Economics: The Study of Choice

“When you make a choice, you change the future.”-Deepak Chopra

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Before we begin, let’s cover some basics!

Each of us has to make choices.

For example, do we buy CD’s or Itunes?

Do we go out or study?Do we order a steak or just a salad?

Nations have to make choices too.

Should we build schools or railroads?

Should we increase defense or provide more unemployment

insurance?

And how should we pay for all this? Do we raise taxes? And if

so…on whom?

Sure, we’d like to have steak AND salad, but we cannot… we face scarcity.

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What do we mean by scarcity?

Simply put, scarcity means there simply isn’t enough stuff to satisfy all our wants.

Because of scarcity, we have to make choices.

Economics is the study of those choices!

Technically, Economics is “the social science concerned with how individuals, institutions, and

society make choices under conditions of scarcity”.Slide 3 of 21

This idea of scarcity is a Key Learning Outcome. I wish there was plenty to go around…but there isn’t!

Life would be great if we did not face scarcity…but we do!

In a perfect world, we would not have to address these issues. There would be plenty of goods and services

to satisfy everyone’s wants all the time.

I think we can agree that generally speaking…more is better.

Simply put, a big house is better than a small house, all else equal.

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Let’s review the technical definition of economics

Economics is the study of how Individuals, institutions, and society make best choices

under conditions of scarcity.

Hint: When you see red boxes like these throughout this semester, it usually means that this material will be on the test!

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Economics is analyzed at two levels

Economics

Microeconomics

• Studies how individuals, households, and firms make decisions to allocate limited resources

• Examines how these decisions effect the supply and demand for goods and services

Microeconomics examines how individuals, households, and

businesses make these decisions.

Think of it as a “bottom-up” view of the economy.

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Economics is analyzed at two levels

Economics

Macroeconomics

• Examines the behavior of the overall economy of a nation(s)

• Examines government policy, economic growth, price stability, employment, and international trade

Macroeconomics examines the overall economy or

broad subdivisions such as a nation, a government, or

all households.

Think of it as a “top-down” view of the economy.

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Economics Positive Economics

Positive Economics involves the study of cause and effect

relationships. It is the study of “What is”.

For example, we might try to determine if there is a link between taxes and

unemployment.

NormativeEconomics

Normative Economics includes value judgments

about the economy. It is the study of “What should be”.

For example, we might study whether we should

lower taxes to reduce unemployment.

The study of Economics can take two forms

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Economics also assumes that people act in their own self interest

Marginal means “extra”, or “additional”.

Think of it like this: “Is the extra cost worth it?”

Does this mean that people never make mistakes?

Of course not…people have imperfect information and

routinely make errors.

For example, Mapquest once told me that it would take 3

hours to drive to from Virginia Beach to Washington D.C. I

think we all know that is wrong!

But we assume that people weigh

benefits of each decision with costs

and try to make themselves happy.

In economics, we call that “Marginal Benefit - Marginal Cost Analysis”.

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Real world application:Do you strategically choose a line?

When you choose a line, you are weighing marginal cost and marginal benefits.

You analyze the cart sizes, line lengths, cashier skill, and many other factors to determine which is MOST in your interest!

And what about the “ten items and fewer line”….do you ever go there with eleven items?

Be honest.I suspect you do. The marginal cost of going there (perhaps getting yelled at?) is nearly zero but the marginal benefit (that

you will check out faster) has real value!

As economic geeks like me would say, the marginal benefit of breaking that rule exceeds the marginal cost…so you do it!

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This brings us to a problem…

Unfortunately, we (as individuals or as a society) want to satisfy an unlimited set of wants with a scarce

set of resources

This dilemma is referred to as the “Economizing problem”.

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The economizing problem

It is easy to explore the economizing problem from the individual perspective.

To do so, let’s build a simple model to explore the idea of scarcity and choice…

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Let’s start by looking at the Economizing Problem from an individual perspective

Assume we live world with only two goods: concert tickets and mealsAssume that an individual’s income is $34,000

Assume concert tickets are $100Assume meals are $50

If all money was spent on Concert tickets, 340 could

be purchased

If all money was spent on meals,

680 could be purchased

Or this individual can chose any combination of

goods, provided they are within

their budget

And any point in this area is attainable

Therefore, any point in this

area is unattainable

This line is referred to as the “Budget Line” or “Budget

Constraint”

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Individuals must satisfy unlimited wants with limited income

As income increases, the

budget line moves right or “out”

As income falls, the budget line

moves left or “in”

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Individuals must satisfy unlimited wants with limited income

Assume we live in a two good worldAssume that an individual’s income is $34,000Assume concert tickets are $100Assume meals are $50

Imagine that a person decides to

operate at this point (340 meals,

and 190 concerts).

An addition of more concert tickets would require fewer meals

An addition of meals would require fewer

concert tickets

These “tradeoffs” are referred to as opportunity costs in economics. To obtain more meals, this individual

would have to give up some concert tickets. To obtain more concert tickets,

this individual would have to give up some meals.

In this case, the opportunity cost of going to a concert is two meals.

The opportunity cost of eating a meal is a half a concert.

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Opportunity Cost

Opportunity cost is the most desired goods or services that are forgone in order to obtain something else

In this example, the opportunity cost of going to a concert might be two meals

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This idea of opportunity costs is a Key Learning Outcome. We use it every day

to measure “pros and cons”.

Kids sometimes do not understand the concept of opportunity cost

Opportunity cost -the most desired goods or services that are forgone in order to obtain

something else.

Many young kids have little understanding of opportunity cost.

If you do not believe me, give them a $5 allowance and see what they do.

In my experience, I see that they run right out and spend it. Then, they never save enough to get that “big toy”. They do not understand that

spending their allowance every week leads to an opportunity cost!

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Real world application:Is the tassel worth the hassle?

Try this exercise: Calculate your opportunity cost of going

to college for four years?

Include missed wages, costs of tuition, cost of books, and other costs

Does this look right?

If so, is it worth it?Slide 18 of 21

But let’s see if the marginal benefit exceeds the marginal cost.

Clearly, you must think so because you are doing it!

High School Graduates earn $35,000 and College Graduates earn $60,000

A $25,000 per year difference

in a 30 year career totals

$750,000

Clearly, you believe the

opportunity cost of NOT going to

college is too high!

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In some cases (very few) the opportunity

cost of going to college IS too high

Each of these people either did not go to college or dropped out (though some returned to get degrees).

For them…the opportunity cost of going to college was too high!

Kevin Garnett

Bill Gates

Oprah Winfrey

Tom Hanks

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In summary

Individuals and countries face scarcity and must make decisions on how to allocate their scarce resources.

These decisions require sacrifices of other things, referred to as opportunity costs.

Economics is the study of these decisions!

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