Economic Decision Making -Scarcity and Choice

1. Economic Decision Making-Scarcity and Choice Opportunity Costs Marginal Analysis Production Possibilities

2. An economic decision involves making a choice of how to allocate (“divide-up”) limited or scarce resources. • The fundamental building blocks of economic decision-making: (i) Opportunity Cost (ii) Marginal Cost-Benefit Analysis

3. Opportunity Costs • The opportunity cost of an activity is the value of the next best alternative which is foregone or sacrificed. • A well functioning market implies that goods that have high (low) opportunity costs also have high (low) monetary costs. • Examples: - Job Offers and Salaries - Natural Resource Depletion - Time Value of Money

4. An interest rate is (i) the rate by which a bank account grows over time. (ii) the price borrowers pay lenders for a loan. (iii) the opportunity cost of holding cash rather than depositing it into a bank account.

5. Marginal Analysis: Cost-Benefit Principle • Marginal benefit is the benefit of one additional unit of an activity. • Marginal cost is the cost of one additional unit of an activity. • Cost-Benefit Principle: An individual or society should take action if the marginal benefits of doing it exceed the marginal costs.

6. Example: Study Time and Grades Total Time Available = 4 hours Activities: Studying or Leisure (partying) Benefit of Leisure (0 to 10) Cost of Lower Grade (0 to 10) Net Happiness = Benefit - Cost

7. Production Possibilities • The production of output requires inputs or the factors of production. The most common inputs are labor and raw materials such as land and capital. • A production possibilities frontier (PPF) shows possible (feasible) combinations of goods which can be produced by a given amount of resources.

8. Example – Software Company • Remarks about PPF: (i) Points inside or along PPF are feasible. (ii) Points outside PPF are unattainable. (iii) Points along PPF are efficient. • Efficiency in economics means that you cannot increase production of one good without sacrificing the production of another.

9. The PPF is (1) Downward-sloping (2) Usually bowed-out – the principle of increasing opportunity costs. • The principle of increasing (opportunity) costs: As the production of one good expands the opportunity cost of the other good sacrificed increases.

10. Cases where increasing costs may not apply. • What causes the PPF to shift outward? (i) Growth in resources (inputs). (ii) Technological progress/human capital.