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

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

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

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.

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.

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

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.

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.

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.

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