◘ When we sacrifice one thing to obtain another, that's

called a trade-off.

◘ Trade-offs create opportunity costs, one of the most

important concepts in economics.  Whenever you
make a trade-off, the thing that you do not choose is
your opportunity cost.
1. WHAT goods will be produced?

2. HOW And WHEN will resources be used in the

production process?

3. WHO will receive the goods?

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The Market System

The Command System

The Mixed System

 In the market system, allocative efficiency may
be achieved as private individuals themselves
are in the best position to know what they want.
There will be incentive for workers to work hard
and for firms to be efficient as they will be
rewarded with high income and profit. There
will fast decision-making as each private
individual only needs to make economic
decisions pertaining to their interest. There will
be liberty as private individuals are allowed to
choose their ways of life.
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 In the command system, allocative efficiency
may be achieved as externalities will be taken
into consideration by the government. There
will be no unemployment as the government
will provide a job for every private individual.
The distribution of income will be equitable as
no private individuals will earn very high or
very low income. Public goods will be produced
by the government through taxation. There will
be no private firms with substantial market
power which can charge high prices.
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 One of the key assumptions underlying
economics is the concept of the rational
behavior; i.e., that individuals know what they
want and seek to make the most of the
available opportunities given the scarcity
constraints they face.

 There are two key components here:

 Individuals have preferences.

 Individuals have constraints.

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 The cost of  The benefits
obtaining one obtained from
additional unit of consuming one
a good or service additional unit of a
is called the good or service are
marginal cost. called the marginal
benefits.

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 Marginal Costs Marginal benefits
gas, other car expenses $1.00 knowledge $0.75
higher lifetime income due $4.00
paper & ink used $0.30 to better economics grade
earned because you learned
about opportunity costs
opportunity costs $3.00 in class today
were able to socialize with $0.25
total marginal costs $4.30 other students
total marginal benefits $5.00

Since the marginal benefits of attending class today are greater

than the marginal costs, rational behavior dictates that you should
have come to class today
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 Externality: A benefit or cost that affects someone who
is not directly involved in the production or
consumption of a good or service.

 Positive externality
 Negative externality

 An externality causes a difference between: the private

cost of production and the social cost of production, or
the private benefit from consumption and the social
benefit from consumption.
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 Incentives are factors that encourage or discourage
various types of behaviors, actions or activities.

 Changes in incentives alter the way people behave.

 Incentives influence behavior at all levels-

personal, familial, business, government, and
national.

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 1. Allocative Efficiency

 2. Technological Efficiency.

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