Cyberlecture

This chapter introduces you to two of the most basic economic principles – the cost-benefit principle and the scarcity principle. You will learn why scarcity forces us to make choices, and how to evaluate those choices using costs and benefits.

What are the implications of scarcity?
Scarcity exists because we never have enough resources to satisfy all of our human needs and wants.

• trade-offs are required
• we must forgo satisfying some desires in order to satisfy others

• to use resources in a given way, the extra benefit received must at least equal the extra cost of choosing that outcome
  • the resources may be tangibles like wood or oil, or intangibles like time

The Scarcity Principle (or the No-Free-Lunch Principle):
Although we have boundless needs and wants, the resources available to use are limited. So having more of one thing means having less of another.

The Cost-Benefit Principle:
An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.

One of the world's scarcest resources is water. While we in Canada have more water than we can use, many countries are experiencing severe shortages. Worldwatch's website http://www.worldwatch.org/topics/water.html looks at the topic of scarcity in the context of a global supply of water and outlines some of the trade-offs which may become necessary as the world's population grows and its demand for water increases.

What is rationality?
We say that people are rational when they work to reach well-defined goals in the best way they can. Most often, people will use the cost-benefit principle to guide them in a quest for economic surplus.

• people calculate the extra benefit they will receive from taking a given action
• they also calculate the extra cost to them of taking the action
• economic surplus – the net benefit derived from taking that action

Practice Activity 1 Try answering some questions about opportunity cost.

Economists use economic models like the cost-benefit principle to predict what choices people will make. Even if people don't consciously add up the benefits and costs of an action, they almost always know intuitively which actions will earn them an economic surplus.
     It is worth noting that people sometimes make decisions that are not rational. However, people generally do make rational decisions.

Economic Naturalist Why does my building have handicap accessible restrooms on the second floor when there is no elevator to allow a person to get to the second floor at all?

What is the difference between positive and normative economics?
If you read the newspaper or watch newscasts on the television, you will know that there are two kinds of economic reporting – opinions about the economy and facts about the economy.
     Normative economics is the economics of value judgments. Because value judgments are subjective, everyone's opinion can, and often does, differ from everyone else's, and no one opinion can be proved correct or incorrect.
     Positive economics is the economics of what is or what will be, based on information that can be checked for accuracy. Economic models rely on positive economics when they make predictions.

Practice Activity 2 Try answering some questions about positive and normative economics.

If you are thinking about a career in economics, check out http://stats.bls.gov/oco/ocos055.htm. This site provides answers to many career-oriented questions like: What does an economist do? What are an economist's working conditions like? What qualifications do you need to work as an economist? This site is American, but most of the information holds for the Canadian economy too.

How can we portray the cost-benefit principle graphically?
When you decide upon a course of action, you calculate the marginal benefit, or extra benefit, you will receive as a result. The cost-benefit principle tells us that you will calculate the marginal cost, or extra cost, to you because of your choice.
     For example, if you choose to put more memory in your computer, the first chunk of extra memory really helps a lot – the marginal benefit is quite high. The second chunk of memory helps more, but not as much as the first chunk – the marginal benefit is not as high. Marginal benefit usually declines as more memory is put into your computer.
     However, each chunk of memory costs the same, so in this example, the marginal cost is constant.

The graph shows a marginal benefit curve (MB) and a marginal cost curve (MC) that reflect the above concepts. The cost-benefit principle says you should continue to put more memory into your computer as long as the marginal benefit exceeds the marginal cost. In this example you should put 128 megabytes of memory into your computer.

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What is the difference between microeconomics and macroeconomics?
     Microeconomics is the study of individual choices and individual markets. Microeconomics tries to predict price and quantity changes in markets for given commodities.
     Macroeconomics is the study of economy-wide forces, of inflation and unemployment, of interest rate and exchange rates. Macroeconomics tries to predict changes in all of these variables.

Understanding Questions Do I understand this chapter? As a check to your understanding of the material in this chapter, you should be able to answer our questions.