Week 1 Flashcards
(5 cards)
Four Basic Principles of Economics
Cost-Benefit Decision Making- an action should only be taken if the benefit from taking the action is greater than the cost
Opportunity Cost- the highest value of foregone alternatives, economic cost is the out-of-pocket expense plus the opportunity cost
Marginal Decision Principle- for example, when you wake up you don’t decide how many cups of coffee you want, you decide one at a time
Sunk Cost Principle (Ignoring Sunk Costs)- a consequence of making choices at the margin is that we should ignore costs incurred which cannot be recovered, for example firms often incur a sunk start-up cost before they start producing output.
If market conditions change, these sunk start-up costs should be ignored in production decisions.
Normative and Positive Statements
Positive Economics- the study of the way things are and the pursuit of objective truths
Normative Economics- the study of the way thing should be and is based on subjective beliefs.
Models and Theory in Economics
Models are a way of structuring our understanding on complex problems and help the economist isolate complicated chains of cause and effect. Models help economists predict the effect of a policy on the economy. They are not supposed to replicate reality, they are an abstraction of reality. A good model also provides a framework for testing theory
Economic models always assume economic agents will act rationally to incentives.
Rational agent: makes choices that make there self at least as well-off as the next best alternative.
Exogenous and Endogenous Variables in Economics
Exogenous variables are not explained by the model.
Endogenous variables are explained within the model.
We think of ceteris paribus changes in variables that are exogenous to the model and how this influences variables that are endogenous to the model. Ceteris paribus meaning all other things equal, thus we only consider changes in one exogenous variable at a time.
