The next thing I wanted to touch on is the
economic way of thinking.
I want to lay out a few assumptions that we
make in introductory economics.
These assumptions apply to all the models
that we will see in the rest of this course.
For every choice that we make, we face a tradeoff.
Scarcity is the reason that we have to make
choices in the first place.
If scarcity was not an issue, we would be
able to do everything that we wanted.
In economics, we assume that people make rational
choices.
This means that before making any decision,
a person will compare the costs and benefits
associated and pick the option that brings
the greatest net benefit to them.
I know in the real world, this is not always
the case.
But for simplicity’s sake, we will assume
that this is.
I talked about comparing costs and benefits,
but it’s very important to understand exactly
what costs and benefits are.
Costs are quite intuitive, they signify something
that we need to give up in order to get something.
Benefits on the other hand, represents the
gain or pleasure that something brings from
consuming it.
The benefit derived from consuming a good
varies from person to person, it depends on
individual preferences.
So the benefit attained by one individual
from consuming a good could be different from
another person.
Economists measure benefit by the maximum
value, whether it be in terms of money or
other goods, that a person is willing to give
up to gain something else.
In the last slide I mentioned this idea of
every choice being a tradeoff; I’ll formally
introduce the concept.
This reality that all choices pose a tradeoff
is known as opportunity cost.
By definition, the opportunity cost of consuming
something is the highest alternative that
must be foregone to attain it.
Let’s say that I have $10 and I can spend
it on either food or a movie.
If I go to see the movie, the opportunity
cost is the food that I could’ve eaten.
Opportunity cost arises because of the problem
of scarcity.
If scarcity weren’t an issue, then neither
the movie nor the food would have had an opportunity
cost.
Economists also assume that people chose at
the margin.
This means that people compare the benefit
of consuming a little more of a good with
the cost of consuming a little more of that
good.
The marginal benefit is known as the benefit
derived from an increase in the consumption
of one more unit of a good, and the marginal
cost is known as the opportunity cost of consuming
one additional unit of a good.
Economists take human nature as given.
We view people as acting in their own self-interest
in order to gain the most benefit for themselves.
As I mentioned before, how much benefit someone
gains depends on their own preferences.
But, in general people will try to maximize
their benefit regardless of their preferences.
The whole point of economics, or at least
microeconomics, is to try to predict the self-interested
choices that people make by looking at the
incentives they face.
We can do this because we assume that people
undertake activities in which the marginal
benefit exceeds the marginal cost.
This means that the additional benefit derived
from consuming an additional unit of a good
is more than the opportunity cost of consuming
an additional unit of the same good.
