2 THE KEY PRINCIPLES OF ECONOMICS

THE PRINCIPLE OF OPPORTUNITY COST The Cost of College Opportunity cost of money spent on tuition and books $120,000 Opportunity cost of college time (four years working for $20,000 per year) 80,000 Economic cost or total opportunity cost $200,000 opportunity cost What you sacrifice to get something

THE PRINCIPLE OF OPPORTUNITY COST Opportunity Cost and the Production Possibilities Curve production possibilities curve A curve that shows the possible combinations of products that an economy can produce, given that its productive resources are fully employed and efficiently used.  Scarcity and the Production Possibilities Curve

THE PRINCIPLE OF OPPORTUNITY COST Opportunity Cost and the Production Possibilities Curve  Shifting the Production Possibilities Curve

THE MARGINAL PRINCIPLE marginal benefit The additional benefit resulting from a small increase in some activity. marginal cost The additional cost resulting from a small increase in some activity.

CONTINENTAL AIRLINES USES THE MARGINAL PRINCIPLE How do firms think at the margin? Average cost of running a flight = $4000 Fixed costs = $2000 Variable costs = $2000 Revenue of a half-full flight = $3000 In applying the marginal principle, determine: The marginal cost of running an additional flight The marginal benefit of running an additional flight Should the next half-full flight run? In the 1960s, Continental Airlines puzzled observers of the airline industry and dismayed its stockholders by running flights with up to half the seats empty. Why did the airline run such flights? Were the managers of the airline irrational? Apply the marginal principle to the following:

THE PRINCIPLE OF VOLUNTARY EXCHANGE Exchange and Markets A market is an institution or arrangement that enables people to exchange goods and services. If participation in a market is voluntary and people are well informed, both people in a transaction—buyer and seller—will be better off.

THE PRINCIPLE OF DIMINISHING RETURNS Diminishing Returns from Sharing a Production Facility When we add a worker to the facility, each worker becomes less productive because he or she works with a smaller piece of the facility: More workers share the same machinery, equipment, and factory space. As we pack more and more workers into the factory, total output increases, but at a decreasing rate. The Law of Diminishing Returns Assume output is produced using two or more inputs. If we increase one input while holding the others fixed, at some point we will see that out put begins to increase at a decreasing rate. This is the point of diminishing returns.

FERTILIZER AND CROP YIELDS Do farmers experience diminishing returns? Table 2.1 | FERTILIZER AND CORN YIELD Bags of Nitrogen FertilizerBushels of Corn Per Acre The notion of diminishing returns applies to all inputs to the production process. For example, one of the inputs in the production of corn is nitrogen fertilizer. Suppose a farmer has a fixed amount of land (an acre) and must decide how much fertilizer to apply. The table below shows the relationship between the amount of fertilizer and the corn output. Why does the farmer experience diminishing returns?

EXTERNALITIES The spillover principle: suggests that some decisions or transactions will impact a third party who was not involved in the decision. This is also called an externality. External cost: a negative impact on someone not directly involved in the decision or transaction. External benefit: a positive impact on someone not directly involved in the decision or transaction.

THE REAL-NOMINAL PRINCIPLE nominal value The face value of an amount of money. real value The value of an amount of money in terms of what it can buy. The real-nominal principle states that what matters to people is the real value of money or income, not the nominal value.