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Principles of Micro Economics

This chapter introduces core concepts in microeconomics including scarcity, economic trade-offs, costs and benefits. It discusses that economics involves studying how people make choices with limited resources. The scarcity principle means having more of one thing requires having less of another. Rational individuals will only take actions where the marginal benefits outweigh the marginal costs. The chapter also outlines important decision-making principles like opportunity costs and sunk costs that people should consider, and pitfalls to avoid like ignoring costs of alternatives or focusing on average rather than marginal costs and benefits. It distinguishes between normative principles about how people should behave and positive principles that predict how they will behave based on incentives.

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Prashanth Ratnabala
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264 views3 pages

Principles of Micro Economics

This chapter introduces core concepts in microeconomics including scarcity, economic trade-offs, costs and benefits. It discusses that economics involves studying how people make choices with limited resources. The scarcity principle means having more of one thing requires having less of another. Rational individuals will only take actions where the marginal benefits outweigh the marginal costs. The chapter also outlines important decision-making principles like opportunity costs and sunk costs that people should consider, and pitfalls to avoid like ignoring costs of alternatives or focusing on average rather than marginal costs and benefits. It distinguishes between normative principles about how people should behave and positive principles that predict how they will behave based on incentives.

Uploaded by

Prashanth Ratnabala
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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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

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