What is Economics? Key Concepts and Terms. It is the study of how people make choices in the marketplace ◦ Consumers (you and me) How to allocate.

What is Economics? Key Concepts and Terms

It is the study of how people make choices in the marketplace◦ Consumers (you and me)

How to allocate your time Studying versus work versus socializing versus sleep

How to allocate your income Saving versus consuming Among various goods

Food, housing, transportation, “fun”

It is the study of how people make choices in the marketplace◦ Firms (and their managers)

Which goods to produce How to allocate your investment (capital) How to allocate your labor among various goods or

models of the product Which technology to use

Capital or labor Which inputs, quality of inputs

The reason people/firms need to make choices is because of scarcity◦ “You can’t have it all”

Limits on resources, time, money/income “dictate” that individuals have to choose how to allocate their “scarce” resources to their maximum value/use

◦ “Opportunity costs” : since resources are scarce and you will have to make choice Means that there are “opportunity costs” of making a

choice That is, there are tradeoffs between alternatives

Lionel Robbins (1932): "the science which studies human

behaviour as a relationship between ends and scarce means which have alternative uses."

Scarcity means that available resources are insufficient to satisfy all wants and needs.

Absent scarcity and alternative uses of available resources, there is no economic problem. The subject thus defined involves the study of choices as they are affected by incentives and resources.

Scarcity Opportunity Cost Tradeoffs Benefit/Cost Analysis

There are not enough resources to produce and consume all of the goods and services we desire

Limits on resources implies that decisions must be made about:◦ What to produce◦ How to produce it◦ Whom to produce it for

Could be done by:◦ Government direction (centrally planned

economy)◦ Market forces (price signals)

Scarcity implies that choices must be made◦ Choice implies that there is a trade-off or “opportunity

cost” (foregone alternative)

Opportunity cost is defined as:◦ The value of a good, service or resource in its next

highest valued use – consequence of scarcity

Every decision has an opportunity cost◦ Alaska: potential value of gold mining could disrupt

Copper River Salmon run◦ Choice of academic majors◦ How to spend time or money

Opportunity costs are not only “observable” economic costs, but also “unobservable” (or non-monetary) costs◦ Opportunity costs of time

Commute example Car Bus Bike

Monetary costs associated with each alternative◦ Car

Initial purchase expense (fixed), O&M (variable: fuel, maintenance, depreciation, licenses, insurance, parking), time of commute

◦ Bus Time + fee

◦ Bike Initial purchase (bike and lock), O&M (tires, tune-ups,

clothing), time of commute

Non-pecuniary benefits/costs◦ Non-pecuniary: not directly measurable by $

Car◦ Benefit: flexibility to come/go◦ Costs: traffic jams, road rage, finding a parking

space Bus

◦ Benefits: reading time, “no hassle”

Bus◦ Costs: no flexibility on time

Bike◦ Benefits: flexibility, improved health ◦ Costs: bad weather, lighting

Choose the alternative that has the greatest net benefits

Individuals [or firms] choose their actions on the basis of expected additional [net] benefits and cost to themselves◦ In this case -> alternative chosen will be the one

that yields the largest net benefits◦ Paul Heynes’ “economizing process”

Modest changes in monetary costs and benefits can induce people to alter their behavior◦ Cold, wet weather increases the costs of bike

commuting (or parking on the street)

Proper framework for analyzing economic decisions is to compare the costs and benefits of the alternatives◦ Cost and benefits include not only directly

observable/measurable economic costs and benefits, but also

◦ Opportunity costs (e.g., time),◦ Non-pecuniary benefits

Common understanding of key terms◦ Use them as shorthand for the concept; but have

a precise/exact meaning Scarcity

◦ There are not enough resources to produce and consume all of the goods and services we desire

Opportunity costs◦ What must be given up (next best alternative

use) as a result of a decision or choice◦ “No such thing as a free lunch” (Milton Friedman)

Cost-benefit analysis◦ Every decision/action has tradeoffs