Chapter 1 The Economic Way of Thinking

Section 2Economic Choice Today: Opportunity Costs

Section-2

KEY CONCEPTS• Economic choices shaped by — Incentives — benefits that encourage people to act in certain ways

— Utility — benefit or satisfaction gained from using a good or service

• To make choices, people economize: — make decisions according to best combination of costs and benefits

Economic Choice Today: Opportunity Cost

Making Choices

Factor 1: Motivations for Choice • People motivated by incentives, expected utility, desire to economize• They weigh costs against benefits to make purposeful choices — motivated by self-interest: look for ways to maximize utility

Factor 2: No Free Lunch • All choices have a cost — choosing one thing means giving up another, or paying a cost

— cost can take form of money, time, other thing of value

Making Choices

KEY CONCEPTS • Trade-off is alternative people give up when they make a choice — usually means giving up some, not all, of a thing to get more of another

Example 1: Making Trade-Offs • Shanti wants to earn college credit over summer — semester-long university course offers more credits

— six-week high school course leaves time for vacation

Example 2: Counting the Opportunity Cost • Opportunity cost is value of next-best alternative a person gives up — not the value of all possible alternatives• Dan chooses to work for six months so he can travel for six months — opportunity cost: six months of salary

Trade-Offs and Opportunity Cost

KEY CONCEPTS • Cost-benefit analysis — examination of costs, expected benefits of

choices — one of most useful tools for evaluating relative worth of economic choices

Example: Max’s Decision-Making Grid • Decision-making grid shows what one gets, gives up with each choice• Max’s grid shows all possible choices for his free hours each week — lists choices, benefits and opportunity cost of each choice• With time, costs and benefits change; also goals and circumstances — Changes influence decisions, make people alter original choices

Example: Marginal Costs and Benefits • Marginal cost — lists choices, benefits and opportunity cost of each choice• Marginal benefit — additional benefit of using one more unit of a good or service

Analyzing Choices

Vocabulary

Incentives benefits that encourage people to act in certain ways

Utility benefit or satisfaction gained from using a good or service

Economize make decisions according to best combination of costs and benefits

Trade-off alternative people give up when they make a choice

Opportunity Cost value of next-best alternative a person gives up

Cost-Benefit Analysis examination of costs, expected benefits of choices

Marginal Cost lists choices, benefits and opportunity cost of each choice

Marginal Benefit additional benefit of using one more unit of a good or service