Study of Choice in economics

1. Economics: The Study of Choice
“When you make a choice, you change the future.”
-Deepak Chopra
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2. Before we begin, let’s cover
some basics!
Each of us has to make choices.
For example, do we buy CD’s or
Itunes?
Do we go out or study?Do we order a steak or just a
salad?
Nations have to make choices too.
Should we build schools or
railroads?
Should we increase defense or
provide more unemployment
insurance?
And how should we pay for all
this? Do we raise taxes? And if
so…on whom?
Sure, we’d like to have steak AND salad,
but we cannot… we face scarcity.
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3. What do we mean
by scarcity?
Simply put, scarcity means there simply
isn’t enough stuff to satisfy all our wants.
Because of scarcity, we have to make
choices.
Economics is the study of those choices!
Technically, Economics is “the social science
concerned with how individuals, institutions, and
society make choices under conditions of scarcity”.
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This idea of scarcity is a Key
Learning Outcome. I wish there was
plenty to go around…but there isn’t!

4. Life would be great if we did not face
scarcity…but we do!
In a perfect world, we would not have to address these
issues. There would be plenty of goods and services
to satisfy everyone’s wants all the time.
I think we can agree that generally speaking…more is better.
Simply put, a big house is better than a small house, all else equal.
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5. Let’s review the technical
definition of economics
Economics is the study of how
Individuals, institutions, and
society make best choices
under conditions of scarcity.
Hint: When you see red boxes like these throughout this
semester, it usually means that this material will be on the test!
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6. Economics is analyzed at two levels
Economics
Microeconomics
•Studies how individuals, households, and firms
make decisions to allocate limited resources
•Examines how these decisions effect the
supply and demand for goods and services
Microeconomics examines
how individuals,
households, and
businesses make these
decisions.
Think of it as a “bottom-up”
view of the economy.
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7. Economics is analyzed at two levels
Economics
Macroeconomics
•Examines the behavior of the overall
economy of a nation(s)
•Examines government policy, economic growth,
price stability, employment, and international trade
Macroeconomics examines
the overall economy or
broad subdivisions such as
a nation, a government, or
all households.
Think of it as a “top-down”
view of the economy.
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8. Economics Positive
Economics
Positive Economics involves
the study of cause and effect
relationships. It is the study of
“What is”.
For example, we might
try to determine if there
is a link between taxes
and unemployment.
Normative
Economics
Normative Economics
includes value judgments
about the economy. It is the
study of “What should be”.
For example, we might
study whether we should
lower taxes to reduce
unemployment.
The study of Economics
can take two forms
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9. Economics also assumes that people act
in their own self interest
Marginal means “extra”, or
“additional”.
Think of it like this: “Is the
extra cost worth it?”
Does this mean that people
never make mistakes?
Of course not…people have
imperfect information and
routinely make errors.
For example, Mapquest once
told me that it would take 3
hours to drive to from Virginia
Beach to Washington D.C. I
think we all know that is wrong!
But we assume that
people weigh
benefits of each
decision with costs
and try to make
themselves happy.
In economics, we call that “Marginal
Benefit - Marginal Cost Analysis”.
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10. Real world application:
Do you strategically choose a line?
When you choose a line, you are weighing marginal cost and
marginal benefits.
You analyze the cart sizes, line lengths, cashier skill, and many
other factors to determine which is MOST in your interest!
And what about the “ten items and fewer line”….do you ever go
there with eleven items?
Be honest.I suspect you do. The marginal cost of going there (perhaps
getting yelled at?) is nearly zero but the marginal benefit (that
you will check out faster) has real value!
As economic geeks like me would say, the marginal benefit of
breaking that rule exceeds the marginal cost…so you do it!
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11. This brings us to a problem…
Unfortunately, we (as
individuals or as a society)
want to satisfy an unlimited
set of wants with a scarce
set of resources
This dilemma is referred to as the
“Economizing problem”.
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12. The economizing problem
It is easy to explore the economizing problem from
the individual perspective.
To do so, let’s build a simple model to explore the
idea of scarcity and choice…
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13. Let’s start by looking at the Economizing
Problem from an individual perspective
Assume we live world with only two goods: concert tickets and meals
Assume that an individual’s income is $34,000
Assume concert tickets are $100
Assume meals are $50
If all money was
spent on Concert
tickets, 340 could
be purchased
If all money was
spent on meals,
680 could be
purchased
Or this individual
can chose any
combination of
goods, provided
they are within
their budget
And any point in
this area is attainable
Therefore, any
point in this
area is
unattainable
This line is referred
to as the “Budget
Line” or “Budget
Constraint”
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14. Individuals must satisfy unlimited wants
with limited income
As income
increases, the
budget line moves
right or “out”
As income falls,
the budget line
moves left or “in”
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15. Individuals must satisfy unlimited wants
with limited income
Assume we live in a two good world
Assume that an individual’s income is $34,000
Assume concert tickets are $100
Assume meals are $50
Imagine that a
person decides to
operate at this
point (340 meals,
and 190 concerts).
An addition of more
concert tickets would
require fewer meals
An addition of
meals would
require fewer
concert tickets
These “tradeoffs” are referred to as
opportunity costs in economics. To
obtain more meals, this individual
would have to give up some concert
tickets. To obtain more concert tickets,
this individual would have to give up
some meals.
In this case, the opportunity cost of
going to a concert is two meals.
The opportunity cost of eating a meal is
a half a concert.
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16. Opportunity Cost
Opportunity cost is the most
desired goods or services that
are forgone in order to obtain
something else
In this example, the opportunity
cost of going to a concert might
be two meals
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This idea of opportunity costs is a Key
Learning Outcome. We use it every day
to measure “pros and cons”.

17. Kids sometimes do not understand the
concept of opportunity cost
Opportunity cost -the most
desired goods or services that
are forgone in order to obtain
something else.
Many young kids have little
understanding of opportunity cost.
If you do not believe me, give them a
$5 allowance and see what they do.
In my experience, I see that they run
right out and spend it. Then, they
never save enough to get that “big
toy”. They do not understand that
spending their allowance every week
leads to an opportunity cost!
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18. Real world application:
Is the tassel worth the hassle?
Try this exercise: Calculate
your opportunity cost of going
to college for four years?
Include missed wages, costs of tuition,
cost of books, and other costs
Does this look right?
If so, is it worth it?
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19. But let’s see if the marginal benefit
exceeds the marginal cost.
Clearly, you must think so
because you are doing it!
High School Graduates earn $35,000
and College Graduates earn $60,000
A $25,000 per
year difference
in a 30 year
career totals
$750,000
Clearly, you
believe the
opportunity cost
of NOT going to
college is too
high!
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20. In some cases (very few) the opportunity
cost of going to college IS too high
Each of these people either did not go to college or
dropped out (though some returned to get degrees).
For them…the opportunity cost of going to college was
too high!
Kevin Garnett
Bill Gates
Oprah Winfrey
Tom Hanks
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21. In summary
Individuals and countries face scarcity and must make
decisions on how to allocate their scarce resources.
These decisions require sacrifices of other
things, referred to as opportunity costs.
Economics is the study of these decisions!
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