ECON1101: Macroeconomics 1

Chapter 1: Thinking as an
economist
Economics
Economics is the study of how people make choices under conditions of scarcity
and the results of those choices for study.

The scarcity principle

The scarcity principle (or the no-free-lunch principle) states that, although
needs and wants are boundless, the resources available are limited.
Consequently, having more of something usually means having less of
something else.

Microeconomics vs. macroeconomics

Microeconomics is the study of individual choice and the combined result of
those choices for the group as a whole.
Macroeconomics is the study of national economies and the government
policies that try to improve them.

The cost-benefit principle

Due to the scarcity principle, the cost-benefit principle states that an
economic agent should only undertake a particular action if the marginal (extra)
benefits exceeds the marginal costs (ceteris paribus).

Ceteris paribus
Ceteris paribus (or all else equal) is the assumption that everything,
except the variable being studied, stays the same.

Benefits and costs

An actions benefits are defined as the largest dollar amount a person
would be willing to pay in order to undertake the action.
An actions costs are defined as the largest dollar amount a person would
be willing to pay in order to avoid undertaking the action.

Marginal benefits and costs

Marginal benefits and costs are the increase in benefits and costs
associated with a small increase in the level of a particular activity.

Economic surplus
The economic surplus is the amount by which a particular actions
marginal benefits outweigh the marginal costs.

The incentive principle

The incentive principle states that economic agents are more likely to
undertake an action if its benefits increase or its costs decrease, and less likely if
its benefits decrease or its costs increase.

Positive vs. normative economics

Positive economics explains what happens and why (e.g. the incentive
principle), but does not state what should happen.
Normative economics explains what should happen (e.g. the cost-benefit
principle).

Decision-making pitfalls
1. Failing to account for all opportunity costs.
The opportunity cost is the value of the next-best alternative to
undertaking a particular action.
2. Failing to ignore sunk costs.
Sunk costs are those that cannot be avoided even if the action is not
undertaken.
3. Failing to account for all relevant benefits.
4. Failing to measure costs and benefits as absolute dollar amounts rather than
as proportions.
For example: A $100 discount on a $1000 TV is better than a $10 discount
on a $20 DVD.
5. Failing to know when to use average or marginal costs and benefits.
Average benefits and costs should be used to determine whether an
activity should be undertaken at all.
Marginal benefits and costs should be used to determine the extent to
which an activity should be undertaken.
6. Failing to incorporate time into cost-benefit thinking.
For example: $100 now is worth more than $100 later.