What is Economics?
Key Concepts and Terms
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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 versus consuming
 Among various goods
 Food, housing, transportation, “fun”
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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 goods or
models of the product
 Which technology to use
 Capital or labor
 Which inputs, quality of inputs
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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
 Means that there are “opportunity costs” of making a
choice
 That is, there are tradeoffs between alternatives
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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.
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Scarcity
Opportunity Cost
Tradeoffs
Benefit/Cost Analysis

There are not enough resources to produce
and consume all of the goods and services we
desire

Limits on resources implies that decisions
must be made about:
◦ What to produce
◦ How to produce it
◦ Whom to produce it for
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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)
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Opportunity cost is defined as:
◦ The value of a good, service or resource in its next highest
valued use – consequence of scarcity
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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
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Opportunity costs are not only “observable”
economic costs, but also “unobservable” (or
non-monetary) costs
◦ Opportunity costs of time
 Commute example
 Car
 Bus
 Bike
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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
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Non-pecuniary benefits/costs
◦ Non-pecuniary: not directly measurable by $
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Car
◦ Benefit: flexibility to come/go
◦ Costs: traffic jams, road rage, finding a parking
space
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Bus
◦ Benefits: reading time, “no hassle”
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Bus
◦ Costs: no flexibility on time
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Bike
◦ Benefits: flexibility, improved health
◦ Costs: bad weather, lighting
 Choose
the alternative that has the greatest
net benefits
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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”
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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)
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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
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Common understanding of key terms
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Scarcity
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Opportunity costs
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Cost-benefit analysis
◦ Use them as shorthand for the concept; but have
a precise/exact meaning
◦ There are not enough resources to produce and
consume all of the goods and services we desire
◦ 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)
◦ Every decision/action has tradeoffs