Chapter 1: Thinking Like an. . Explain and apply the Scarcity . Explain and apply the Cost-Benefit . Explain and apply the Incentive . Discuss the pitfall of measuring costs and. benefits as proportions rather than as absolute. dollar . Discuss the pitfall of ignoring implicit . Discuss the pitfall of failing to weigh costs and. benefits at the marginMcGrawHill/Irwin Copyright © 2011 by The McGrawHill Companies, Inc. All rights Scarcity Principle. 12 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. 13 Economic Surplus.• The economic surplus of an action is equal. to its benefit minus its costs. 14 Opportunity Cost.• Opportunity 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: NOT the combined value of all possible. activities. – Opportunity cost considers only your best. alternative 15 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. 16 Three Decision Pitfalls.• Economic analysis predicts likely behavior.• Three general cases of mistakes. 1. Measuring costs and benefits as proportions. instead of absolute amounts. 2. Ignoring implicit costs. 3. Failure to think at the margin. 17 Pitfall # benefits amount.• Would you walk to. town to save $10 on. a $25 item?.• Would you walk to. town to save $10 on. a $2,500 item?. 18Pitfall #2. Ignoring implicit. costs. • Consider your. alternatives. – The value of a. Frequent Flyer coupon. depends on its next. best use. • Expiration date. • Do you have time for. another trip?. • Cost of the next best. trip 19 Pitfall # to think at the. margin. • Sunk costs cannot be. recovered.– Examples:. • Eating at an all-you-. can-eat restaurant. • Attend a second year. of law school. 110 Marginal Analysis Ideas.• Marginal cost is the increase in total cost from. one additional unit of an activity. – Average cost is total cost divided by the number. of units.• Marginal benefit is the increase in total. benefit from one additional unit of an activity. – Average benefit is total benefit divided by the. number of units 111 Normative and Positive. Economics.– Normative economic – Positive economic. principle says how principle predicts how. people should behave people will behave. • Gas prices are too • The average price of. high gasoline in May 2008. • Building a space base was higher than in. on the moon will cost May 2007. too much • Building a space base. on the moon will cost.
