Ten Principles of

Economics
Topic 1
 Announcements
 Assigned Reading:
Textbook, Chapter 1 and 2
 Problem Set (Ch1):
Quick Quiz (Multiple Choice): Except Q6
Problem and Applications: Q2, Q3, Q5, Q6, Q8
 Due Date: 22 February 2019, at 11:45pm

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 Way of Economic Thinking
 There are “many ways” to understand
people’s choice and behavior
Sociology, history, psychology, etc.
 Different discipline has different focus on
people’s behavior
 Economics is a “way of thinking” to analyze
people’s choice under constraint(s)
 (1) We assume people are “maximizer”:
When an individual makes a choice, his/her
objective is to maximize the happiness
received
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 Way of Economic Thinking
 (2) Choice without limitation is meaningless
Just like if you have unlimited amount of money
to spend, it is meaningless to talk about spending
wisely
 Following are some basic “principles” of
Economic Way of Thinking:

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 1. People Face Trade-offs
 (1) Individually, you have to decide what you
want to do with your summer?
 (2) Society perspective, who can get “this
apple”?
If a government policy is to “help” someone, it
may also mean it “hurts” someone
 There is no Economics, if there is no
“SCARCITY”

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 1. People Face Trade-offs
 The amount of an item is insufficient to satisfy
ALL wants of a person or wants of ALL
people, then scarcity happens for the item
 “Scarcity” is about “availability” AND “want”
TOGETHER
A box of eggs usually has limited number of bad
eggs (limited in availability), but if no one wants
(or wants is less than availability), there is no
scarcity for bad eggs!!!

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 2. Choices and Opportunity Cost
 You can do the following with time tonight: (A)
Study, (B) Game, (C) Dating
 In Economics, Opportunity Cost of
doing/choosing (A)?
 Note: Doing (A) means you cannot do
EITHER (B) or (C), BUT NOT BOTH
 Opportunity Cost for doing XXX is the
best/highest valued alternative you give up
to get it
(B) or (C), which carries higher value?
YES, it could be different for different persons
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 2. Choices and Opportunity Cost
Extend your thought … …
 Opportunity Cost is about “choice” or
“decision-making”
1. No choice = no cost!!! When there is no
alternative, it is not part of the cost (Ch1-
p5, example of sleep and food)
2. Cost is a forward-looking concept: When
there is change in available choices, the
cost of the same choice can change
Things HAPPENED and not reversible should not
be part of the cost
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 EXAMPLE: Cost
 All operations of Bank of
China are in the BOC Tower?
 In fact, BOC leases out many
office spaces to other
companies AND rent spaces
somewhere else for some of
its operations
 What’s in BOC
management’s mind?
 The choice/decision is: To
use BOC Tower space or not

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 EXAMPLE: Cost
 Building cost? No
These costs (construction, land costs, etc.) are
“Sunk Cost”, so it is not relevant to the choice
 If BOC does not use the office space itself,
any alternative uses for those space? Yes
Alternative: Leasing to others for rental income.
For example: HK$50 per square feet
“Rental income” is the cost for using the office
space of BOC Tower

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 EXAMPLE: Cost
C t – ChChange in
i
Alternatives
 Suddenly, market of office space in Central is
heating up, rental rises to HK$80
Cost for BOC using the office space “increases”
Cost is a “forward-looking” concept
 Suddenly, HK gov’t passed a law to prohibit
the leasing of office space by owners
Alternatives? No
Cost for BOC using the floor space equal zero

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 ANOTHER EXAMPLE: Cost
 As a business, Opportunity
Cost of keep using the land for
swimming pool?
 Building Cost?
NO!
“Sunk Cost”, not relevant to
the choice/decision
 If not use for swimming pool,
alternatives?
Camping site, etc. or even
lease it out (rental income)

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 EXAMPLE: Cost
C t – ChChange in
i
Alternatives
 Suddenly, Hong Kong Gov’t passed a law
that the land only can be use for swimming
pool
Alternatives anymore? No
Cost?
 Suddenly, oil is found underground!
Cost?

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 Check Point (1)
Computing the opportunity cost of attending a
concert:
1) the price you pay for the ticket and the value
of your time
2) the price you pay for the ticket, but not the
value of your time
3) the value of your time, but not the price you
pay for the ticket
4) neither the price of the ticket nor the value of
your time
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 Check Point (1)
When computing the opportunity cost of
attending a concert you should include the $30
she earns working
1) the price you pay for the ticket and the value
of your time
2) the price you pay for the ticket, but not the
value of your time
3) the value of your time, but not the price you
pay for the ticket
4) neither the price of the ticket nor the value of
your time
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 Check Point (1)
 Alternatives for not attending concert:
Time Cost: Use the time to work and earn money
Save the money for concert ticket
 “Cost” can be more than one component!
Choosing concert means you have to give up
money, time

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 Check Point (2)
You are earning $30,000 per year. Now, you have
an opportunity to enroll in a one-year Master
program that requires you to quit your job. Which
of the following should not be included in the
opportunity cost of study?
1) the cost of tuition and books for study
2) the $30,000 salary that you could have earned if you
retained your job
3) the $45,000 salary that you will be able to earn after
having completed your graduate program
4) the value of insurance coverage and other employee
benefits you would have received if you retained your job
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 Check Point (2)
You are earning $30,000 per year. Now, you have
an opportunity to enroll in a one-year Master
program that requires you to quit your job. Which
of the following should not be included in the
opportunity cost of study?
1) the cost of tuition and books for study
2) the $30,000 salary that you could have earned if you
retained your job
3) the $45,000 salary that you will be able to earn after
having completed your graduate program
4) the value of insurance coverage and other employee
benefits you would have received if you retained your job
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 Check Point (3)
 You are selling your 1996 Toyota. You have
already spent $10,000 on repairs.
 At the last minute, the transmission dies. You
can pay $6,000 to have it repaired, or sell the
car “as is.”
1) Selling price is $65,000 if transmission works,
$57,000 if it doesn’t
2) Selling price is $60,000 if transmission works,
$55,000 if it doesn’t

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 Check Point (3)
 Cost of fixing transmission = $6,000
 Value is $6,500 if transmission works,
$57,000 if it doesn’t
Benefit of fixing the transmission = $8000
($6500 – 5700), so it’s worthwhile to have the
transmission fixed
 Blue book value is $60,000 if transmission
works, $55,000 if it doesn’t
Benefit of fixing the transmission is only $5,000.
Paying $6,000 to fix transmission is not
worthwhile
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3. Rational People Think at the Margin
 In Economics, we assume individuals are
Rational
Decision making: Choosing the best alternative
 Roughly: Able to (1) rank choices under all
situation, and (2) pick the best one
 Is it too demanding on human beings?
Can you always rank all your choices?
Can you always choose the “best” choices?
 You heard many times: Human being is not
rational !!!

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3. Rational People Think at the Margin
 EXAMPLE: Is “Herding Behavior” in
investment irrational?
 Economists try to explain this by regarding
investors are rational but due to incomplete
information
We sometimes “follow” someone who we believe
they know better
 Can we explain some behaviors by saying
that people are rational, but some irrational?
We can explain anything or in fact NOTHING!
 Economists are proud of their consistent
analysis framework
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 Oops~~~
 Sometimes, human beings
appear not quite “rational” as
assumed by economic models
We have apple and cherry pie: you
choose apple
Now, also peach pie: What will be
your choice?
Will you choose cherry?
 Psychology meets Economics!
 Behavioral approach: Relaxation
of the assumption of rationality
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 3. Rational People Think at the Margin
 You want some chicken wings
 Each costs HK$6
 How many you want?

 Thinking … …
5 wings costs me HK$ 30
Pleasure from 5 wing is worth HK$ 35
I eat 5 wings

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 3. Rational People Think at the Margin
 The “marginal unit” is the “additional” unit
“Marginal benefit/cost” is the benefit/cost of an
additional unit
 When considering how many units to buy or
sell, we think at “margin”

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 EXAMPLE: The 5th chicken wing?
 One by one wing, let say, Value $ Value of Wings
after eating 4 wings, the
pleasure/benefit from the
5th wing drops to HK$65
 5th is indifferent
$6
 We think at margin!
 Maximize the gain from
consumption!!!

1 2 3 4 5 Q

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 EXAMPLE: The 5th chicken wing?
 When price change Value $ Value of Wings
slightly
 E.g. from $6 to $5, what
will happen?
 You will consume 1 more
wing!
 Your decision is to be $5
evaluated at the
marginal unit!
1 2 3 4 5 Q

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 ANOTHER EXAMPLE: Buffet dinner
 Buffet Dinner: Paying a fixed price, eat as
much as you want
 How many you will eat? Will price changes
from HK$500 to HK$600 affect how much
you will eat?
No, you will eat the same amount
However, you may decide not to go for that
 Think at the margin!!!
Cost of eating additional (marginal) plate of food?
Marginal cost of food is zero!!!
 Can you use a similar graph for chicken wing
to make the analysis?
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 4. People Respond to Incentives
Very simple example:
 Optional reading = No weighting = NO /
LOW incentive
 “Incentive” affects human’s behavior
significantly
Benefit and cost / Carrot and stick
 Why incentive is important in analyzing
human’s behavior?
Human is not a machine. You cannot just tell a
person to do something

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 4. People Respond to Incentives
 People respond to incentives smartly – Out
of policy makers’ expectation / calculation
 EXAMPLE: Help the low income group –
rental cap (ceiling), but can it actually?
 Landlords respond to rental cap “smartly”:
More difficult to rent an apartment
“Side-payment” may be asked
Poor maintenance of apartments, etc.
 More discussion later in “Government Policy
Section”

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 Check Point (4)
 Will compulsory use of seat belt reduce the
no. of causality (death) from auto accident?
1) Yes
2) No
3) Don’t know
4) None of the above

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 Check Point (4)
 Will compulsory use of seat belt reduce the
no. of causality (death) from auto accident?
1) Yes
2) No
3) Don’t know
4) None of the above
Correct answer is 3): Given the positive and
negative forces working against each other,
empirical studies (evidence or observations)
are needed to resolve the final outcome
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 EXAMPLE: Seat belts
 To promote auto safety, seat belts are
required as standard equipment and
passengers are required to use them
 Positive aspect: Wearing seat belt protects
passengers, and increase the chance of
surviving an accident, HOWEVER
 It also changes the incentive for driver !
 Using seat belt, lower the chance of serious
injury, in response: Drivers drive faster !

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5. Trade Can Make Everyone Better Off
 The answer is ???
 Will be discussed in more detail in Ch3:
Interdependence and Gain from Trade

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 6 Markets
6. M k are Usually
U ll a Good
G d Way
W to
Organize Economic Activity
 Sometimes yes, sometimes NO
 I am going to show you under “Perfect
Competition”, then market is a good way
 But, will market fail to bring the “best benefit”
to the society?
 However, what is “best benefit”?

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