1.1 How economists think about choices

• the fundamental assumptions of economic analysis is that :

  • consumers are rational
  • consumers respond to incentives
• Rationality means making decisions where the benefits outweigh the costs.
• Individuals are assumed to make rational decisions, comparing the benefits and costs of each action.
• The opportunity cost of an action is the value of the next best alternative that you give up when making a choice.
• if you choose to watch a movie instead of working, what is the opportunity cost?

  the potential earnings lost from not working during that time
• Explicit Costs: The actual monetary cost of performing an action.
• Opportunity Costs: The value of the best alternative you forego when making a decision.
• If you spend £60 going to the beach but could have earned £70 working what is your opportunity cost?

  £70 (the value of the foregone income).
• Choosing at the Margin:

  • Decisions are often made at the margin, meaning people compare the additional (marginal) benefits and costs of doing a little bit more or less of something.
• Extensive Margin: Decisions about whether or not to do something.
• Intensive Margin: Decisions about how much to do of something.
• Economics is the study of 

  • How society decides what, how & for whom to produce
  • How societies allocate their scarce resources to satisfy unlimited wants.
• Marginal benefits : the maximum cost a consumer will pay for an additional good or service
• Marginal costs: the change in total production cost that comes from making or producing one additional unit.
• rationality means:

  • Comparing the benefits & costs of each action 
  • Means making decisions where the benefits outweigh the costs 
  • Individuals make choices that give them the most value / benefit 
• People respond to incentives, which can be rewards or penalties that influence their decisions
• Sunk Costs:

  • Costs that have already been incurred and cannot be recovered. They should not influence future economic decisions.
• Sunk Cost Fallacy: The mistake of allowing sunk costs to affect future decisions