ofb micro3e chp1final

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


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.


The Cost-Benefit Principle I of IIIThe Cost-Benefit Principle I of III


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?


The Cost-Benefit Principle II of IIIThe Cost-Benefit Principle II of III


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.


The Cost-Benefit Principle III of The Cost-Benefit Principle III of IIIIII


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


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


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


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.


The Role of Economic Models I of IIThe Role of Economic Models I of II


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.


The Role of Economic Models II of IIThe Role of Economic Models II of II


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.


Two Logical ErrorsTwo Logical Errors


Rational people apply the cost–benefit principle most of the time.

Rational behaviour can help economists predict likely behaviour.


Rationality And Imperfect Rationality And Imperfect Decision MakersDecision Makers


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



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


Recognizing the Relevant Recognizing the Relevant Alternative II of IVAlternative II of IV



Calculation 2:(use the coupon)

Costs :1000 (flight is free)


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


Recognizing the Relevant Recognizing the Relevant Alternative III of IVAlternative III of IV


Example 1.5 : Frequent Flyer Coupon expires in a week

Calculation 3: (cannot use the Coupon to Ottawa)

Costs :$1000


Should you go?

Total costs are lower than maximum willing to pay

GO!


Recognizing the Relevant Recognizing the Relevant Alternative IV of IVAlternative IV of IV


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!


The Time Value of Money I of IIThe Time Value of Money I of II


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


The Time Value of Money II of IIThe Time Value of Money II of II


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


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


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.


Sunk Costs II of IIISunk Costs II of III


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


Sunk Costs III of IIISunk Costs III of III


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


Pitfall 3: Failure to Understand the Average-Marginal Distinction Ch1 -31

Weighing Marginal Benefits AndWeighing Marginal Benefits AndMarginal Costs GraphicallyMarginal Costs Graphically


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


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


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


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


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


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


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


Graphing the Equation of a Straight Line Ch1 -42

Graphing the Equation of a Straight Line I of II


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


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

© 2009 McGraw-Hill Ryerson Limited Ch1 - 44

Deriving the Equation of a Straight Line from its Graph

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

© 2009 McGraw-Hill Ryerson Limited Ch1 - 45

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


Point A

Point C



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

ofb micro3e chp1final

Technology