Thinking as an Economist
The fundamental economic problem is that there is scarcity, i.e. our resources are finite and not enough to satisfy our boundless needs and wants. Therefore, we must make choices and compromises between competing interests. Microeconomics is the study of small economic units, such as households, firms and industries that together makes up the entire economy.
Opportunity Cost
Opportunity cost is the cost of an action, implicit and explicit, measured as the value of the next best alternative to that action.
Cost-Benefit Principle
An individual/firm/society etc. should only take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs. We assume ceteris paribus, i.e. only 2 variables change and others remain constant, and everyone is rational.
Economic Surplus
Economic surplus is the difference between the benefits and the costs of an action. An economist’s goal is to maximise the positive economic surplus
Pitfalls of Cost-Benefit Principle
Ø Failing to account for all opportunity costs, including time
- Measuring costs and benefits as proportions rather than absolute dollar amounts
- Saving $10 off $25 and $10 off $2000 is equivalent in rational decision making
Ø Failing to ignore sunk costs
- Sunk cost is a cost that cannot be recovered and should not affect future decisions
Ø Failing to know when to use averages costs and benefits and when to use marginal cost and benefits
- Marginal benefit should be considered when expanding production or trials
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Average Cost |
Average Benefit |
|
The total cost of n units divided by n |
The total benefit of n units divided by n |
|
Marginal Cost |
Marginal Benefit |
|
The cost associated with a small increase in unit or level of activity |
The benefit associated with a small increase in unit or level of activity |
