Chapter 1

• Cost-benefit principle


  Costs and benefits are the incentives that shape decisions

  
• Willingness to pay


  The most I am willing to pay to get this benefit (or avoid that cost)
• Economic surplus


  The total benefits minus the total costs flowing from a decision. It measures how much a decision has improved your well-being.
• Framing effect
• Opportunity cost
• Sunk cost
• Production Possibilities Frontier (PPF)


  Shows the different sets of output that are attainable with your scarce resources
• Moving along the PPF reveals your opportunity costs
• Production Possibility Frontier (PPF)


  Illustrates the trade-offs you confront when deciding how to allocate your scarce resources (like your time)
• Scenario 4: You have 3 hours per night of study time for economics and/or psychology

  1. 1 hour toward econ for an 8-point boost in grade

  2. 1 hour toward psych for a 4-point boost in grade
• Production Possibility Frontier


  • All 3 hours toward econ improve econ grade by 24 points
  • All 3 hours toward psych improve psych grade by 12 points
  • 2 hours on econ and 1 hour on psych improve econ grade by 16 points and psych grade by 4 points
• Moving along your PPF


  Reveals your opportunity costs
• Moving from point A to B along the PPF

  • To gain 4 points in psychology, you had to sacrifice 8 points in economics
• Opportunity cost


  The most valuable alternative you had to give up to pursue your choice
• Even if the choice has no direct financial cost, there is always a cost because every choice has an opportunity cost associated with it
• Scarcity makes opportunity costs (trade-offs) inescapable
• Good decision makers ignore sunk costs
• The production possibilities frontier (PPF) can be used to visualize the opportunity costs we face
• Marginal principle


  Decisions about quantities are best made incrementally. You should break "how many" questions into a series of smaller, or marginal, decisions weighing the marginal benefits and marginal costs.

  
• Marginal Benefit


  The extra benefit from one extra unit (of goods purchased, hours studied, etc.)
• Marginal Cost


  The extra cost from one extra unit
• Rational Rule: If something is worth doing, keep doing it until your marginal benefits equal your marginal costs

  
• Economic surplus is maximized when the marginal benefit equals the marginal cost
• Interdependence principle


  Your best choice depends on 1) your other choices, 2) the choices others make, 3) developments in other markets, 4) and expectations about the future
• When any of these factors changes, your best choice might change
• You are not making decisions in isolation. You are part of a larger network.