Incentive Principle
- Incentives are central to people's choices.
Principle of Unequal Costs
- Marginal cost: The additional cost incurred by producing one more unit of a good.
- Opportunity cost: The value of the next-best alternative forgone when making a choice.
- Sunk cost: A cost that has already been incurred and cannot be recovered.
- Average cost: The total cost of production divided by the number of units produced.
Principle of Comparative Advantages
- Everyone does best when each concentrates on the activity for which they are relatively the most productive.
Equilibrium Principle
- A market in equilibrium leaves no unexploited opportunities for individuals, but may not exploit all gains achievable through collective actions.
Efficiency Principle
- Efficiency makes the economic pie grow larger.
Ceteris Paribus
- A Latin phrase meaning "all other things being equal". Used to isolate the effect of a single variable on an outcome.
Rationality
- Acting in a way to maximize one's self-interest.
Decision Pitfalls
- Measuring costs and benefits as proportions rather than absolute amounts: The benefits and costs of smaller amounts can be misleading.
- Ignoring opportunity (implicit) costs: These costs are the value of the next-best alternative foregone.
- Taking sunk costs into account: Sunk costs should be ignored when making decisions about the future.
- Failure to think at the margin: Decision-makers should focus on the benefits and costs of an additional unit of activity.
Economic Surplus
- The economic surplus of an action is equal to its benefit minus its costs.
- Economic Surplus = Total Benefits - Total Costs.
Example of Measuring Costs and Benefits as Proportions:
- Should you walk 3km to save €10 on a €1,000 laptop?
Example of Ignoring Opportunity Costs:
- Should you go to London?
- Frequent-flyer ticket otherwise costs €500.
- Other relevant costs (hotel, food): €1,000.
- Reservation price: €1,350.
Example of Failure to Ignore Sunk Costs:
- How much should you eat at an all-you-can-eat restaurant?
- Cost: €5 at the door.
- 20 randomly selected guests eat for free.
Example of Failure to Understand Average-Marginal Distinction:
- Should you allocate your resources differently to get more coconuts?
- The focus should always be on the benefit and cost of an additional unit of activity (marginal).
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