Lecture 1: Scarcity and Choice

definition of economics
scarcity
opportunity costs
marginal costs and marginal benefits

Definition of Economics
Economists study the economy. In the economy, goods and services are produced,
exchanged, and consumed. So, economics is the study of the production, exchange,
and consumption of goods and services.

The subject matter of economics can be approached from two levels of analysis:
macroeconomics and microeconomics. Microeconomics looks at the production,
exchange, and consumption of goods and services at the level of an individual
producer of the good or the market in which a single good or service is exchanged or
an individual consumer of the product. The key word is individual; microeconomics
deals with the behavior of the individual entities that make up the economy.

Macroeconomics deals with the entire national economy. Rather than being concerned
with the production of a single good or service, say, vacuum cleaners,
macroeconomics looks at the total production of all goods and services including
vacuum cleaners, coffee makers, and frozen pizza. Rather than worrying about why
the price of gasoline has risen or fallen over the last several weeks macroeconomics is
concerned with the inflation rate, a measure of how the average price of all goods and
services has changed.

Scarcity
Economics is

the study of the allocation of scarce resources among competing and

insatiable needs so as to maximize welfare.

Economists assume that people do not act randomly. Instead, people's behavior has a
purpose. We assume that people act in their own rational self-interest. People make
the choices they believe leave them best off.

Economics resources are used to produce goods and services. There are three
categories of economic resources:

1. land - raw materials and natural resources

2. labor - workers
3. capital - buildings, machinery, factories, equipment

Each of the resources exists in a finite, limited quantity.

We assume that people have unlimited wants. There is always something that people
want more of. Since we have a limited amount of resources, we can produce a limited
amount of goods and services. No matter how large that amount is, we cannot
produce enough to satisfy everyone's unlimited wants. This is known as scarcity and
much of economics looks at how people cope with scarcity.

Opportunity Costs
Because resources are scarce, people must make choices. A choice is a comparison of
alternatives. For example, suppose I had a choice of having Kix, Cheerios, or Lucky
Charms for breakfast, and I decided to eat the Lucky Charms. When I chose to eat the
Lucky Charms I was simultaneously choosing not to eat Cheerios and not to eat Kix. I
gave up the chance to eat the Cheerios or the Kix. What I gave up has a value. This
value is called the opportunity cost.

Every choice has an opportunity cost. Opportunity cost is the value of the next best
alternative. Since I chose the Lucky Charms, my opportunity cost is the Cheerios or
the Kix, whichever I most prefer.

For an accountant, the cost of an activity is the out-of-pocket expenses, all of the
money paid to undertake the activity. For an economist, the cost of an activity is
everything given up for it, including opportunity costs. For example, what are the total
costs of a college education?

tuition $44,000
books 3,200
beer costs 4,800
transportation 4,800
opportunity costs 56,000
total costs $112,800

Instead of attending college you could be doing something else such as working or
backpacking across Europe. That something has a value to you; the value of whatever
you would have done if you had not attended college is the opportunity cost of going
to college.

Let's say you would have found a job making sandwiches at Sheetz and would have
made $14,000 a year. Then, your opportunity cost of attending college would be the
wages you could have earned instead.

Marginal Costs and Marginal Benefits

Most decisions are not of the all or nothing variety. Most decisions involve choosing a
little more or a little less of something. Rational decision making involves comparing
the costs and benefits of that incremental change. Loosely put, the additional costs of
undertaking some activity are called the marginal costs. The additional benefits of
engaging in that activity are called the marginal benefits. If the marginal benefits
are greater than the marginal costs, do it; otherwise, do not.

Should you have come to class today? Let's compare the marginal costs and benefits.

marginal costs
gas, other car expenses $2.00
paper & ink used 0.25
opportunity costs (sleeping) 1.00
breakfast 2.00
total marginal costs $5.25

marginal benefits
knowledge $0.50
higher lifetime income due to better economics grade
earned because you learned about opportunity costs 0.25
in class today
were able to socialize with other students 2.00
total marginal benefits $2.75

So, since the marginal costs of attending class today are greater than the marginal
benefits, rational behavior dictates that you should not have come to class today.

But, many of you did attend class today. There are two possible explanations. One,
you've all behaved irrationally. You came to class knowing that the marginal benefits
were smaller than the marginal costs. However, it is not a good idea to assume that so
many people have behaved irrationally. So, second, we have incorrectly measured the
costs and benefits.

marginal costs
gas, other car expenses $2.00
paper & ink used 0.25
opportunity costs (sleeping) 1.00
breakfast 2.00
total marginal costs $5.25

marginal benefits
knowledge $0.50
higher lifetime income due to better economics grade 0.25
earned because you learned about opportunity costs
in class today
were able to socialize with other students 2.00
spent 50 minutes with me 2.51
total marginal benefits $5.26