chapter one: economic principles Flashcards
what are the four core principles of economics?
1) cost-benefit principle
2) opportunity cost principle
3) marginal principle
4) interdependence principle
what is the cost-benefit principle?
costs and benefits are the incentives that shape decisions
before you make a decision
1) evaluate the full set of costs and benefits associated with that choice
2) pursue that choice ONLY if the benefits are at least as good as the costs
how do you compare the benefits with the costs?
convert costs and benefits into dollars by evaluating your willingness to pay
what is willingness to pay (WTP)?
in order to convert nonfinancial costs or benefits into their monetary equivalent, ask yourself: “what is the most I am willing to pay to get this benefit (or avoid that cost)”
what is money in the cost-benefit principle?
money is the measuring stick that allows you to take into account the financial and nonfinancial costs and benefits of a decision
money is the measuring stick not the objective
hence, cost-benefit analysis allows for unselfish decisions
what is an economic surplus?
the total benefits minus the total costs flowing from a decision.
you want to maximize economic surplus
what does economic surplus measure?
measures how much a decision has improved your wellbeing
what is the framing effect?
when a decision is affected by how a choice is described or framed
your choice should depend on the costs and benefits of that item - don’t allow framing effects to alter your decisions
when should you pursue a choice according to the cost-benefit principle?
when the benefits are at least as large as the costs
what is the opportunity cost principle?
the true cost of something is the NEXT (only, the 2nd best or 3rd best alternative do not matter) best alternative you have to give up to get it
relates to trade-offs and scarcity
what is scarcity?
resources are limited, therefore any resources you spend pursuing one activity leaves fewer resources to pursue others
makes opportunity costs inescapable
what is forgone wages?
this is how entrepreneurs are affected by the opportunity cost principle
decision between starting a new business/ quitting current job or staying in existing job
forgone wage is the paycheck you are giving up by quitting your job
forgone are an opportunity cost
what is forgone interest/ forgone investment opportunity?
relates to the opportunity cost principle
the decision between investing your money in a new business or leaving it in the bank/ stock market
forgone interest is the interest you would’ve earned by leaving it in the bank
forgone investment opportunity is the investment that would’ve happened in the stock market
what is a sunk cost?
a cost that has been incurred and cannot be reversed. a sunk cost exists in whatever choice you make, and hence it is not an opportunity cost
they are irrelevant to the current decision
what is PPF?
a ppf is a production possibilities frontier (PPF)
shows the different sets of output that are attainable with your scarce resources
illustrates the trade-offs you confront when deciding how to allocate scarce resources
how can you calculate opportunity cost based off a PPF?
the opportunity cost of horizontal axis - slope
the opportunity cost of the vertical axis - inverse of slope
what do the different areas in a PPF represent? (along, inside, and outside PPF)
along: all time is utilized (efficiently)
inside: feasible but not efficient
outside: not feasible (not possible) unless productivity is increased in some way
what is the marginal principle?
decisions about quantities are best made incrementally (one by one)
“how many” questions are broken into a series of smaller, or marginal decisions weighing the marginal benefits and the marginal costs
question that have with “how many” or “one more” refer to the marginal principle
what is marginal benefit (MB)?
the extra benefit from one extra unit
the same as the WTP
what is marginal cost (MC)?
the extra cost from one extra unit
what is the rational rule?
if something is worth doing (based off cost-benefit principle), keep doing it until your marginal benefits equal your marginal costs
when is economic surplus maximized?
when marginal benefit equals marginal cost
what is the interdependence principle?
when your best choice depends on:
1) individual choices
2) between people or businesses
3) between markets
4) through time
you are not making decisions in isolation, you are part of a larger network
describe dependence between each of your individual choices
your own choices are all connected because you have limited resources
