Chapter 1 The Economic Way of Thinking Section 2 Economic Choice Today: Opportunity Costs

Economic Choice Today: Opportunity Cost Section-2 Economic Choice Today: Opportunity Cost Making Choices 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

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

Trade-Offs and Opportunity Cost 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

Analyzing Choices KEY CONCEPTS Example: Max’s Decision-Making Grid 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 Marginal benefit — additional benefit of using one more unit of a good or service

value of next-best alternative a person gives up Cost-Benefit Analysis 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