Chapter 1 - Thinking like an economist. This chapter to show that the Cost-Benefit Principle, deciding whether to take an action by comparing the cost and benefit of the action, is a useful approach for dealing with the inevitable trade-offs that scarcity creates. After discussing several important decision pitfalls, the chapter concludes by describing the Incentive Principle and introducing the concept of economic naturalism. | Thinking Like an Economist Chapter 1 Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved. McGraw-Hill/Irwin 1 Learning Objectives Explain and apply the Scarcity Principle Explain and apply the Cost-Benefit Principle Discuss three important pitfalls that occur when applying the Cost-Benefit Principle inconsistently Explain and apply the Incentive Principle The Scarcity Principle 3 The Scarcity Principle: Examples 4 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 5 Applying the Cost – Benefit Principle Assume people are rational A rational person has well defined goals and tries to fulfill those goals as best they can Would you walk to town to save $10 on an item? Benefits are clear Costs are harder to define Hypothetical auction Would you walk to town if someone paid you $9? If you would walk to town for less than $10, you gain from buying the item in town 6 Cost – Benefit Principle Examples 7 Economic Surplus The economic surplus of an action is equal to its benefit minus its costs 8 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 9 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 10 Three Decision Pitfalls Economic analysis predicts likely behavior Three general cases of mistakes Measuring costs and benefits as proportions instead of absolute amounts Ignoring implicit | Thinking Like an Economist Chapter 1 Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved. McGraw-Hill/Irwin 1 Learning Objectives Explain and apply the Scarcity Principle Explain and apply the Cost-Benefit Principle Discuss three important pitfalls that occur when applying the Cost-Benefit Principle inconsistently Explain and apply the Incentive Principle The Scarcity Principle 3 The Scarcity Principle: Examples 4 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 5 Applying the Cost – Benefit Principle Assume people are rational A rational person has well defined goals and tries to fulfill those goals as best they can Would you walk to town to save $10 on an item? Benefits are clear Costs are harder to define Hypothetical auction Would you walk to town if someone paid you $9? If you would walk to town for less than $10, you gain from buying the item in town 6 Cost
