Economics 214
Chapter 1: Thinking like an economist
Cost benefit approach to decisions
Should I do activity x?
- Determine all the costs and benefits
- If the benefit obtained from doing the activity outweighs the cost, keep doing the
activity
- When the cost becomes greater than the activity, stop
- Benefit is a hypothetical magnitude
- Cost consists of all resources sacrificed in order to do activity x
Common pitfalls
1. Ignoring implicit costs
- An implicit cost, or opportunity cost, is the value of the next best alternative
not chosen
- E.g. 1. When choosing between an IPhone or Samsung, the opportunity cost
of the IPhone would be the Samsung, and the opportunity cost of the
Samsung would be the IPhone
- E.g. 2. When choosing between studying and relaxing, one must weigh up the
opportunity cost.
- The benefit of studying is getting a good mark, the con is the
unpleasantness of studying
- The benefit of relaxing is the activity, the con is getting a bad mark
- If the benefit of getting a high mark is greater than the benefit of
relaxing, one will have to sacrifice relaxing, making it an opportunity
cost, in order to study
2. Failing to ignore sunk costs
- Sunk costs are costs that are beyond recovery at the moment a decision is
made
- As the cost is unrecoverable, it should be ignored when making a decision
- E.g. Treating all costs as the same, instead of splitting them into fixed and
variable
- However, people will often have a ‘get your money’s worth’ mind-set
- If a buffet is free for certain people and others have to pay, the ones
that have to pay will generally eat a lot more than the people who didn’t
pay
- They should only be motivated by how hungry they are, and eat until
satisfied
- However, unless they ‘get their money’s worth’, they will be unsatisfied
, 3. Measuring cost and benefit as a proportion, instead as an absolute amount
- E.g. If a toaster costs R200 at a store close to you, but costs R160 a bit further
away, would you drive to save the R40?
- Many would weigh up the cost as a percentage, stating that a further
journey could save 20%, and then go to the further store
- But if a TV costing R8000 at the store close to you, and R7960 further
away, would you still make the journey
- While the decrease is only 0.5%, it has the same absolute value as
before
- If you were willing to travel further to save R40 on the toaster, you
should also be willing to travel further to save R40 on the TV
Marginal cost vs. marginal benefit
Marginal cost: The increase in total cost that results from carrying out one additional unit of
the activity
Marginal benefit: The increase in total benefit that results from carrying out one additional
unit of an activity
Possible combinations:
1. MB > MC
- If the marginal benefit is greater than the marginal cost, more of the activity
should be done
2. MB < MC
- If the marginal benefit is less than the marginal cost, the activity should be
stopped
3. MB = MC
- When the marginal benefit is equal to the marginal cost, the perfect quantity
of the activity performed has been reached
- If less is performed, the person can be made better off by carrying out an
additional unit
- If more is performed, they will experience decreasing total benefit
Positive and normative questions
Positive question: A question about the consequences of specific policies or institutional
arrangements
- A correct answer can be determined based on relevant data
- Positive statement: A factual statement, does to have to be right, but can be tested
to determine a correct answer
- E.g. That chair is blue
,Normative question: A question about which policies or institutional arrangements lead to
the best outcomes
- A question on what should be done, based on your specific morals and beliefs
- Has no right or wrong answer
- Normative statement: A statement on how something ought to be
- E.g. That chair should be blue
Macro vs. Micro economics
Macro-economics: The study of broad aggregations of markets
Micro-economics: The study of individual choices, and the study of group behaviour in
individual markets
,Chapter 2: Supply and demand
Supply and demand curves
Market: Any place or situation where buyers and sellers, or their agents, make contact to
negotiate prices and quantities of a good or service to be traded
Real price: The price of a good relative to the prices of other goods and services
- Prices on supply and demand curves are shown at the real price
Law of demand: When the price of a product falls, people demand larger quantities of it
(Reasons covered in Chapter 4)
- The demand curve is based off this law
- It is a graphical explanation of the various cost-benefit calculations buyers make
when considering a good
- The negative slope of the demand curve tells us that fewer people will be able to
meet the cost-benefit criterion
Law of supply: When the price of a product rises, firms offer more of it for sale (Covered further
in chapter 7)
- The supply curve is based off this law
- The upward sloping curve tells us that not only are suppliers more willing to supply
more, more people will become suppliers as well
- E.g. If the price of snoek increases, fisherman will fish (Supply) less hake and
will fish more snoek
, Determinants of supply and demand
Demand:
1. Price
- If the price of a product increases, people generally demand less
2. Incomes
- Normally, the quantity demanded of all goods will increase when income rises
- These are called normal goods
- Goods that are not demanded more when income increases are called inferior
goods
- When income increases, consumers abandon these goods in favour of
higher quality substitutes
3. Tastes
- Taste varies between people, cultures, and time
- Taste is generally referred to as consumer preference
4. Price of substitutes and compliments
- A substitute good satisfies the same want as another good
- E.g. Hamburgers and chicken burgers – if the price of one increases, the
quantity demanded of the other will increase
- Complimentary goods are generally consumed together
- E.g. peanut butter and Jelly – when the price of one increases, the
quantity consumed of both will decrease
5. Expectations
- Expectations about future incomes or price levels can influence demand
- If a person expects an increase in income soon, they may demand more now
which they can pay off later with their increased income
- If a person expects an increase in price levels, they will consume more than
necessary now in order to save on the expected increase
6. Population
- Generally, as the population increase, more people are potential consumers,
which should increase demand
Supply:
1. Price
- As the price of a product increases, producers wil generally supply more
2. Technology
- The quantity producers are willing to supply at any price level generally
depends on their costs of production
- An increase in technology can allow more to be produced will less input,
which decreases factor costs and shifts the supply curve to the right
3. Factor prices
- If any of the factors of production (Labour, Capital, Natural resources, entrepreneurship)
increase in price, the supply curve will shift to the left
Chapter 1: Thinking like an economist
Cost benefit approach to decisions
Should I do activity x?
- Determine all the costs and benefits
- If the benefit obtained from doing the activity outweighs the cost, keep doing the
activity
- When the cost becomes greater than the activity, stop
- Benefit is a hypothetical magnitude
- Cost consists of all resources sacrificed in order to do activity x
Common pitfalls
1. Ignoring implicit costs
- An implicit cost, or opportunity cost, is the value of the next best alternative
not chosen
- E.g. 1. When choosing between an IPhone or Samsung, the opportunity cost
of the IPhone would be the Samsung, and the opportunity cost of the
Samsung would be the IPhone
- E.g. 2. When choosing between studying and relaxing, one must weigh up the
opportunity cost.
- The benefit of studying is getting a good mark, the con is the
unpleasantness of studying
- The benefit of relaxing is the activity, the con is getting a bad mark
- If the benefit of getting a high mark is greater than the benefit of
relaxing, one will have to sacrifice relaxing, making it an opportunity
cost, in order to study
2. Failing to ignore sunk costs
- Sunk costs are costs that are beyond recovery at the moment a decision is
made
- As the cost is unrecoverable, it should be ignored when making a decision
- E.g. Treating all costs as the same, instead of splitting them into fixed and
variable
- However, people will often have a ‘get your money’s worth’ mind-set
- If a buffet is free for certain people and others have to pay, the ones
that have to pay will generally eat a lot more than the people who didn’t
pay
- They should only be motivated by how hungry they are, and eat until
satisfied
- However, unless they ‘get their money’s worth’, they will be unsatisfied
, 3. Measuring cost and benefit as a proportion, instead as an absolute amount
- E.g. If a toaster costs R200 at a store close to you, but costs R160 a bit further
away, would you drive to save the R40?
- Many would weigh up the cost as a percentage, stating that a further
journey could save 20%, and then go to the further store
- But if a TV costing R8000 at the store close to you, and R7960 further
away, would you still make the journey
- While the decrease is only 0.5%, it has the same absolute value as
before
- If you were willing to travel further to save R40 on the toaster, you
should also be willing to travel further to save R40 on the TV
Marginal cost vs. marginal benefit
Marginal cost: The increase in total cost that results from carrying out one additional unit of
the activity
Marginal benefit: The increase in total benefit that results from carrying out one additional
unit of an activity
Possible combinations:
1. MB > MC
- If the marginal benefit is greater than the marginal cost, more of the activity
should be done
2. MB < MC
- If the marginal benefit is less than the marginal cost, the activity should be
stopped
3. MB = MC
- When the marginal benefit is equal to the marginal cost, the perfect quantity
of the activity performed has been reached
- If less is performed, the person can be made better off by carrying out an
additional unit
- If more is performed, they will experience decreasing total benefit
Positive and normative questions
Positive question: A question about the consequences of specific policies or institutional
arrangements
- A correct answer can be determined based on relevant data
- Positive statement: A factual statement, does to have to be right, but can be tested
to determine a correct answer
- E.g. That chair is blue
,Normative question: A question about which policies or institutional arrangements lead to
the best outcomes
- A question on what should be done, based on your specific morals and beliefs
- Has no right or wrong answer
- Normative statement: A statement on how something ought to be
- E.g. That chair should be blue
Macro vs. Micro economics
Macro-economics: The study of broad aggregations of markets
Micro-economics: The study of individual choices, and the study of group behaviour in
individual markets
,Chapter 2: Supply and demand
Supply and demand curves
Market: Any place or situation where buyers and sellers, or their agents, make contact to
negotiate prices and quantities of a good or service to be traded
Real price: The price of a good relative to the prices of other goods and services
- Prices on supply and demand curves are shown at the real price
Law of demand: When the price of a product falls, people demand larger quantities of it
(Reasons covered in Chapter 4)
- The demand curve is based off this law
- It is a graphical explanation of the various cost-benefit calculations buyers make
when considering a good
- The negative slope of the demand curve tells us that fewer people will be able to
meet the cost-benefit criterion
Law of supply: When the price of a product rises, firms offer more of it for sale (Covered further
in chapter 7)
- The supply curve is based off this law
- The upward sloping curve tells us that not only are suppliers more willing to supply
more, more people will become suppliers as well
- E.g. If the price of snoek increases, fisherman will fish (Supply) less hake and
will fish more snoek
, Determinants of supply and demand
Demand:
1. Price
- If the price of a product increases, people generally demand less
2. Incomes
- Normally, the quantity demanded of all goods will increase when income rises
- These are called normal goods
- Goods that are not demanded more when income increases are called inferior
goods
- When income increases, consumers abandon these goods in favour of
higher quality substitutes
3. Tastes
- Taste varies between people, cultures, and time
- Taste is generally referred to as consumer preference
4. Price of substitutes and compliments
- A substitute good satisfies the same want as another good
- E.g. Hamburgers and chicken burgers – if the price of one increases, the
quantity demanded of the other will increase
- Complimentary goods are generally consumed together
- E.g. peanut butter and Jelly – when the price of one increases, the
quantity consumed of both will decrease
5. Expectations
- Expectations about future incomes or price levels can influence demand
- If a person expects an increase in income soon, they may demand more now
which they can pay off later with their increased income
- If a person expects an increase in price levels, they will consume more than
necessary now in order to save on the expected increase
6. Population
- Generally, as the population increase, more people are potential consumers,
which should increase demand
Supply:
1. Price
- As the price of a product increases, producers wil generally supply more
2. Technology
- The quantity producers are willing to supply at any price level generally
depends on their costs of production
- An increase in technology can allow more to be produced will less input,
which decreases factor costs and shifts the supply curve to the right
3. Factor prices
- If any of the factors of production (Labour, Capital, Natural resources, entrepreneurship)
increase in price, the supply curve will shift to the left
