chapter one: economic principles

Question 1

what are the four core principles of economics?

Answer 1

1) cost-benefit principle
2) opportunity cost principle
3) marginal principle
4) interdependence principle

Question 2

what is the cost-benefit principle?

Answer 2

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

Question 3

how do you compare the benefits with the costs?

Answer 3

convert costs and benefits into dollars by evaluating your willingness to pay

Question 4

what is willingness to pay (WTP)?

Answer 4

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)”

Question 5

what is money in the cost-benefit principle?

Answer 5

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

Question 6

what is an economic surplus?

Answer 6

the total benefits minus the total costs flowing from a decision.

you want to maximize economic surplus

Question 7

what does economic surplus measure?

Answer 7

measures how much a decision has improved your wellbeing

Question 8

what is the framing effect?

Answer 8

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

Question 9

when should you pursue a choice according to the cost-benefit principle?

Answer 9

when the benefits are at least as large as the costs

Question 10

what is the opportunity cost principle?

Answer 10

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

Question 11

what is scarcity?

Answer 11

resources are limited, therefore any resources you spend pursuing one activity leaves fewer resources to pursue others

makes opportunity costs inescapable

Question 12

what is forgone wages?

Answer 12

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

Question 13

what is forgone interest/ forgone investment opportunity?

Answer 13

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

Question 14

what is a sunk cost?

Answer 14

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

Question 15

what is PPF?

Answer 15

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

Question 16

how can you calculate opportunity cost based off a PPF?

Answer 16

the opportunity cost of horizontal axis - slope
the opportunity cost of the vertical axis - inverse of slope

Question 17

what do the different areas in a PPF represent? (along, inside, and outside PPF)

Answer 17

along: all time is utilized (efficiently)
inside: feasible but not efficient
outside: not feasible (not possible) unless productivity is increased in some way

Question 18

what is the marginal principle?

Answer 18

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

Question 19

what is marginal benefit (MB)?

Answer 19

the extra benefit from one extra unit

the same as the WTP

Question 20

what is marginal cost (MC)?

Answer 20

the extra cost from one extra unit

Question 21

what is the rational rule?

Answer 21

if something is worth doing (based off cost-benefit principle), keep doing it until your marginal benefits equal your marginal costs

Question 22

when is economic surplus maximized?

Answer 22

when marginal benefit equals marginal cost

Question 23

what is the interdependence principle?

Answer 23

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

Question 24

describe dependence between each of your individual choices

Answer 24

your own choices are all connected because you have limited resources

Question 25

describe dependence between people or businesses

Answer 25

the choices made by other economic actors (people, businesses, governments, etc) shape the choices available to you

Question 26

describe the dependence between markets

Answer 26

changes in price and opportunities in one market affect the choices you might make in other markets

Question 27

describe dependence through time

Answer 27

is it better to act today or tomorrow

decisions today shape future opportunities and decisions