1303AFE Lecture Notes - Lecture 1: Marginal Utility, Marginal Cost, Opportunity Cost
30 May 2018
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Economics for Decision Making Lecture 1 Notes
Discussed in topic
• Scarcity
• Defining economics, micro vs macro
• Economic way of thinking
• Cost and benefit in economics
• Opportunity cost
• Production possibility frontier
• Absolute advantage and comparative advantage (economist prefer comparative)
Scarcity
• All economic questions arise because we, as a society, face the problem of scarcity
• Scarcity: resources are limited; but our needs and wants are unlimited
• Scarcity is the condition that arises because needs and wants exceeds the ability of
our scarce/ limited resources to satisfy them
• Resources are not just something we can see (i.e. $$$) but also something intangible
(i.e. time)
o E.g. a student wants to buy a shirt, shoes and a book (wants. But only has $50
(resources)
o E.g. even a billionaire business man faces scarcity. Want to play golf, travel to
Fiji, see the prime minister within 8 hours? Impossible-why? Time constraints
(limited resources)
• Faced with scarcity, we must make choices- we must choose among the available
alternatives
• The choices we make depend on the incentives we face
Different types of resources
• $$$
• Time
• Land (natural endowment)
• Labour and human resources
• Physical capital
Economics Defined
• Economics is the social science that studies the choices that individuals, businesses,
governments and entire societies make as they cope with scarcity, and the incentives
that influence those choices and the arrangements that coordinate them
• In brief: we want everything but we cannot afford everything- we need to choose.
We a e idiidual, a fail, a usiess, a goeret et.
• Economics studies these choices
• Economics deals with effectiveness and efficiency is managing our resources
Two majors of studies in economics
• Microeconomics: the study of the choices and interactions between individuals and
businesses (consumers and producers) in a market, and how their interactions are
influenced by governments (TOPIC 2: DEMAND SUPPLY)
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find more resources at oneclass.com
• Macroeconomics: the study of the aggregate (or total) effects on the national
economy and the global economy of the choices that individuals, businesses and
governments make (TOPICS 3 TO 11)
Thinking like an economist
• Six economic ways of thinking:
1. Choice is a tradeoff
2. Cost is what you must give up to get something
3. Benefit is what you gain from something
4. People make rational choices by comparing benefits and costs
5. Most hoies are ho uh hoies ade at the argi
6. Choices respond to incentives
• A Choice is a Tradeoff
o Because we face scarcity we must make choices.
o To make a choice we select from alternatives (e.g. shirt, shoes or book).
o Whatever choice you make, you could have chosen something else.
o You can think about your choices as trade-offs.
o A trade-off is an exchange—giving up one thing to get something else.
o You chose to attend this lecture; what was your tradeoff? (i.e. what would
ou hae doe istead if ou didt oe to the leture?
• Cost: What you must give up
o Opportunity cost is the best thing that you must give up to get something;
the highest-valued alternative forgone.
▪ Very important concept-ensure you try and understand OC.
o You are in this lecture now. You could have also used this time to sleep, work,
watch TV, exercise. Your OC of attending this lecture is not all of the above,
but the most likely alternative.
o For Tim, it would be watching TV & for Paula it would be working.
• Benefit: What you gain
o Benefit is the gain or pleasure that something brings
o Benefit is measured by what you are willing to give up
o You can see the relationship with costs; costs are the price of enjoying your
benefits
▪ e.g. When you attend this lecture, it is because you believe you gain a
benefit from doing so (i.e. gain better grades and later a better job).
But attending the lecture involves a tradeoff (say, cannot sleep
longer). Thus, the cost is the OC of sleeping less, but the benefit (gain)
is that of hopefully getting better grades and later a better job.
▪ Next, we look at benefits and costs together to decide how much of
an activity to undertake (marginal benefit [MB] & marginal cost [MC]).
• Rational choice
o A rational choice is a choice that uses the available resources to best achieve
the objective of the person making the choice
o We make rational choices by comparing costs and benefits
• How much? Choosing at the margin
o A choice made at the margin is a choice made by comparing all the relevant
alternatives systematically and incrementally
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find more resources at oneclass.com
o Marginal cost is the opportunity cost of a one-unit increase in an activity
o The marginal cost of something is what you must give up to get one
additional unit of it
o Marginal benefits is the what you gain when you get one more unit of
something
o The marginal benefit of something is measured by what you are willing to
give up to get one additional unit of it
o Attempting to get more of something (e.g. higher grades) certainly increases
your benefits (chance of a good job) but the extra time spent studying also
comes with extra costs (less time sleeping). We should not just look at just
benefits or just costs; we need to consider both!
o You make a rational choice when you take those actions for which marginal
benefit exceeds or equals marginal cost. Thus, while I would like you to study
every day for this course, it may not be a rational outcome for you given your
circumstances.
• Choices respond to incentives
o An incentive is a reward or a penalty- a arrot or a stik- that encourages
or discourages an action
o ‘eard arrot is the MB; pealt stik is the MC
o Should you study for the 10% exam? What are your MBs and MCs?
o What if I increased it to 20%? Now that I changed the incentives, are you
more likely to study now? Have your MBs and MCs changed?
Calculating OC (opportunity Cost) (slide 12-13)
• OC= Explicit Costs (what you actually pay) + Implicit Costs (what you are giving up)
• So even if something is apparently free (i.e. no explicit cost), it could still have a very
high opportunity cost
o E.g. spending an hour chatting (free) has the opportunity cost of one hour of
not revising and therefore costs lost marks in an exam
o Tom goes to the swimming pool for 1 hour instead of working. His admission
prie is $5 ad if he orked he ould hae eared $. What is Tos OC?
• OC= Explicit Costs +Implicit Costs
• Tos EC is the adissio prie of $5
• Tos IC is hat he gae up i order to go siig. I this ase $ ioe he
would have earned had he worked instead
• OC= $5 + $10= $15
• Important to understand- we come back to OC time and again
Example:
• Benefits of coming to University include the present enjoyment of student life and a
higher future income
• The costs of being at university for a full-time student include tuition, books, other
study costs and forgone earnings
• The costs are incurred now, but the benefits accrue over a working lifetime
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Economics for decision making lecture 1 notes: scarcity, defining economics, micro vs macro, economic way of thinking, cost and benefit in economics, opportunity cost, production possibility frontier, absolute advantage and comparative advantage (economist prefer comparative) But only has (resources: e. g. even a billionaire business man faces scarcity. Time constraints (limited resources: faced with scarcity, we must make choices- we must choose among the available alternatives, the choices we make depend on the incentives we face. Different types of resources: time, land (natural endowment, labour and human resources, physical capital. Economics defined: economics is the social science that studies the choices that individuals, businesses, governments and entire societies make as they cope with scarcity, and the incentives that influence those choices and the arrangements that coordinate them. You could have also used this time to sleep, work, watch tv, exercise. But attending the lecture involves a tradeoff (say, cannot sleep longer).
