Main Concepts & Definitions

• Satisfaction & Utility

• Scarcity & Choice

• Opportunity cost

• Rationality

• Decision-making process (Thinking rationally)

• Nominal values and real values

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 Satisfaction & Utility

• Utility refers to the usefulness an individual gets

from having a good or service. it is a useful way to
explain how and why people make their decisions. It
is the starting point of consumption.

"Ordinal" utility refers to the concept of one good being

more useful or desirable than another.

• Satisfaction is the enjoyable feeling, feeling of

happiness, you get when you receive something
you want, or when you have done or are doing
something you wanted to do. It is the end result of
consumption.

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 Scarcity & Choice

All economic questions arise because we want more

than we can get.

Our inability to satisfy all our wants is called scarcity.

Because we face scarcity, we must make choices.

The choices we make depend on the incentives we

face.

An incentive is a reward that encourages an action or a

penalty that discourages an action.

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 Scarcity & Choice
• Scarcity means that there are fewer
resources than are needed to fulfill human
wants and needs. These resources can come
from land, labor resources, or capital resources.

• Scarcity indicates that the demand for a

resource cannot be met. These resources could
include natural resources, such as crops and
water, or economic resources, such as labor
and land.

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 There are two types of scarcity, depending on the scarcity's
nature: relative scarcity and absolute scarcity

• Relative scarcity occurs when resources are scarce

relative to the public's demand. When more people want
a resource, it creates a shortage caused by slow
distribution or limited supply. The resource exists, but the
people cannot get it immediately. Economists consider
relative scarcity as a basic element of economics.
• Absolute scarcity refers to a situation in which there is
simply not enough a resource to go around. Unlike
relative scarcity, absolute scarcity cannot be resolved by
increasing supply or improving distribution. Demand has
little to no impact on absolute scarcity; the resource is
gone, or nearly gone, and cannot be increased. (24 hours
per day)
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 • Choice refers to the ability of a consumer or producer
to decide which good, service, or resource to
purchase or provide from a range of possible options.
Being free to choose is regarded as a fundamental
indicator of economic well-being and development.

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 Opportunity cost
• Opportunity costs represent the potential benefits that
an individual, investor, or business misses out on when
choosing one alternative over another. Because
opportunity costs are unseen by definition, they can be
easily overlooked.

• In microeconomic theory, the opportunity cost of a

particular activity option is the value or benefit given up
by engaging in that activity, relative to engaging in an
alternative activity. More simply, it means if you choose
one activity you are giving up the opportunity to do a
different option

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 Rationality

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 Decision- making process
The Rational Way of Thinking
Six key ideas define the economic way of thinking:

1.A choice is a tradeoff.

2. People make rational choices by comparing benefits
and costs.

3.Benefit is what you gain from something.

4.Cost is what you must give up to get something.
5.Most choices are “how-much” choices made at the
margin.

6.Choices respond to incentives.

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 1. A Choice Is a Tradeoff

The economic way of thinking places scarcity and its

implication, choice, at center stage.

You can think about every choice as a tradeoff—an

exchange—giving up one thing to get something else.

On Saturday night, will you study or have fun?

You can’t study or have fun at the same time, so you must
make a choice.

Whatever you choose, you could have chosen something

else. Your choice is a tradeoff.

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 2. Making a Rational Choice

A rational choice is one that compares costs and

benefits and achieves the greatest benefit over cost for the
person making the choice.

Only the wants of the person making a choice are relevant

to determine its rationality.

The idea of rational choice provides an answer to the first

question: What goods and services will be produced and
in what quantities?

The answer is; Those that people rationally choose to buy!

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 How do people choose rationally?
The answers turn on benefits and costs.

3. Benefit: What you Gain

The benefit of something is the gain or pleasure that it

brings and is determined by preferences

Preferences are what a person likes and dislikes and the

intensity of those feelings.

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 4. Cost: What you Must Give Up

The opportunity cost of something is the highest-valued

alternative that must be given up to get it.

What is your opportunity cost of going to an AC/DC

concert?

Opportunity cost has two components:

1. The things you can’t afford to buy if you purchase the

AC/DC ticket.

2. The things you can’t do with your time if you spend at

the concert.

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5. How Much? Choosing at the Margin

You can allocate the next hour between studying and

instant messaging your friends.

The choice is not all or nothing, but you must decide how
many minutes to allocate to each activity.

To make this decision, you compare the benefit of a little bit

more study time with its cost—you make your choice at the
margin.

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 To make a choice at the margin, you evaluate the
consequences of making incremental changes in the use
of your time.

The benefit of pursuing an incremental increase in activity

is its marginal benefit.

The opportunity cost of pursuing an incremental increase

in activity is its marginal cost.

If the marginal benefit, from an incremental increase in an

activity, exceeds its marginal cost, your rational choice is
to do more of that activity.

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 6.Choices Respond to Incentives

The central idea of economics is that we can predict how

choices will change by looking at changes in incentives.

Incentives are also the key to reconciling self-interest and

social interest.

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 Producing Goods & Services

Production is the process of combining various material

inputs and immaterial inputs (plans, knowledge) in order
to make something for consumption (output).

Goods and services are the objects that people value

and produce to satisfy human wants.

Goods: tangible Ex: food, cars, …

Services: intangible Ex: healthcare, tourism, …

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 Goods and services are produced by using productive
resources that economists call factors of production.

Factors of production are grouped into four categories:

 Land
 Labor
 Capital
 Entrepreneurship

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 The “gifts of nature” that we use to produce goods and
services are land.

The work time and work effort that people devote to

producing goods and services is labor.

The quality of labor depends on human capital, which is

the knowledge and skill that people obtain from education,
on-the-job training, and work experience.

The tools, instruments, machines, buildings, and other

constructions that businesses use to produce goods and
services are capital.

The human resource that organizes land, labor, and

capital is entrepreneurship.

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 Economic Returns

Who gets the goods and services depends on the incomes

that people earn.

 Land earns rent.

 Labor earns wages.
 Capital earns interest.
 Entrepreneurship earns profit.

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