What is Economics? Key Concepts and Terms

 It is the study of how people make choices in the marketplace ◦ Consumers (you and me)  How to allocate your time  Studying versus work versus socializing versus sleep  How to allocate your income  Saving versus consuming  Among various goods  Food, housing, transportation, “fun”

 It is the study of how people make choices in the marketplace ◦ Firms (and their managers)  Which goods to produce  How to allocate your investment (capital)  How to allocate your labor among various goods or models of the product  Which technology to use  Capital or labor  Which inputs, quality of inputs

 The reason people/firms need to make choices is because of scarcity ◦ “ You can’t have it all”  Limits on resources, time, money/income “dictate” that individuals have to choose how to allocate their “scarce” resources to their maximum value/use ◦ “Opportunity costs ” : since resources are scarce and you will have to make choice  Means that there are “opportunity costs” of making a choice  That is, there are tradeoffs between alternatives

 Lionel Robbins (1932): Lionel Robbins  "the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses."  Scarcity means that available resources are insufficient to satisfy all wants and needs. Scarcityresources  Absent scarcity and alternative uses of available resources, there is no economic problem. The subject thus defined involves the study of choices as they are affected by incentives and resources.economic problemchoices

 Scarcity  Opportunity Cost  Tradeoffs  Benefit/Cost Analysis

 There are not enough resources to produce and consume all of the goods and services we desire

 Limits on resources implies that decisions must be made about: ◦ What to produce ◦ How to produce it ◦ Whom to produce it for  Could be done by: ◦ Government direction (centrally planned economy) ◦ Market forces (price signals)

 Scarcity implies that choices must be made ◦ Choice implies that there is a trade-off or “opportunity cost” (foregone alternative)  Opportunity cost is defined as: ◦ The value of a good, service or resource in its next highest valued use – consequence of scarcity  Every decision has an opportunity cost ◦ Alaska: potential value of gold mining could disrupt Copper River Salmon run ◦ Choice of academic majors ◦ How to spend time or money

 Opportunity costs are not only “observable” economic costs, but also “unobservable” (or non-monetary) costs ◦ Opportunity costs of time  Commute example  Car  Bus  Bike

 Monetary costs associated with each alternative ◦ Car  Initial purchase expense (fixed), O&M (variable: fuel, maintenance, depreciation, licenses, insurance, parking), time of commute ◦ Bus  Time + fee ◦ Bike  Initial purchase (bike and lock), O&M (tires, tune-ups, clothing), time of commute

 Non-pecuniary benefits/costs ◦ Non-pecuniary: not directly measurable by $  Car ◦ Benefit: flexibility to come/go ◦ Costs: traffic jams, road rage, finding a parking space  Bus ◦ Benefits: reading time, “no hassle”

 Bus ◦ Costs: no flexibility on time  Bike ◦ Benefits: flexibility, improved health ◦ Costs: bad weather, lighting  Choose the alternative that has the greatest net benefits

 Individuals [or firms] choose their actions on the basis of expected additional [net] benefits and cost to themselves ◦ In this case -> alternative chosen will be the one that yields the largest net benefits ◦ Paul Heynes’ “economizing process”  Modest changes in monetary costs and benefits can induce people to alter their behavior ◦ Cold, wet weather increases the costs of bike commuting (or parking on the street)

 Proper framework for analyzing economic decisions is to compare the costs and benefits of the alternatives ◦ Cost and benefits include not only directly observable/measurable economic costs and benefits, but also ◦ Opportunity costs (e.g., time), ◦ Non-pecuniary benefits

 Common understanding of key terms ◦ Use them as shorthand for the concept; but have a precise/exact meaning  Scarcity ◦ There are not enough resources to produce and consume all of the goods and services we desire  Opportunity costs ◦ What must be given up (next best alternative use) as a result of a decision or choice ◦ “No such thing as a free lunch” (Milton Friedman)  Cost-benefit analysis ◦ Every decision/action has tradeoffs