Ch. 1 - “Four Cores of Economics” Study Guide
Economics - study of choices
Cost-Benefit Principle
● Definition: Evaluating the costs and benefits, only making decisions if the benefits outweigh the
costs.
● Key Concepts:
○ Willingness to pay: Helpful in quantifying non-financial costs and benefits.
■ Don’t confuse “want to pay” and “willingness to pay”
○ Money is a measurement, not the end goal
● Goal: Following this principle maximizes economic surplus (measures how much a decision has
improved wellbeing).
● Caution: Be wary of framing effects - they can make identical choices seem different, clouding
cost-benefit analysis.
Opportunity Cost Principle
● Definition: The next best alternative you have to give up (due to scarcity and limited resources)
in order to pursue your top choice
● Key Concepts:
○ Not all options are opportunity costs, just the next best one.
○ Ask “Or what?” to consider opportunity cost.
○ Ignore sunk costs (irreversible and typically happen no matter what choice you make).
● Production Possibility Frontier (PPF)
○ Maps outcomes attainable with scarce resources, showing alternate outputs.
○ Moving along PPF reveals opportunity costs
○ At PPF = efficient; below PPF = inefficient, above PPF = unattainable
○ Depicts most you can produce given your current circumstances
○ Productivity gains shift PPF
○ Slope of PPF: Represents opportunity cost of an item on the x-axis (inverse will show y-axis)
Marginal Principle
● Definition: Decisions about quantities are best made incrementally. You should break down
“How many?” questions into a series of smaller decisions using cost-benefit analysis.
● Key Concepts:
○ Marginal benefit: The benefit from one additional unit
○ Marginal cost: The cost from one additional unit
○ Rational Rule: If something is worth doing, do it until the marginal benefits = marginal costs.
● Goal: Maximize and increase economic surplus.
Interdependence Principle
● Definition: Your choices depend on other choices.
● Four Types of Interdependencies:
○ Between your own choices (because of limited resources, choices affect each other).
○ Between people and businesses in the same market.
○ Between people and businesses in different markets.
○ Between time - decisions today affect future decisions.
, Ch. 2 - “Demand and Consumer Choice” Study Guide
Individual Demand Curve
● Definition: Plots the quantity of an item that an individual buyer plans to purchase at each price.
○ Simplified: a graph of one person’s buying decisions
● Shape: Downward sloping due to an inverse relationship between price and quantity demanded.
Price vs. Quantity
● P’s before Q’s: Price is placed on the vertical axis, and quantity is placed on the horizontal axis.
Ceteris Paribus
● Definition: Assumes all other factors remain constant when analyzing the effect of one variable.
Law of Demand
● Definition: Quantity demanded tends to increase as the price decreases.
Rational Rule For Buyers
● Definition: Buyers should purchase more of a good if the marginal benefit of one additional unit is greater than or
equal to its price.
● Outcome: Maximizes economic surplus.
Marginal Benefit and the Demand Curve
● The demand curve also represents the marginal benefit curve because it shows the marginal benefit for all quantities.
● Downward Slope Explanation: Due to diminishing marginal benefit—each additional unit provides less benefit than
the previous one, though this does not imply a negative benefit, only a smaller one.
Market Demand
● Definition: The total quantity demanded by each person at each price
○ Note: Made up of data of each potential customer.
Movement Along a Demand Curve
● Definition: A change in price causes movement along a fixed curve.
● Result: Yields a change in quantity demanded.
Shifts in Demand
● Increase in demand: A rightward shift - at each price, the quantity demanded is higher.
● Decrease in demand: A leftward shift - at each price, the quantity demanded is lower.
Factors That Shift Demand (“PEPTIC”)
● Preferences: (ex. Christmas trees in-season v. out-of-season)
● Expectations: Anticipations of future events (e.g., buying more toilet paper in anticipation of shortages during covid)
● Prices of Related Goods
○ Complementary goods: Used together (e.g., rise in coffee prices may decrease demand for coffee filters).
○ Substitute goods: Replace each other (e.g., rise in tea prices may increase demand for coffee).
● Type and Number of Buyers: Changes in population or demographics can affect demand.
● Income:
○ Normal good: Demand increases as income rises.
○ Inferior good: Demand decreases as income rises.
● Congestion and Network Effects
○ Network Effect: A product becomes more valuable as more people use it (e.g., Social media), increasing
demand
○ Congestion Effect: A product becomes less valuable as more people use it (ex. roads), decreasing demand.
Economics - study of choices
Cost-Benefit Principle
● Definition: Evaluating the costs and benefits, only making decisions if the benefits outweigh the
costs.
● Key Concepts:
○ Willingness to pay: Helpful in quantifying non-financial costs and benefits.
■ Don’t confuse “want to pay” and “willingness to pay”
○ Money is a measurement, not the end goal
● Goal: Following this principle maximizes economic surplus (measures how much a decision has
improved wellbeing).
● Caution: Be wary of framing effects - they can make identical choices seem different, clouding
cost-benefit analysis.
Opportunity Cost Principle
● Definition: The next best alternative you have to give up (due to scarcity and limited resources)
in order to pursue your top choice
● Key Concepts:
○ Not all options are opportunity costs, just the next best one.
○ Ask “Or what?” to consider opportunity cost.
○ Ignore sunk costs (irreversible and typically happen no matter what choice you make).
● Production Possibility Frontier (PPF)
○ Maps outcomes attainable with scarce resources, showing alternate outputs.
○ Moving along PPF reveals opportunity costs
○ At PPF = efficient; below PPF = inefficient, above PPF = unattainable
○ Depicts most you can produce given your current circumstances
○ Productivity gains shift PPF
○ Slope of PPF: Represents opportunity cost of an item on the x-axis (inverse will show y-axis)
Marginal Principle
● Definition: Decisions about quantities are best made incrementally. You should break down
“How many?” questions into a series of smaller decisions using cost-benefit analysis.
● Key Concepts:
○ Marginal benefit: The benefit from one additional unit
○ Marginal cost: The cost from one additional unit
○ Rational Rule: If something is worth doing, do it until the marginal benefits = marginal costs.
● Goal: Maximize and increase economic surplus.
Interdependence Principle
● Definition: Your choices depend on other choices.
● Four Types of Interdependencies:
○ Between your own choices (because of limited resources, choices affect each other).
○ Between people and businesses in the same market.
○ Between people and businesses in different markets.
○ Between time - decisions today affect future decisions.
, Ch. 2 - “Demand and Consumer Choice” Study Guide
Individual Demand Curve
● Definition: Plots the quantity of an item that an individual buyer plans to purchase at each price.
○ Simplified: a graph of one person’s buying decisions
● Shape: Downward sloping due to an inverse relationship between price and quantity demanded.
Price vs. Quantity
● P’s before Q’s: Price is placed on the vertical axis, and quantity is placed on the horizontal axis.
Ceteris Paribus
● Definition: Assumes all other factors remain constant when analyzing the effect of one variable.
Law of Demand
● Definition: Quantity demanded tends to increase as the price decreases.
Rational Rule For Buyers
● Definition: Buyers should purchase more of a good if the marginal benefit of one additional unit is greater than or
equal to its price.
● Outcome: Maximizes economic surplus.
Marginal Benefit and the Demand Curve
● The demand curve also represents the marginal benefit curve because it shows the marginal benefit for all quantities.
● Downward Slope Explanation: Due to diminishing marginal benefit—each additional unit provides less benefit than
the previous one, though this does not imply a negative benefit, only a smaller one.
Market Demand
● Definition: The total quantity demanded by each person at each price
○ Note: Made up of data of each potential customer.
Movement Along a Demand Curve
● Definition: A change in price causes movement along a fixed curve.
● Result: Yields a change in quantity demanded.
Shifts in Demand
● Increase in demand: A rightward shift - at each price, the quantity demanded is higher.
● Decrease in demand: A leftward shift - at each price, the quantity demanded is lower.
Factors That Shift Demand (“PEPTIC”)
● Preferences: (ex. Christmas trees in-season v. out-of-season)
● Expectations: Anticipations of future events (e.g., buying more toilet paper in anticipation of shortages during covid)
● Prices of Related Goods
○ Complementary goods: Used together (e.g., rise in coffee prices may decrease demand for coffee filters).
○ Substitute goods: Replace each other (e.g., rise in tea prices may increase demand for coffee).
● Type and Number of Buyers: Changes in population or demographics can affect demand.
● Income:
○ Normal good: Demand increases as income rises.
○ Inferior good: Demand decreases as income rises.
● Congestion and Network Effects
○ Network Effect: A product becomes more valuable as more people use it (e.g., Social media), increasing
demand
○ Congestion Effect: A product becomes less valuable as more people use it (ex. roads), decreasing demand.
