MGEA02H3 Chapter Notes -Externality, Marginal Utility, Invisible Hand

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- Economy comes from the Greek word for one who manages a household
- The management of society’s resources (people, land,…) are important because resources are
scarce
- Scarcity: the limited nature of society’s resources, that society has limited resources and therefore
cannot produce all the goods and services people wish to have
- Economics: the study of how society manages it scarce resources
- Economists study how people make decisions (ie:what they buy, how people interact)
How people make decisions
- 4 principles
- Economy is just a group of people interacting with one another as they go about their lives
- Behaviour of an economy reflects the behaviour of the individuals who make the economy
Principle #1: people face tradeoffs
- There is no such thing as a free lunch (first lesson about making decisions)
- Get something we like we usually have to give up something else
- Example: for every hour a student study’s, they give up an hour to watch tv OR when a family
spends an extra dollar on this good they have one less dollar for another good
- Pollution regulations give us a cleaner environment but reduces income
- Efficiency: the society is getting the most it can from its scarce resources
- Equity: the benefits of those resources are distributed fairly among society’s members (distributing
economic prosperity fairly among the members of society)
- Efficiency refers to the size of the economic pie, equity refers to how the pie is divided
- P.5 examples
Principle #2: the cost of something is what you give up to get
- Making decisions requires comparing the costs and benefits of alternative courses of action
- Some are not obvious when they first appear p.5-6 college university example
- Opportunity cost: whatever must be given up to obtain some item (what you give up to get that
item)
- Example: athletes opportunity cost at postsecondary education is very high, they decide the benefit
is not worth the cost
Principle #3: rational people think at the margin
- Rational people: people who systematically and purposefully do the best they can to achieve their
objectives, given the opportunities they have
- Marginal changes: small incremental adjustments to a plan of action
- Margin means edge, so marginal changes are adjustments around the edges of what you are
doing
- Make decisions by comparing marginal benefits and marginal costs
- Example: standby passenger for an airplane, marginal cost is merely the cost of peanuts and soda.
As long as they pay more than marginal cost, selling the ticket is profitable
- Marginal benefit, people will pay for a diamond rather than a cup of water because diamonds are
rare so the marginal benefit is larger (marginal decision making)
- Rational decision maker takes an action if and only if the marginal benefit of the action exceeds the
marginal cost (explain why people buy diamonds and why airlines sell tickets below average cost)
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