Ch. 1 - Core Principles Flashcards
What is the Cost-Benefit Principle?
Says that costs and benefits are incentives that shape decisions
Before you make a decision, you should:
- Evaluate the full set of costs and benefits associated with that choice
- Pursue that choice, only if the benefits are at least as large as the costs
(Convert costs and benefits into $ by evaluating your willingness to pay)
What is Economic Surplus?
The difference between benefits you enjoy and costs you incur
- A measure of how much your decision has improved your well-being
What is the Opportunity Cost Principle?
The opportunity cost of something is the next best alternative you have to give up
- Some out-of-pocket costs are opportunity costs
- Opportunity costs need not involve out-of-pocket financial costs
- Not all out-of-pocket costs are opportunity costs
- Some non-financial costs are not opportunity costs
- Ignore Sunk Costs when making decisions
What are Sunk Costs?
Costs of time/effort/money put into a project that cannot be reversed
What is the Framing Effect?
Refers to how the way information is presented influences decision-making, with people responding differently to the same information depending on whether it is framed positively or negatively
What is a Production Possibility Frontier?
Illustrates the trade-offs/opportunity cost
- Moving along PPF reveals opportunity costs
- Productivity gains shift your PPF forward
What is the Marginal Principle?
Says that decisions about quantities are best made incrementally
X How many workers should I hire?
✓ Should I hire one more worker?
- Extra benefit you get from each decision is called the Marginal Benefit
- Extra cost from each decision is called the Marginal Cost
You should make the decision if…
the Marginal Benefit >= Marginal Cost (increases economic surplus)
What is the Rational Rule?
If something is worth doing, keep doing it until your Marginal Benefit = Marginal Cost
What is the Interdependence Principle?
Recognizes that your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future
- When any of these factors changes, your best choice might change
What are the 4 Interdependency Sets?
- Dependencies between each of your individual choices
- Dependencies between people or businesses in the same market
- Dependencies between markets
- Dependencies through time
What order should you apply the core principles when confronting a problem?
- Marginal Principle
- Cost-Benefit Principle
- Opportunity Cost Principle
- Interdependence Principles
