Individual Choice: Understanding Economics Principles

2. What you will learn in this chapter: ➤ A set of principles for understanding the economics of how individuals make choices ➤ A set of principles for understanding how individual choices interact One must choose

3. Individual Choice: The Core of Economics Individual choice is the decision by an individual of what to do, which necessarily involves a decision of what not to do.

4. Individual Choice: The Core of Economics • Resources Are Scarce A resource is anything that can be used to produce something else. Resources are scarce—the quantity available isn’t large enough to satisfy all productive uses.

5. Individual Choice: The Core of Economics • Opportunity Cost: The Real Cost of Something Is What You Must Give Up to Get It The real cost of an item is its opportunity cost: what you must give up in order to get it. Tiger Woods understood the concept of opportunity cost. The rest is history.

6. Individual Choice: The Core of Economics • “How Much?” Is a Decision at the Margin You make a trade-off when you compare the costs with the benefits of doing something. Decisions about whether to do a bit more or a bit less of an activity are marginal decisions. The study of such decisions is known as marginal analysis.

7. Individual Choice: The Core of Economics • People Usually Exploit Opportunities to Make Themselves Better Off An incentive is anything that offers rewards to people who change their behavior.

8. Individual Choice: The Core of Economics • Individual Choice: Summing It Up We have just seen that there are four basic principles of individual choice: ■Resources are scarce. It is always necessary to make choices. ■ The real cost of something is what you must give up to get it. All costs are opportunity costs. ■ “How much?” is a decision at the margin. Usually the question is not “whether,” but “how much. And that is a question whose answer hinges on the costs and benefits of doing a bit more. ■People usually exploit opportunities to make themselves better off. As a result, people will respond to incentives.

9. Interaction: How Economies Work Interaction of choices—my choices affect your choices, and vice versa—is a feature of most economic situations. The results of this interaction are often quite different from what the individuals intend.

10. Interaction: How Economies Work • There Are Gains from Trade “I hunt and she gathers-otherwise we couldn’t make ends meet.”

11. Interaction: How Economies Work • There Are Gains from Trade In a market economy, individuals engage in trade: They provide goods and services to others and receive goods and services in return. There are gains from trade: people can get more of what they want through trade than they could if they tried to be self-sufficient. This increase in output is due to specialization: each person specializes in the task that he or she is good at performing.

12. Interaction: How Economies Work • Markets Move Toward Equilibrium An economic situation is in equilibrium when no individual would be better off doing something different. Witness equilibrium in action at the checkout lines in your neighborhood supermarket.

13. Interaction: How Economies Work • Resources Should Be Used as Efficiently as Possible to Achieve Society’s Goals An economy is efficient if it takes all opportunities to make some people better off without making other people worse off. Equity means that everyone gets his or her fair share. Since people can disagree about what’s “fair,” equity isn’t as well-defined a concept as efficiency.

14. Interaction: How Economies Work • Markets Usually Lead to Efficiency The incentives built into a market economy already ensure that resources are usually put to good use, that opportunities to make people better off are not wasted.

15. Interaction: How Economies Work • When Markets Don’t Achieve Efficiency, Government Intervention Can Improve Society’s Welfare A very important branch of economics is devoted to studying why markets fail and what policies should be adopted to improve social welfare. They fail for three principal reasons: ■ Individual actions have side effects that are not properly taken into account by the market. ■ One party prevents mutually beneficial trades from occurring in the attempt to capture a greater share of resources for itself. ■ Some goods, by their very nature, are unsuited for efficient management by markets.

16. K E Y T E R M S Interaction Trade Gains from trade Specialization Equilibrium Efficient Equity Individual choice Resource Scarce Opportunity cost Trade-off Marginal decisions Marginal analysis Incentive