Lec 1: ch1 & ch2 Thursday, January 30, 2014 10:15 AM
What is this course about? “Economics is the social science that studies the choices that individuals, business, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. “ (p 2) “How do choices end up determining what, how, and for whom goods and services are produced?” (p 3) --
maximize net benefit - the difference between total benefits and total costs -Principle #1: All decisions involve tradeoffs Principle #2: The Cost of Something Is What You Give Up to Get It Principle #3: Rational Decision-Making Means to Think at the Margin - we will get back to the idea over and over again.
Marginal changes are small incremental changes to a plan of action.
Individuals and firms can make better decisions by thinking at the margin. A rational decision maker continues to take an action if and only if the marginal benefit of the action is at least as large as the marginal cost.
MB: benefit gained for selling one more ton of steel MC: extra input used for producing one more ton of steel
rational decision choose at the intersection. • MC - rational maker will go forward because MB is a lot greater than MC • =100, MB = MC - just right • the last ounce of steel's mb equals to mc = marginal benefit at the least marginal • >100, MC > MB - rational maker will not act • item 101's marginal cost exceeds the benefit it will gain, thus we stay at 100
Principle #4: People Respond to Incentives -A sunk cost is a cost that has already been committed and cannot be recovered. • no crying over spilt milk Sunk Costs and an Investment Decision Original estimate • Revenues = $9,000 • Costs = $6,000 • Profit = $3,000 You start construction and have spent $1,500. You now realize that revenues will be just $4,000. Should you complete the project? • The $1,500 you have already spent is a sunk cost; you cannot recover that money. • At the margin, the cost of finishing the project is $6,000 - $1,500 = $4,500 • The marginal benefit is $4,000 • Since the MB is less than MC you should not complete the project
- questions below on sunk cost: don't let it influence your decision. A pizza parlor offers an all-you-can-eat lunch for $8. You pay at the door, and then the waiter brings you as many slices of pizza as you like. A researcher performed the following experiment. He had an assistant serve as the waiter for one group of tables. The “waiter” selected half the tables at random and gave everyone at those tables an $8 refund before taking orders. The remaining half the tables got no refund. He then kept careful count of the number of slices of pizza each diner ate. What difference do you predict in the amount eaten by the two groups?
which group ate more pizza? A.The group that received a refund ate more pizza B.The group that did not receive a refund ate more pizza C.The two groups ate roughly the same amount of pizza $8 is sunk cost!
-You would like to play tennis on Saturday morning. The weather might be bad, and so you make a reservation at an indoor court. You have paid $40 for two hours of court time; the $40 cannot be refunded. The weather on Saturday morning turns out to be beautiful and outdoor courts are available for free. You prefer playing outdoors to playing indoors. Where would you play? A.Indoors B.Outdoors marginal cost of play indoors & outdoors are both zero. marginal benefit of playing outdoors is higher. the $40 is sunk cost, money down the drain, cannot let it influence your decisions. --
You have tickets to a basketball game that will be played 60 miles away. Suddenly, it starts snowing very hard. The roads remain open, but the drive will be difficult. Would you be more likely to go to the game if you had paid $100 for the tickets or if someone had given you the tickets for free? Would you be equally likely to go if you had bought the tickets or if someone gave them to you? You Would be More Likely to Go to the Game if ………
A.you had paid $100 for the tickets B.someone had given the tickets to you C.equally likely
sunk cost should not influence your decisions.