1. Thinking as an Economist

Question 1

Opportunity Cost

Answer 1

Opportunity cost is the cost of an action, implicit and explicit, measured as the value of the next
best alternative to that action.

Question 2

Cost-Benefit Principle

Answer 2

An individual/firm/society etc. should only take an action if, and only if, the extra benefits from
taking the action are at least as great as the extra costs. We assume ceteris paribus, i.e. only 2
variables change and others remain constant, and everyone is rational.

Question 3

Economic Surplus

Answer 3

Economic surplus is the difference between the benefits and the costs of an action. An economist’s
goal is to maximise the positive economic surplus

Question 4

Pitfalls of Cost-Benefit Principle

Answer 4

􀂾 Failing to account for all opportunity costs, including time
􀂾 Measuring costs and benefits as proportions rather than absolute dollar amounts
􀂾 Failing to ignore sunk costs
􀂾 Failing to know when to use averages costs and benefits and when to use marginal cost
and benefits

Question 5

Average Cost

Answer 5

The total cost of n units divided by n

Question 6

Average Benefit

Answer 6

The total benefit of n units divided by n

Question 7

Marginal Cost

Answer 7

The cost associated with a small increase in unit

or level of activity

Question 8

Marginal Benefit

Answer 8

The benefit associated with a small increase in

unit or level of activity