1. McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Chapter 1 Thinking Like an Economist

2. 1-2 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Learning Objectives: Understand 1.The Scarcity Principle 2.The Cost-Benefit Principle 3.Opportunity cost 4.Pitfalls in reasoning

3. 1-3 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 1 The Scarcity Principle Economics: The study of choices and results under scarcity The Scarcity Principle: Unlimited wants and limited resources means having more of one good means having less of another. Also called No Free-Lunch Principle

4. 1-4 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 2 The Cost-Benefit Principle  Take an action if and only if the extra benefits are at least as great as the extra costs Marginal Benefits Marginal Costs

5. 1-5 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 2 Cost – Benefit Example  Drive to Des Moines to save $20 (Extra Benefit) on an item?  Benefits are clear  Costs are harder to define  Hypothetical auction  Would you drive to Des Moines if someone paid you $19?  If you would drive to Des Moines for less than $20 (Extra Cost), you gain from buying the item in Des Moines.

6. 1-6 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 2 Opportunity Cost  The value of what must be foregone in order to undertake an activity  Caution: NOT the combined value of all possible activities  Opportunity cost considers only your best alternative

7. 1-7 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 – 4, 5, 6 Possible Decision Pitfalls  Measuring costs and benefits as proportions instead of absolute amounts  Failure to think at the margin

8. 1-8 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 4 Pitfall #1  Measuring costs and benefits as proportions instead of absolute amount  Would you drive to Des Moines to save $20 on a $25 item?  Would you drive to Des Moines to save $20 on a $2,500 item? Action Marginal Costs Marginal Benefits

9. 1-9 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 6 Pitfall #2  Failure to think at the margin  Sunk costs cannot be recovered  Example: Eating at an all-you-can- eat restaurant Marginal Benefits Marginal Costs

10. 1-10 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Microeconomics and Macroeconomics  Microeconomics studies individual choice and its implications for price and quantity in individual markets  Sugar  Carpets  House cleaning services  Macroeconomics studies the performance of national economies and the policies that governments use to try to improve that performance  Overall price level  National unemployment rate  Total value of national product

11. 1-11 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Economics Is Choosing  Focus in this course  Explain many economic issues  Predict decisions made in a variety of circumstances  Core Principles are the foundation for solving economic problems

12. McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Chapter 1 Appendix Working with Equations, Graphs, and Tables

13. 1-13 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Definitions  Equation  Variable  Dependent variable  Independent variable  Parameter (constant)  Slope  Intercept

14. 1-14 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO - 5 From Words to an Equation  Identify the variables  Calculate the parameters  Slope  Intercept  Write the equation  Example: Phone bill is $5 per month plus 10 cents per minute B = 5 + 0.10 T

15. 1-15 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All B = 5 + 0.10 T  Draw and label axes  Horizontal is independent variable  Vertical is dependent variable  To graph,  Plot the intercept  Plot one other point  Connect the points From Equation to Graph T B 5 6 A C D 12 8 103070

16. 1-16 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All From Graph to Equation  Identify variables  Independent  Dependent  Identify parameters  Intercept  Slope  Write the equation B = 4 + 0.2 T

17. 1-17 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Changes in the Intercept  An increase in the intercept shifts the curve up  Slope is unchanged  Caused by an increase in the monthly fee  A decrease in the intercept shifts the curve down  Slope is unchanged

18. 1-18 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Changes in the Slope  An increase in the slope makes the curve steeper  Intercept is unchanged  Caused by an increase in the per minute fee  A decrease in the slope makes the curve flatter  Intercept is unchanged

19. 1-19 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All From Table to Graph  Identify variables  Independent  Dependent  Label axes  Plot points  Connect points Time (minutes/month) 10203040 Bill ($/month) $10.50$11.00$11.50$12.00

20. 1-20 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All From Table to Equation  Identify independent and dependent variables  Calculate slope  Slope = (11.5 – 10.5) / (30 – 10) = 1/20 = 0.05  Solve for intercept, f, using any point B = f + 0.05 T 12 = f + 0.05 (40) = f + 2 f = 12 – 2 = 10 B = 10 + 0.05 T Time (minutes/month) 10203040 Bill ($/month) $10.50$11.00$11.50$12.00

21. 1-21 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - All Simultaneous Equations  Two equations, two unknowns  Solving the equations gives the values of the variables where the two equations intersect  Value of the independent and dependent variables are the same in each equation  Example  Two billing plans for phone service  How many minutes make the two plans cost the same?

22. 1-22 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO - 5  Plan 1B = 10 + 0.04 T  Plan 2B = 20 + 0.02 T  Plan 1 has higher per minute price while Plan 2 has a higher monthly fee  Find B and T for point A Simultaneous Equations

23. 1-23 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 1 - 5  Find B when T = 500 B = 10 + 0.04 T B = 10 + 0.04 (500) B = $30 OR B = 20 + 0.02 T B = 20 + 0.02 (500) B = $30 Simultaneous Equations  Plan 1B = 10 + 0.04 T  Plan 2B = 20 + 0.02 T  Subtract Plan 2 equation from Plan 1 and solve for T B = 10 + 0.04 T – B = – 20 – 0.02 T 0 = – 10 + 0.02 T T = 500