1 TEN PRINCIPLES OF f f
WHAT’S NEW IN THE NINETH EDITION:
f f f f f
There fare fno fmajor fchanges fto fthis fchapter.
LEARNING OBJECTIVES: f
By fthe fend fof fthis fchapter, fstudents fshould funderstand:
that feconomics fis fabout fthe fallocation fof fscarce fresources.
that findividuals fface ftrade-offs.
the fmeaning fof fopportunity fcost.
how fto fuse fmarginal freasoning fwhen fmaking fdecisions.
how fincentives faffect fpeople’s fbehavior.
why ftrade famong fpeople for fnations fcan fbe fgood ffor feveryone.
why fmarkets fare fa fgood, fbut fnot fperfect, fway fto fallocate fresources.
what fdetermines fsome ftrends fin fthe foverall feconomy.
CONTEXT AND PURPOSE: f f
Chapter f1 fis fthe ffirst fchapter fin fa fthree-chapter fsection fthat fserves fas fthe fintroduction fto fthe
e
ftx .jtfChapter f1 fintroduces ften ffundamental fprinciples fon fwhich fthe fstudy fof feconomics fis fbased.
fIn fajfbroad fsense, fthe frest fof fthe ftext fis fan felaboration fon fthese ften fprinciples. fChapter f2 fwill
fdevelopjfhow feconomists fapproach fproblems fwhile fChapter f3 fwill fexplain fhow findividuals fand
fcountries fgainjffrom ftrade.
The fpurpose fof fChapter f1 fis fto flay fout ften feconomic fprinciples fthat fwill fserve fas fbuilding
fb locksjffor fthe frest fof fthe ftext. fThe ften fprinciples fcan fbe fgrouped finto fthree fcategories: fhow fpeople
fm akejfdecisions, fhow fpeople finteract, fand fhow fthe feconomy fworks fas fa fwhole. fThroughout fthe
ftext,jfreferences fwill fbe fmade frepeatedly fto fthese ften fprinciples.
1
©jf2018jfCengagejfLearning®.jfAlljfRightsjfReserved.jfMayjfnotjfbejfscanned,jfcopiedjforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
,2j ❖jChapterjf1/TenjfPrinciplesjfofjfEconomics
KEY POINTS:f
The ffundamental flessons fabout findividual fdecision fmaking fare fthat fpeople fface ftrade-offs
famongjfalternative fgoals, fthat fthe fcost fof fany faction fis fmeasured fin fterms fof fforgone
fopportunities, fthatjfrational fpeople fmake fdecisions fby fcomparing fmarginal fcosts fand fmarginal
fbenefits, fand fthatjfpeople fchange ftheir fbehavior fin fresponse fto fthe fincentives fthey fface.
The ffundamental flessons fabout finteractions famong fpeople fare fthat ftrade fand
finterdependencejfcan fbe fmutually fbeneficial, fthat fmarkets fare fusually fa fgood fway fof
fcoordinating feconomicjfactivity famong fpeople, fand fthat fthe fgovernment fcan fpotentially
fimprove fmarket foutcomes fb yjfremedying fa fmarket ffailure for fby fpromoting fgreater feconomic
fequality.
The ffundamental flessons fabout fthe feconomy fas fa fwhole fare fthat fproductivity fis fthe
fu ltimatejfsource fof fimproving fliving fstandards, fthat fgrowth fin fthe fquantity fof fmoney fis fthe
fultimatejfsource fof finflation, fand fthat fsociety ffaces fa fshort-run ftrade-off fbetween finflation
fandjfunemployment.
CHAPTER OUTLINE: f
I. Introduction
Beginjfbyjfpointingjfoutjfthatjfeconomicsjfisjfajfsubjectjfthatjfstudentsjfmustjfconfrontjfinjfthei
rjfdailyjflives.jfPointjfoutjfthatjftheyjfalreadyjfspendjfajfgreatjfdealjfofjftheirjftimejfthinkingjfabo
utjfeconomicjfissues:jfchangesjfinjfprices,jfbuyingjfdecisions,jfusejfofjftheirjftime,jfconcernsjf
aboutjfemployment,jfetc.
A. The fword f“economy” fcomes ffrom fthe fGreek fword foikonomos fmeaning f“one fwho fmanages
fajfhousehold.”
B. Both fhouseholds fand feconomies fface fmany fdecisions fabout fhow fto fallocate fresources.
C. Resources fare fscarce fso fthey fmust fbe fmanaged fcarefully.
Youjfwilljfwantjftojfstartjfthejfsemesterjfbyjfexplainingjftojfstudentsjfthatjfpartjfofj flearningjfe
conomicsjfisjfunderstandingjfajfnewjfvocabulary.jfEconomistsjfgenerallyjfusejfveryjfprecisejf
(andjfsometimesjfdifferent)jfdefinitionsjfforjfwordsjfthatjfarejfcommonlyjfusedjfoutsidejfofjft
hejfeconomicsjfdiscipline.jfTherefore,jfitjfwilljfbejfhelpfuljftojfstudentsjfifjfyoujffollowjfthejfdef
initionsjfprovidedjfinjfthejftextjfasjfmuchjfasjfpossible.
D. Definition fof fj scarcity: fthe flimited fnature fof fsociety’s fresources.
E. Definition fof fjeconomics: fthe fstudy fof fhow fsociety fmanages fits fscarce fresources.
Becausejfmostjfcollegejffreshmenjfandjfsophomoresjfhavejflimitedjfexperiencesjfwithjfvie
wingjfthejfworldjffromjfajfcause-and-
effectjfperspective,jfdojfnotjfunderestimatejfhowjfchallengingjfthesejfprinciplesjfwilljfbejffo
rjfthejfstudent.
Asjfyoujfdiscussjfthejftenjfprinciples,jfmakejfsurejfthatjfstudentsjfrealizejfthatjfitjfisjfokayjfifjfth
eyjfdojfnotjfgraspjfeachjfofjfthejfconceptsjfcompletelyjforjffindjfeachjfofjfthejfargumentsjffullyj
fconvincing.
©jf2018jfCengagejfLearning®.jfAlljfjThese jfideasjjfMay
fRightsjfReserved. fwill jfbe
jfnot jfjexplored
jfbe jfmore
fscanned,jfcopied jfcompletely
jforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
, Chapterjf1/TenjfPrinciplesjfofjfEconomicsj ❖j3
II. How fPeople fMake fDecisions
A. Principle f#1: fPeople fFace fTrade-offs
1. “There fain’t fno fsuch fthing fas fa ffree flunch.” fTo fget fsomething fthat fwe flike, fwe
fusuallyjfhave fto fgive fup, for ftrade ffor, fsomething felse fthat fwe falso flike.
2. Examples finclude fhow fstudents fspend ftheir ftime, fhow fa ffamily fdecides fto fspend
fitsjfincome, fhow fthe fU.S. fgovernment fspends ftax fdollars, fand fhow fregulations fmay
fprotectjfthe fenvironment fat fa fcost fto ffirm fowners.
3. An fimportant ftrade-off fthat fsociety ffaces fis fthe ftrade-off fbetween fefficiency fand fequality.
a. Definition fof fjefficiency: fthe fproperty fof fsociety fgetting fthe fmost fit fcan
romjfits fscarce fresources.
ff
b. Definition fof fjequality: fthe fproperty fof fdistributing feconomic
fprosperityjfuniformly famong fthe fmembers fof fsociety.
c. For fexample, ftax fdollars fpaid fby fwealthy fAmericans fand fthen fdistributed fto
fthosejfless ffortunate fmay fimprove fequality fbut flower fthe freturn fto fhard fwork fand
fthereforejfreduce fthe flevel fof foutput fproduced fby four fresources.
d. This fimplies fthat fthe fcost fof fthis fincreased fequality fis fa freduction fin fthe fefficient
fusejfof four fresources.
4. Recognizing fthat ftrade-offs fexist fdoes fnot findicate fwhat fdecisions fshould for fwill
fb
ejfmade.
B. Principle f#2: fThe fCost fof fSomething fIs fWhat fYou fGive fUp fto fGet fIt
1. Making fdecisions frequires findividuals fto fconsider fthe fbenefits fand fcosts fof fsome faction.j
2. What fare fthe fcosts fof fgoing fto fcollege?
a. We fshould fnot fcount froom fand fboard f(unless fthey fare fmore fexpensive fat
fcollegejfthan felsewhere) fbecause fthe fstudent fwould fhave fto fpay ffor ffood fand
fshelter fevenjfifjfshe fwere fnot fin fschool.
b. We fshould fcount fthe fvalue fof fthe fstudent’s ftime fbecause fshe fcould fbe fworking
fforjfpay finstead fof fattending fclasses fand fstudying.
3. Definition fof fopportunity fcost: fwhatever fmust fbe fgiven fup fin forder fto
fobtainjfsome fitem.
Onej fofj fthej fhardestj fideasj fforj fstudentsj ftoj fgraspj fisj fthatj f“free”j fthingsj farej fnotjftrulyjff
ree.j fj fProvidejfstudentsjfwithjfmanyjfexamplesjfofjfsuchjf“free”jfthingsjfwithjfhiddenjfcosts,
jfespeciallyjfthejfvaluejfofjftime.jfSuggestedjfexamplesjfincludejfthejftimejfstudentsjfspendjf
waitingjfinjflinejfforjf“free”jfsportingjfeventjfticketsjfatjftheirjfuniversities,jftimejfspentjfrelaxi
ngjfinjfthejfsunjfoutsidejftheirjfresidencejfhalls,jforjfdrivingjfonjfajfroadjfwithjfnojftollsjfbutjflots
jfofjfcongestion.
©jf2018jfCengagejfLearning®.jfAlljfRightsjfReserved.jfMayjfnotjfbejfscanned,jfcopiedjforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
, 4j ❖jChapterjf1/TenjfPrinciplesjfofjfEconomics
C. Principle f#3: fRational fPeople fThink fat fthe fMargin
1. Economists fgenerally fassume fthat fpeople fare frational.
a. Definition fof fjrational fpeople: fpeople fwho fsystematically fand fpurposefully
jfthe fbest fthey fcan fto fachieve ftheir fobjectives.
fd
o
b. Consumers fwant fto fpurchase fthe fgoods fand fservices fthat fallow fthem fthe
fgreatestjflevel fof fsatisfaction fgiven ftheir fincomes fand fthe fprices fthey fface.
c. Firm fmanagers fwant fto fproduce fthe flevel fof foutput fthat fmaximizes fthe fprofits
hejffirms fearn.
ft
2. Many fdecisions fin flife finvolve fincremental fdecisions: fShouldjfIjfremain fin fschool
fthisjfsemester? fShouldjfIjftake fanother fcourse fthis fsemester? fShouldjfIjfstudy fanother
fhour fforjftomorrow’s fexam?j fj f
a. Definition fof fjmarginal fchange: fa fsmall fincremental fadjustment fto fa fplan
fofjfaction.
b. Example: fSuppose fthat fyou fare fconsidering fwatching fa fmovie ftonight.j fj fYou fpay
f$40jfa fmonth ffor fa fstreaming fservice fthat fgives fyou funlimited faccess fto fits ffilm
flibrary. fjfIf fyou ftypically fwatch f8 fmovies fa fmonth, fthe faverage fcost fof fa fmovie fis
f$5.j fj fThejfmarginal fcost, fhowever, fis fzero fbecause fyou fpay fthe fsame f$40
fregardless fhowjfmany fmovies fyou fstream.j fj fAt fthe fmargin, fstreaming fis
ffree.j fj fWhen fdecidingjfwhether fto fwatch fa fmovie, fa frational fperson fwould
fcompare fthe fmarginal fbenefit fofjfwatching fa fmovie fto fthe fmarginal fcost.j fj fIn fthis
fcase, fthe fonly fcost fis fthe fvalue fofjfyour ftime. f
c. Suppose fthat fflying fa f200-seat fplane facross fthe fcountry fcosts fthe fairline
fjjjj
$100,000,jfwhich fmeans fthat fthe faverage fcost fof feach fseat fis f$500. fSuppose fthat
f
fthe fplane fisjfminutes ffrom fdeparture fand fa fpassenger fis fwilling fto fpay f$300 ffor fa
fseat. fShouldjfthe fairline fsell fthe fseat ffor f$300? fIn fthis fcase, fthe fmarginal fcost
fof fan fadditionaljfpassenger fis fvery fsmall.
d. Another fexample: fWhy fis fwater fso fcheap fwhile fdiamonds fare fexpensive?
fThejfmarginal fbenefit fof fa fgood fdepends fon fhow fmany funits fa fperson
falready fhasj.fBecause fwater fis fplentiful, fthe fmarginal fbenefit fof fan fadditional
fcup fis fsmall.jfBecause fdiamonds fare frare, fthe fmarginal fbenefit fof fan fextra
fdiamond fis fhigh.
3. A frational fdecision fmaker ftakes fan faction fif fand fonly fif fthe fmarginal fbenefit fis fat
fle
asjtfas flarge fas fthe fmarginal fcost.
D. Principle f#4: fPeople fRespond fto fIncentives
1. Definition fof fj incentive: fsomething fthat finduces fa fperson fto fact.
2. Because frational fpeople fmake fdecisions fby fweighing fcosts fand fbenefits, ftheir
fdecisionsjfmay fchange fin fresponse fto fincentives.
a. When fthe fprice fof fa fgood frises, fconsumers fwill fbuy fless fof fit fbecause fits fcost
fhasjfrisen.
©jf2018jfCengagejfLearning®.jfAlljfRightsjfReserved.jfMayjfnotjfbejfscanned,jfcopiedjforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
WHAT’S NEW IN THE NINETH EDITION:
f f f f f
There fare fno fmajor fchanges fto fthis fchapter.
LEARNING OBJECTIVES: f
By fthe fend fof fthis fchapter, fstudents fshould funderstand:
that feconomics fis fabout fthe fallocation fof fscarce fresources.
that findividuals fface ftrade-offs.
the fmeaning fof fopportunity fcost.
how fto fuse fmarginal freasoning fwhen fmaking fdecisions.
how fincentives faffect fpeople’s fbehavior.
why ftrade famong fpeople for fnations fcan fbe fgood ffor feveryone.
why fmarkets fare fa fgood, fbut fnot fperfect, fway fto fallocate fresources.
what fdetermines fsome ftrends fin fthe foverall feconomy.
CONTEXT AND PURPOSE: f f
Chapter f1 fis fthe ffirst fchapter fin fa fthree-chapter fsection fthat fserves fas fthe fintroduction fto fthe
e
ftx .jtfChapter f1 fintroduces ften ffundamental fprinciples fon fwhich fthe fstudy fof feconomics fis fbased.
fIn fajfbroad fsense, fthe frest fof fthe ftext fis fan felaboration fon fthese ften fprinciples. fChapter f2 fwill
fdevelopjfhow feconomists fapproach fproblems fwhile fChapter f3 fwill fexplain fhow findividuals fand
fcountries fgainjffrom ftrade.
The fpurpose fof fChapter f1 fis fto flay fout ften feconomic fprinciples fthat fwill fserve fas fbuilding
fb locksjffor fthe frest fof fthe ftext. fThe ften fprinciples fcan fbe fgrouped finto fthree fcategories: fhow fpeople
fm akejfdecisions, fhow fpeople finteract, fand fhow fthe feconomy fworks fas fa fwhole. fThroughout fthe
ftext,jfreferences fwill fbe fmade frepeatedly fto fthese ften fprinciples.
1
©jf2018jfCengagejfLearning®.jfAlljfRightsjfReserved.jfMayjfnotjfbejfscanned,jfcopiedjforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
,2j ❖jChapterjf1/TenjfPrinciplesjfofjfEconomics
KEY POINTS:f
The ffundamental flessons fabout findividual fdecision fmaking fare fthat fpeople fface ftrade-offs
famongjfalternative fgoals, fthat fthe fcost fof fany faction fis fmeasured fin fterms fof fforgone
fopportunities, fthatjfrational fpeople fmake fdecisions fby fcomparing fmarginal fcosts fand fmarginal
fbenefits, fand fthatjfpeople fchange ftheir fbehavior fin fresponse fto fthe fincentives fthey fface.
The ffundamental flessons fabout finteractions famong fpeople fare fthat ftrade fand
finterdependencejfcan fbe fmutually fbeneficial, fthat fmarkets fare fusually fa fgood fway fof
fcoordinating feconomicjfactivity famong fpeople, fand fthat fthe fgovernment fcan fpotentially
fimprove fmarket foutcomes fb yjfremedying fa fmarket ffailure for fby fpromoting fgreater feconomic
fequality.
The ffundamental flessons fabout fthe feconomy fas fa fwhole fare fthat fproductivity fis fthe
fu ltimatejfsource fof fimproving fliving fstandards, fthat fgrowth fin fthe fquantity fof fmoney fis fthe
fultimatejfsource fof finflation, fand fthat fsociety ffaces fa fshort-run ftrade-off fbetween finflation
fandjfunemployment.
CHAPTER OUTLINE: f
I. Introduction
Beginjfbyjfpointingjfoutjfthatjfeconomicsjfisjfajfsubjectjfthatjfstudentsjfmustjfconfrontjfinjfthei
rjfdailyjflives.jfPointjfoutjfthatjftheyjfalreadyjfspendjfajfgreatjfdealjfofjftheirjftimejfthinkingjfabo
utjfeconomicjfissues:jfchangesjfinjfprices,jfbuyingjfdecisions,jfusejfofjftheirjftime,jfconcernsjf
aboutjfemployment,jfetc.
A. The fword f“economy” fcomes ffrom fthe fGreek fword foikonomos fmeaning f“one fwho fmanages
fajfhousehold.”
B. Both fhouseholds fand feconomies fface fmany fdecisions fabout fhow fto fallocate fresources.
C. Resources fare fscarce fso fthey fmust fbe fmanaged fcarefully.
Youjfwilljfwantjftojfstartjfthejfsemesterjfbyjfexplainingjftojfstudentsjfthatjfpartjfofj flearningjfe
conomicsjfisjfunderstandingjfajfnewjfvocabulary.jfEconomistsjfgenerallyjfusejfveryjfprecisejf
(andjfsometimesjfdifferent)jfdefinitionsjfforjfwordsjfthatjfarejfcommonlyjfusedjfoutsidejfofjft
hejfeconomicsjfdiscipline.jfTherefore,jfitjfwilljfbejfhelpfuljftojfstudentsjfifjfyoujffollowjfthejfdef
initionsjfprovidedjfinjfthejftextjfasjfmuchjfasjfpossible.
D. Definition fof fj scarcity: fthe flimited fnature fof fsociety’s fresources.
E. Definition fof fjeconomics: fthe fstudy fof fhow fsociety fmanages fits fscarce fresources.
Becausejfmostjfcollegejffreshmenjfandjfsophomoresjfhavejflimitedjfexperiencesjfwithjfvie
wingjfthejfworldjffromjfajfcause-and-
effectjfperspective,jfdojfnotjfunderestimatejfhowjfchallengingjfthesejfprinciplesjfwilljfbejffo
rjfthejfstudent.
Asjfyoujfdiscussjfthejftenjfprinciples,jfmakejfsurejfthatjfstudentsjfrealizejfthatjfitjfisjfokayjfifjfth
eyjfdojfnotjfgraspjfeachjfofjfthejfconceptsjfcompletelyjforjffindjfeachjfofjfthejfargumentsjffullyj
fconvincing.
©jf2018jfCengagejfLearning®.jfAlljfjThese jfideasjjfMay
fRightsjfReserved. fwill jfbe
jfnot jfjexplored
jfbe jfmore
fscanned,jfcopied jfcompletely
jforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
, Chapterjf1/TenjfPrinciplesjfofjfEconomicsj ❖j3
II. How fPeople fMake fDecisions
A. Principle f#1: fPeople fFace fTrade-offs
1. “There fain’t fno fsuch fthing fas fa ffree flunch.” fTo fget fsomething fthat fwe flike, fwe
fusuallyjfhave fto fgive fup, for ftrade ffor, fsomething felse fthat fwe falso flike.
2. Examples finclude fhow fstudents fspend ftheir ftime, fhow fa ffamily fdecides fto fspend
fitsjfincome, fhow fthe fU.S. fgovernment fspends ftax fdollars, fand fhow fregulations fmay
fprotectjfthe fenvironment fat fa fcost fto ffirm fowners.
3. An fimportant ftrade-off fthat fsociety ffaces fis fthe ftrade-off fbetween fefficiency fand fequality.
a. Definition fof fjefficiency: fthe fproperty fof fsociety fgetting fthe fmost fit fcan
romjfits fscarce fresources.
ff
b. Definition fof fjequality: fthe fproperty fof fdistributing feconomic
fprosperityjfuniformly famong fthe fmembers fof fsociety.
c. For fexample, ftax fdollars fpaid fby fwealthy fAmericans fand fthen fdistributed fto
fthosejfless ffortunate fmay fimprove fequality fbut flower fthe freturn fto fhard fwork fand
fthereforejfreduce fthe flevel fof foutput fproduced fby four fresources.
d. This fimplies fthat fthe fcost fof fthis fincreased fequality fis fa freduction fin fthe fefficient
fusejfof four fresources.
4. Recognizing fthat ftrade-offs fexist fdoes fnot findicate fwhat fdecisions fshould for fwill
fb
ejfmade.
B. Principle f#2: fThe fCost fof fSomething fIs fWhat fYou fGive fUp fto fGet fIt
1. Making fdecisions frequires findividuals fto fconsider fthe fbenefits fand fcosts fof fsome faction.j
2. What fare fthe fcosts fof fgoing fto fcollege?
a. We fshould fnot fcount froom fand fboard f(unless fthey fare fmore fexpensive fat
fcollegejfthan felsewhere) fbecause fthe fstudent fwould fhave fto fpay ffor ffood fand
fshelter fevenjfifjfshe fwere fnot fin fschool.
b. We fshould fcount fthe fvalue fof fthe fstudent’s ftime fbecause fshe fcould fbe fworking
fforjfpay finstead fof fattending fclasses fand fstudying.
3. Definition fof fopportunity fcost: fwhatever fmust fbe fgiven fup fin forder fto
fobtainjfsome fitem.
Onej fofj fthej fhardestj fideasj fforj fstudentsj ftoj fgraspj fisj fthatj f“free”j fthingsj farej fnotjftrulyjff
ree.j fj fProvidejfstudentsjfwithjfmanyjfexamplesjfofjfsuchjf“free”jfthingsjfwithjfhiddenjfcosts,
jfespeciallyjfthejfvaluejfofjftime.jfSuggestedjfexamplesjfincludejfthejftimejfstudentsjfspendjf
waitingjfinjflinejfforjf“free”jfsportingjfeventjfticketsjfatjftheirjfuniversities,jftimejfspentjfrelaxi
ngjfinjfthejfsunjfoutsidejftheirjfresidencejfhalls,jforjfdrivingjfonjfajfroadjfwithjfnojftollsjfbutjflots
jfofjfcongestion.
©jf2018jfCengagejfLearning®.jfAlljfRightsjfReserved.jfMayjfnotjfbejfscanned,jfcopiedjforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
, 4j ❖jChapterjf1/TenjfPrinciplesjfofjfEconomics
C. Principle f#3: fRational fPeople fThink fat fthe fMargin
1. Economists fgenerally fassume fthat fpeople fare frational.
a. Definition fof fjrational fpeople: fpeople fwho fsystematically fand fpurposefully
jfthe fbest fthey fcan fto fachieve ftheir fobjectives.
fd
o
b. Consumers fwant fto fpurchase fthe fgoods fand fservices fthat fallow fthem fthe
fgreatestjflevel fof fsatisfaction fgiven ftheir fincomes fand fthe fprices fthey fface.
c. Firm fmanagers fwant fto fproduce fthe flevel fof foutput fthat fmaximizes fthe fprofits
hejffirms fearn.
ft
2. Many fdecisions fin flife finvolve fincremental fdecisions: fShouldjfIjfremain fin fschool
fthisjfsemester? fShouldjfIjftake fanother fcourse fthis fsemester? fShouldjfIjfstudy fanother
fhour fforjftomorrow’s fexam?j fj f
a. Definition fof fjmarginal fchange: fa fsmall fincremental fadjustment fto fa fplan
fofjfaction.
b. Example: fSuppose fthat fyou fare fconsidering fwatching fa fmovie ftonight.j fj fYou fpay
f$40jfa fmonth ffor fa fstreaming fservice fthat fgives fyou funlimited faccess fto fits ffilm
flibrary. fjfIf fyou ftypically fwatch f8 fmovies fa fmonth, fthe faverage fcost fof fa fmovie fis
f$5.j fj fThejfmarginal fcost, fhowever, fis fzero fbecause fyou fpay fthe fsame f$40
fregardless fhowjfmany fmovies fyou fstream.j fj fAt fthe fmargin, fstreaming fis
ffree.j fj fWhen fdecidingjfwhether fto fwatch fa fmovie, fa frational fperson fwould
fcompare fthe fmarginal fbenefit fofjfwatching fa fmovie fto fthe fmarginal fcost.j fj fIn fthis
fcase, fthe fonly fcost fis fthe fvalue fofjfyour ftime. f
c. Suppose fthat fflying fa f200-seat fplane facross fthe fcountry fcosts fthe fairline
fjjjj
$100,000,jfwhich fmeans fthat fthe faverage fcost fof feach fseat fis f$500. fSuppose fthat
f
fthe fplane fisjfminutes ffrom fdeparture fand fa fpassenger fis fwilling fto fpay f$300 ffor fa
fseat. fShouldjfthe fairline fsell fthe fseat ffor f$300? fIn fthis fcase, fthe fmarginal fcost
fof fan fadditionaljfpassenger fis fvery fsmall.
d. Another fexample: fWhy fis fwater fso fcheap fwhile fdiamonds fare fexpensive?
fThejfmarginal fbenefit fof fa fgood fdepends fon fhow fmany funits fa fperson
falready fhasj.fBecause fwater fis fplentiful, fthe fmarginal fbenefit fof fan fadditional
fcup fis fsmall.jfBecause fdiamonds fare frare, fthe fmarginal fbenefit fof fan fextra
fdiamond fis fhigh.
3. A frational fdecision fmaker ftakes fan faction fif fand fonly fif fthe fmarginal fbenefit fis fat
fle
asjtfas flarge fas fthe fmarginal fcost.
D. Principle f#4: fPeople fRespond fto fIncentives
1. Definition fof fj incentive: fsomething fthat finduces fa fperson fto fact.
2. Because frational fpeople fmake fdecisions fby fweighing fcosts fand fbenefits, ftheir
fdecisionsjfmay fchange fin fresponse fto fincentives.
a. When fthe fprice fof fa fgood frises, fconsumers fwill fbuy fless fof fit fbecause fits fcost
fhasjfrisen.
©jf2018jfCengagejfLearning®.jfAlljfRightsjfReserved.jfMayjfnotjfbejfscanned,jfcopiedjforjfduplicated,jforjfpostedjftojfajfpubliclyjfaccessiblejfwebsite,jfinjfwholejforjfinj fpart,jf
exceptjfforjfusejfasjfpermittedjfinjfajflicensejfdistributed jfwithjfajfcertainjfproductjforjfservicejforjfotherwisejfonjfajfpassword-protected jfwebsitejforjfschool-
j approvedjflearningjfmanagementjfsystemjfforjfclassroomjfuse.
