PowerPoint® Lecture Slides Prepared By Amy Peng, Ryerson University
PowerPoint® Lecture Slides Prepared By Amy Peng, Ryerson University
1.1 Economics: Studying Choice in a World of Scarcity
1.2 Applying the Cost– Benefit Principle
1.3 Three Common Pitfalls
1.4 Pitfall 1: Ignoring Opportunity Costs
1.5 Pitfall 2: Failure to Ignore Sunk Costs
1.6 Pitfall 3: Failure to Understand the Average–Marginal Distinction
1.7 Economics: Micro and Macro
1.8 The Approach of This Text
1.9 Economic Naturalism
Ch1 -2
Chapter OutlineChapter Outline
© 2009 McGraw-Hill Ryerson Limited
Outline
1.1 Economics: Studying 1.1 Economics: Studying Choice in a World of Choice in a World of
ScarcityScarcity
We have boundlessboundless needs and wants.
The resources available to us, including time, are limitedlimited.
ScarcityScarcity means that we have to make choices
having more of one good thing usually means having less of another.
Trade-offs are widespread and important
Economics: Economics: the study of how people make choices under conditions of scarcity and of the results of those choices for society.
Economics: Studying Choice in a World of Scarcity Ch1 -4
The Scarcity ProblemThe Scarcity Problem
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The Cost–Benefit Principle: An individual (or a firm or a society) will be better off taking an action if, and only if, the extra benefits from taking the action are greater than the extra costs.
Measuring costs and benefits often difficult.
Economics: Studying Choice in a World of Scarcity Ch1 -5
The Cost-Benefit Principle I of IIIThe Cost-Benefit Principle I of III
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Example: “Best” Class Size
Assumption
Class size 20 or 100 students
Room costs 5000, instructor costs $15000 per class
Cost Calculation:
For class size 20: ($5000+$15000)/20 = $1000
For class size 100: ($5000+$15000)/100 = $200
The cost of reducing class size: $1000 – $200 = $800
Would you (or your parents) be willing to pay an extra 800 for a smaller economics class?
Economics: Studying Choice in a World of Scarcity Ch1 -6
The Cost-Benefit Principle II of IIIThe Cost-Benefit Principle II of III
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More Analysis on the “Best” Class Size
Education Psychologist may have a different view
Increasing class size in Canadian colleges and universities
Public operating grants decreased by 25% in the last decade
Federal government’s effort to reduce deficit
Students pay higher tuition (twice more) and attend larger class
Government believe tax payers are not willing to raise taxes to increase the funding of postsecondary education.
Insufficient amount of people are willing to bear the cost of small class.
Economics: Studying Choice in a World of Scarcity Ch1 -7
The Cost-Benefit Principle III of The Cost-Benefit Principle III of IIIIII
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1.2 Applying the Cost-1.2 Applying the Cost-Benefit PrincipleBenefit Principle
Economists usually assume that people are rational
in the sense that they know their own goals and try to fulfill these goals as best they can
Using cost-benefit principle to study how people make rational choice
Example 1.1: Will you be better off if you walk downtown to save $10 on a $25 computer game?
Extra benefit: $10
What is your cost of a 30 minutes walk?
Applying the Cost-Benefit Principle Ch1 -9
RationalityRationality
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Economic surplus
the benefit of taking any action minus its cost
If the cost of walking downtown is $9, the economic surplus of buying the computer game from downtown is $1
In general, you will be best off if you choose those actions that generate the largest possible economic surplus.
Money isn’t everything, dollar is a convenient unit.
Applying the Cost-Benefit Principle Ch1 -10
Economic SurplusEconomic Surplus
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Opportunity Cost: The value of the next-best alternative that must be forgone in order to undertake an activity.
Rational decisions depend upon opportunity costs
Opportunity cost is value of the next best alternative
A crucial economic concept – with many practical applications
Applying Cost-Benefit Principle Ch1 -11
Opportunity CostOpportunity Cost
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Economists often use abstract models of how an idealized rational individual would choose among competing alternatives.
Many economic models are examples of positive economics.
Positive economics has two dimensions
It offers cause-and-effect explanations of economic relationships.
It has an empirical dimension.
Applying Cost-Benefit Principle Ch1 -12
The Role of Economic Models I of IIThe Role of Economic Models I of II
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Other economic models are examples of normative economics.
Such models overlap with positive economic models.
But they incorporate valuation of different possible outcomes. They lead to normative statements about what "ought" to be: say, what is best, what is most socially efficient, or what is optimal.
Hence they have an element which cannot be tested with empirical evidence.
Applying Cost-Benefit Principle Ch1 -13
The Role of Economic Models II of IIThe Role of Economic Models II of II
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Two logical errors are to be avoided when modelling economic relationships.
The fallacy of compositionfallacy of composition
occurs if one argues that what is true for a part must also be true for the whole.
The post hoc fallacy post hoc fallacy
occurs if one argues that because event A precedes event B, event A causes event B.
Applying Cost-Benefit Principle Ch1 -14
Two Logical ErrorsTwo Logical Errors
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Rational people apply the cost–benefit principle most of the time.
Rational behaviour can help economists predict likely behaviour.
Applying Cost-Benefit Principle Ch1 -15
Rationality And Imperfect Rationality And Imperfect Decision MakersDecision Makers
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1.3 Three Common Pitfalls1.3 Three Common Pitfalls
1.4 1.4 Pitfall 1: Ignoring Pitfall 1: Ignoring Opportunity CostsOpportunity Costs
Example 1.4 : Frequent Flyer Coupon
Assumption:
Round trip airfare from Edmonton to Vancouver $500
Vacation at Whistler costs $1000
The maximum you would be willing to pay is $1350
You need to go to Ottawa after winter break, airfare from Edmonton to Ottawa is $400
A frequent flyer coupon can be applied to either airfare
Pitfall 1: Ignoring Opportunity Costs Ch1 - 18
Recognizing the Relevant Recognizing the Relevant Alternative I of IVAlternative I of IV
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Example 1.4 : Frequent Flyer Coupon
Calculation 1:(without the coupon)
Costs :$1500
Maximum willing to pay: $1350
Should you go?
Total costs are higher than maximum willing to pay
NOT to go
Pitfall 1: Ignoring Opportunity Costs Ch1 - 19
Recognizing the Relevant Recognizing the Relevant Alternative II of IVAlternative II of IV
© 2009 McGraw-Hill Ryerson Limited
Example 1.4 : Frequent Flyer Coupon
Calculation 2:(use the coupon)
Costs :1000 (flight is free)
Maximum willing to pay: $1350
Should you go?
Opportunity costOpportunity cost of going to Vancouver : airfare to Ottawa $400
Total costs: $1400
Total costs are still higher than maximum willing to pay
NOT to go
Pitfall 1: Ignoring Opportunity Costs Ch1 - 20
Recognizing the Relevant Recognizing the Relevant Alternative III of IVAlternative III of IV
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Example 1.5 : Frequent Flyer Coupon expires in a week
Calculation 3: (cannot use the Coupon to Ottawa)
Costs :$1000
Maximum willing to pay: $1350
Should you go?
Total costs are lower than maximum willing to pay
GO!
Pitfall 1: Ignoring Opportunity Costs Ch1 - 21
Recognizing the Relevant Recognizing the Relevant Alternative IV of IVAlternative IV of IV
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Example 1.6: Alternative Use of the Coupon
Calculation 4:
A trip a year from now costs $363, interest rate is 10% ?
How much you need to put in the bank now to have $363 in a year?
$363(1+10%) = $330, $330 is the opportunity cost of the trip
Total costs: $1000 + $330 = $1330
Total costs are lower than maximum willing to pay
GO!
Pitfall 1: Ignoring Opportunity Costs Ch1 - 22
The Time Value of Money I of IIThe Time Value of Money I of II
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Try exercise 1.2: if the interest rate is 2%, will you go
Time value of money:
a given dollar amount today is equivalent to a larger dollar amount in the future
money can be invested in an interest-bearing account in the meantime
Pitfall 1: Ignoring Opportunity Costs Ch1 - 23
The Time Value of Money II of IIThe Time Value of Money II of II
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1.5 1.5 Pitfall 2: Failure to Pitfall 2: Failure to Ignore Sunk CostsIgnore Sunk Costs
Sunk costs are those costs that will be incurred whether or not an action is taken
E.g., money that you cannot recover
Therefore irrelevant to decision on whether to take an action
should not be counted for decision-making purposes
Rational decision makers compare benefits to only the additional costs that must be incurred
Pitfall 2: Failure to Ignore Sunk Costs Ch1 -25
Sunk Costs and Decision-makingSunk Costs and Decision-making
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Example 1.7: a Hockey Game
Assumption:
You and Joe have the same taste
A nonrefundable ticket from ticketmaster costs $30
70km drive from Smiths Falls to Ottawa
Joe will buy ticket at the game, cost $25
Snowstorm starts at 4pm unexpectedly
Who is more attend the game
Pitfall 2: Failure to Ignore Sunk Costs Ch1 - 26
Sunk Costs I of IIISunk Costs I of III
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Example 1.7: a Hockey Game
Who is more likely to go to the game
Joe has a cost of $25 if he goes to the game.
$30 is a sunk costsunk cost, a money you cannot recover.
$30 cannotcannot add to the cost-benefit analysis.
Joe has an opportunity cost of $25 higher than you.
Joe is less less likely to go.
Pitfall 2: Failure to Ignore Sunk Costs Ch1 - 27
Sunk Costs II of IIISunk Costs II of III
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Example 1.8: Joe has a freefree ticket
Who is more likely to go to the game
Joe and you has the same relevant costs and benefits.
Joe and you will make similar decision.
A sense of regret can play a role
Pitfall 2: Failure to Ignore Sunk Costs Ch1 - 28
Sunk Costs III of IIISunk Costs III of III
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1.6 1.6 Pitfall 3: Failure to UnderstandPitfall 3: Failure to Understandthe Average–Marginal Distinctionthe Average–Marginal Distinction
Marginal cost
the increase in total cost that results from carrying out one additional unit of an activity
Marginal benefit
the increase in total benefit that results from carrying out one more unit of an activity
Average cost
total cost of undertaking n units of an activity divided by n
Average benefit
total benefit of undertaking n units of an activity divided by n
Failure to Understand the Average-Marginal Distinction Ch1 - 30
Pitfall 3: Failure to Understand The Pitfall 3: Failure to Understand The Average and Marginal DistinctionAverage and Marginal Distinction
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Pitfall 3: Failure to Understand the Average-Marginal Distinction Ch1 -31
Weighing Marginal Benefits AndWeighing Marginal Benefits AndMarginal Costs GraphicallyMarginal Costs Graphically
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FIGURE 1.1: The Marginal Cost and Benefit of Additional RAM
The gain from the NASA program are estimated at $24 billion per year (an average of $6 billion per launch)
The cost are estimated at $20 billion per year
Table 1.1 How Cost Varies with the Number of Launches
Example 1:10: Does the cost-benefit principle tell NASA to Example 1:10: Does the cost-benefit principle tell NASA to expand the space shuttle program from 4 launches per year to 5?expand the space shuttle program from 4 launches per year to 5?
Pitfall 3: Failure to Understand the Average-Marginal Distinction Ch1 -32
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Number of Launches per year
Total costs per year ($ billions)
Marginal cost per launch ($ billions)
1 6
2 8
3 12
4 20
5 30
2
4
8
10
The optimal number of launch should only be 3
1.7 Economics: 1.7 Economics: Micro and MacroMicro and Macro
Microeconomics studies subjects like
Choices of individuals
Choices of Firms
The determinants of prices and quantities in specific markets
Macroeconomics studies subjects like
The performance of national economies
Long run growth and prosperity
Short run booms and busts
Government policies to change performance
Economics: Micro and Macro Ch1 -34
Micro and MacroMicro and Macro
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1.8 1.8 The Approach of this The Approach of this TextText
Increase our understanding of economic processes
Scarcity
Efficiency
Obtaining the maximum possible output from a given amount of inputs
Equity
A state of impartiality and fairness
The Approach of This Text Ch1 - 36
The Approach of this TextThe Approach of this Text
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Economics is the study of how people make choices under conditions of scarcity scarcity and of the results of those choices for society.
Our focus in this chapter was on how rationalrational people make choices between alternative courses of action. Our basic tool for analyzing these decisions is cost–cost–benefit benefit analysis.
The rational actor pursues additional units as long as the marginal benefitmarginal benefit of the activity (the benefit from pursuing an additional unit of it) exceeds its marginal marginal costcost (the cost of pursuing an additional unit of it).
Chapter Summary Ch1 -37
Chapter SummaryChapter Summary
© 2009 McGraw-Hill Ryerson Limited
The opportunity costopportunity cost of an activity is the value of the next-best alternative that must be foregone to engage in that activity.
A sunk costsunk cost is a cost that is already irretrievably committed at the moment a decision must be made.
To apply the cost–benefit principle correctly, we must compare marginal cost with marginal benefitcompare marginal cost with marginal benefit.
Chapter Summary Ch1 -38
Chapter SummaryChapter Summary
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Equation: Equation: a mathematical expression that describes the relationship between two or more variables
Variable: Variable: a quantity that is free to take a range of different values
Dependent Variable: Dependent Variable: a variable in an equation whose value is determined by the value taken by another variable in the equation
Independent variable: Independent variable: a variable in an equation whose value determines the value taken by another variable in the equation
Constant (or parameter): a Constant (or parameter): a quantity that is fixed in value
Using a Verbal Description to Construct a Equation Ch1 -40
Using a Verbal Description to Using a Verbal Description to Construct a Equation I of IIConstruct a Equation I of II
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My telephone bill is $5.00 per month plus 10 cents for every minute that I talk
Telephone Bill = 5.00 + 0.10 * (Minutes Talked)
B = 5.00 + 0.10 T
If you make 32 minutes phone call, monthly bill will be:
B = 5.00 + 0.1 (32) = 8.20
Or one can draw a picture of the relationship
Using a Verbal Description to Construct a Equation Ch1 -41
Using A Verbal Description ToConstruct An Equation II of II
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Graphing the Equation of a Straight Line Ch1 -42
Graphing the Equation of a Straight Line I of II
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Dependent Variable
Independent Variable
6 = 5 + 0.1(10)
8 = 5 + 0.1(30)
12 = 5 + 0.1(70)
B = 5 + 0.1T
Graphing the Equation of a Straight Line Ch1 -43
Graphing the Equation of a Straight Line II of II
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The graph of the equation B =5 + 0.10T is the straight line shown. Its vertical intercept is 5, and its slope is 0.10.
The graph of the equation B =5 + 0.10T is the straight line shown. Its vertical intercept is 5, and its slope is 0.10.
Vertical Intercept (Constant) is 5Vertical Intercept (Constant) is 5
Slope = Rise/RunSlope = 2/20 = 0.1Slope = Rise/RunSlope = 2/20 = 0.1
Deriving the Equation of a Deriving the Equation of a Straight Line from its GraphStraight Line from its Graph
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Deriving the Equation of a Straight Line from its Graph
Vertical Intercept (Constant) is 4
Vertical Intercept (Constant) is 4
Slope = Rise/RunSlope = 4/20 = 0.2
Slope = Rise/RunSlope = 4/20 = 0.2
The Equation For the Billing Plan: B = 4 + 0.20T
The Equation For the Billing Plan: B = 4 + 0.20T
Shifting the Curve – Intercept Shifting the Curve – Intercept ChangesChanges
Suppose the fixed fee increases from $4 to $8 ?
But the per-minute charge remains the same
Old Telephone Bill was determined by the equation
B = 4 + 0.20 T
New Bill is determined by the equation
B = 8 + 0.20 T
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Changes in the Vertical Intercept and Slope
A
C
D
A′
C′
D′
Original monthly bill
New monthly bill
Shifting the Curve – Slope ChangesShifting the Curve – Slope Changes
The slope of a graph indicates how much of a “rise” one can expect, for a given “run”
Old Telephone Bill was determined by the equation
B = 4 + 0.20 T
New Telephone Bill is determined by the equation
B = 4 + 0.40 T
© 2009 McGraw-Hill Ryerson Limited Ch1-46Changes in the Vertical Intercept and Slope
A
CA′
C′
Original monthly bill
New monthly bill
Run = 20
Rise = 8
Constructing Equations and Graphs from Tables Ch1 -47
Constructing Equations and Constructing Equations and Graphs from TablesGraphs from Tables
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Point A
Point C
Vertical Intercept (Constant) is 10
Vertical Intercept (Constant) is 10
Slope = Rise/RunSlope = 1/20 = 0.05Slope = Rise/RunSlope = 1/20 = 0.05
The Equation For the Billing Plan: B = 10+ 0.05TThe Equation For the Billing Plan: B = 10+ 0.05T
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