Principles of Micro- economics:

Core principles

key terms

Chapter 1: Thinking like an Economist:

Economics: Studying Choice in a World of Scarcity:
Economics: the study of how ppl make choices under conditions of scarcity & of
the results of those choices for society
Scarcity principle: having more of one good thing usually means having less of
another
o Compromising between competing interests
o i.e. when class size quality of instruction & cost/ student (economic
trade-off)
The cost- benefit principle: an individual/firm/society should only take action
when its marginal benefit marginal cost
o i.e. when the cost of offering smaller classes , but the willingness to pay for
smaller classes doesnt unis shift to larger class sizes
o suggest that we take only those actions that create additional economic
surplus
Scarcity & trade-offs that result also apply to resources other than money i.e. Bill
Gates projects
Applying the Cost-Benefit Principle:
Rational person: someone with well-defined goals who tries to fulfill those
goals as best as they can
Rational decision: one that is explicitly/implicitly based on a weighing of costs
& benefits
Must come up with reasonable measures of the relevant benefits & costs
Economic surplus: the benefit - cost of taking an action
Goal as economic decision maker: choose those actions that generate the
largest possible economic surplus
Opportunity cost (O.C): the value of the next-best alternative that must be
forgone in order to undertake the activity
Exercise 1.1: $2 economic deficit downtown thus, buy it in the nearby
campus store
Abstract model: a simplified description that captures the essential elements
of a situation & allows us to analyse them in a logical way
o Can help to explain & predict human behaviour
Trial/errorwe gradually lean what kinds of choices tend to work best in diff.
contexts
4 Important Decision Pitfalls:
1. Measuring costs & benefits as proportions rather than absolute $
amounts:
The benefit isnt the proportion you save on the original price it is the
absolute $ amount you save
Exercise 1.2: saving $100 on a $2000 plane ticket to Tokyo is more valuable,
as the absolute $ amount is $10 > than the plane ticket to Chicago

2. Ignoring O.Cs:
Many of us tend to overlook the implicit value of activities that fail to happen
Intelligent decisions require taking the value of forgone opp. properly into
account
Exercise 1.3:
3. Failure to ignore sunk costs:
Sunk cost: cost that is beyond recovery at the moment a decision must be
made i.e. money spent on a nontransferable, nonrefundable airline ticket
People are influenced by the costs they ought to ignore
The only costs that should influence a decision about whether to take an
action are those that we can avoid by not taking the action
i.e. even though a ticket to a concert may have cost you $100, if you have
already bought it & cant sell it to anyone else, the $100 is a sunk cost &
shouldnt influence your decision about whether to go to the concert
4. Failure to understand the average-marginal distinction:
Marginal benefit: the in total benefit that results from carrying out 1
additional unit of an activity
Marginal cost: the in total cost that results from carrying out 1 additional
unit of an activity
Average cost: the total cost of undertaking n units of an activity divided by
n
Average benefit: the total benefit of undertaking n units of an activity
divided by n
A common mistake is to conclude that an activity should be if its average
benefit > average cost but, the cost-benefit rule is to keep the level, as
long as marginal benefit > marginal cost
Example 1.5, 1.6
Exercise 1.4, 1.5, 1.6
Normative Economics vs. Positive Economics:
The economists focus on rational choice offers useful advice about making
better decisions & a basis for predicting & explaining human behaviour
Normative economic principle: one that says how ppl should behave i.e. costbenefit principle
Positive economic principle: one that predicts how ppl will behave
The incentive principle: a person/firm/society is more likely to take an action if
its benefit , & less likely to take it if its cost is a positive economic
principle
i.e. if the price of heating oil we would invoke the cost-benefit principle to
say that ppl should turn their thermostats down & invoke the incentive principle
to predict that average thermostat settings will in fact go in most cases
Economics: Micro & Macro:
microeconomics: the study of individual choice under scarcity & its
implications for the behaviour of prices & quantities in individual markets
macroeconomics: the study of the performance of national economies & the
policies that governments use to try to improve that performance tries to

understand the determinants of such things as the national unemployment rate,

the overall price level & the total value of national output