What is Economics?
Key Concepts and Terms

• It is the study of how people make choices in the marketplace
– Consumers (you and me)
• How to allocate your time
– Studying versus work versus socializing versus sleep
• How to allocate your income
– Saving (future consumption) versus current consumption
– Allocating income/budget among various goods
» Food, housing, transportation, “fun”

• It is the study of how people make choices in the marketplace
– Firms (and their managers)
• Which goods to produce
– How to allocate your investment (capital)
– How to allocate your labor among various products and/or lines-of-business (wireline vs wireless)
• Which technology to use
– Emphasize capital or labor
– Which inputs, quality of inputs
» Coal vs natural gas – electricity production

• The reason people/firms need to make choices is because of scarcity
– “ You can’t have it all”
• Limits on resources, time, money/income “dictate” that individuals have to choose how to allocate their “scarce” resources to their maximum value/use
– “Opportunity costs ” : since resources are scarce and you will have to make choice
• Opportunity costs: what did you have to give up in order to use the resource for this particular use
• “opportunity costs” are the costs of the “highest valued” foregone alternative
• That is, there are tradeoffs between alternatives

• Lionel Robbins (1932):
• "the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses."
• Scarcity means that available resources are insufficient to satisfy all wants and needs.
• Absent scarcity and alternative uses of available resources, there is no economic problem . The subject thus defined involves the study of choices as they are affected by incentives and resources.

• Scarcity
• Opportunity Cost
• Tradeoffs
• Benefit/Cost Analysis

• There are not enough resources to produce and consume all of the goods and services we desire
– Consumer: income, time are scarce resources
• Income – allocated between various goods, current vs future consumption
– Firms
• Allocation of labor/materials between various products or lines-of-business (wireless vs landline)
• Decisions about technology to use (coal vs nat gas)

• Limits on resources implies that decisions must be made about:
– What to produce (how to allocate scarce natural resources, labor)
– How to produce it (which technologies, natural resources)
– Whom to produce it for (allocation of the good)
• Could be done by:
– Government direction (centrally planned economy)
– Market forces (price signals)

• Scarcity implies that choices must be made
– Choice implies that there is a trade-off or “opportunity cost”
(foregone alternative)
• Opportunity cost is defined as:
– The value of a good, service or resource in its next highest valued use – consequence of scarcity
• Every decision has an opportunity cost
– Alaska: potential value of gold mining could disrupt Copper
River Salmon run
– Choice of academic majors
– How to spend time or money

• Opportunity costs are not only
“observable” economic costs, but also
“unobservable” (or non-monetary) costs
– Opportunity costs of time
• Commute example
– Car
– Bus
– Bike

• Monetary costs associated with each alternative
– Car
• Initial purchase expense (fixed), O&M (variable: fuel, maintenance, depreciation, licenses, insurance, parking), time of commute
– Bus
• Time + fee
– Bike
• Initial purchase (bike and lock), O&M (tires, tune-ups, clothing), time of commute

• Non-pecuniary benefits/costs
– Non-pecuniary: not directly measurable by $
• Car
– Benefit: flexibility to come/go
– Costs: traffic jams, road rage, finding a parking space
• Bus
– Benefits: reading time, “no hassle”

• Bus
– Costs: no flexibility on time
• Bike
– Benefits: flexibility, improved health
– Costs: bad weather, lighting

Choose the alternative that has the greatest net benefits

• Individuals [or firms] choose their actions on the basis of expected additional [net] benefits and cost to themselves
– In this case -> alternative chosen will be the one that yields the largest net benefits
– Paul Heynes’ “ economizing process ”
• Modest changes in monetary costs and benefits can induce people to alter their behavior
– Cold, wet weather increases the costs of bike commuting (or parking on the street)

• Proper framework for analyzing economic decisions is to compare the costs and benefits of the alternatives
– Cost and benefits include not only directly observable/measurable economic costs and benefits, but also
– Opportunity costs (e.g., time),
– Non-pecuniary benefits

• Common understanding of key terms
– Use them as shorthand for the concept; but have a precise/exact meaning
• Scarcity
– There are not enough resources to produce and consume all of the goods and services we desire
• Opportunity costs
– What must be given up (next best alternative use) as a result of a decision or choice
– “No such thing as a free lunch” (Milton Friedman)
• Cost-benefit analysis
– Every decision/action has tradeoffs