Chapter 1: Thinking Like an

Economist
1. Explain and apply the 0
  

—. Explain and apply the   

3. Explain and apply the   

4. Discuss the pitfall of measuring costs and
benefits as proportions rather than as absolute
dollar amounts
5. Discuss the pitfall of ignoring implicit costs
6. Discuss the pitfall of failing to weigh costs and
benefits at the margin

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The Scarcity Principle

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 The Cost-Benefit Principle
‡ Take an action if and only if the extra benefits
are at least as great as the extra costs
‡ Costs and benefits are not just money

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 Economic Surplus
‡ The ˜

 
 of an action is equal
to its benefit minus its costs

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 ‰pportunity Cost
‡ ‰

is the value of what must be
foregone in order to undertake an activity
± Consider explicit and implicit costs
‡ Examples:
± Give up an hour of babysitting to go to the movies
± Give up watching TV to walk to town
‡ Caution: N‰T the combined value of all
possible activities
± ‰pportunity cost considers only your best
alternative

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 Economic Models
‡ Simplifying assumptions
± Which aspects of the decision are absolutely
essential?
± Which aspects are irrelevant?
‡ Abstract representation of key relationships
± The Cost-Benefit Principle is a model
‡ If costs of an action increase, the action is less likely
‡ If benefits of an action increase, the action is more
likely

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 Three Decision Pitfalls
‡ Economic analysis predicts likely behavior
‡ Three general cases of mistakes
1. Measuring costs and benefits as proportions
instead of absolute amounts
—. Ignoring implicit costs
3. Failure to think at the margin

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 Pitfall #1
|˜ 

˜˜  







˜ 



˜ 
 



‡ Would you walk to
town to save $10 on
a $—5 item? =


‡ Would you walk to

town to save $10 on
a $—,500 item?
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 Pitfall #—


 


Explicit ‡ Consider your
Costs alternatives
± The value of a
‰pportunity
Cost Frequent Flyer coupon
depends on its next
Implicit best use
Costs
‡ Expiration date
‡ Do you have time for
another trip?
‡ Cost of the next best
trip !
 Pitfall #3
* 
˜
 ˜
  Marginal
‡ 
cannot be Benefits
recovered
± Examples:
‡ Eating at an all-you-
can-eat restaurant
‡ Attend a second year Marginal
of law school Costs

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 Marginal Analysis Ideas
‡ | 

is the increase in total cost
from one additional unit of an activity
± ˜ ˜
is total cost divided by the number
of units
‡ | 
˜˜is the increase in total
benefit from one additional unit of an activity
± ˜ ˜˜˜is total benefit divided by the
number of units

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 Normative and Positive
Economics
± Î
 ˜˜

  ± G
˜˜

 
 
˜says how  
˜predicts how
people  
 behave people m

behave
‡ Gas prices are too ‡ The average price of
high gasoline in May —008
‡ Building a space base was higher than in
on the moon will cost May —007
too much ‡ Building a space base
on the moon will cost
more than the shuttle
program

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 Incentive Principle

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 Microeconomics and
Macroeconomics
6 | 
˜

  studies

˜

 studies
choice and its implications
for price and quantity in
individual markets
6 Sugar
6 Carpets
6 House cleaning services
6 Microeconomics considers
topics such as
6 Costs of production
6 Demand for a product
6 Exchange rates
6 |
the performance of national
economies and the policies
that governments use to try
to improve that performance
6 Inflation
6 Unemployment
6 Growth
6 Macroeconomics considers
6 Monetary policy
6 Deficits
6 Tax policy

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 Economics Is Choosing
‡ Focus in this course is on a short list of powerful
ideas
± Explain many economic issues
± Predict decisions made in a variety of
circumstances
‡ Core Principles are the foundation for solving
economic problems

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