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Microeconomics and Behaviour. ECON 290. Scarcity &Choice. Limited resources Unlimited wants. 1.1 The Cost –Benefit Approach to Decisions. If B(x) > C(x), then do x; otherwise do not. Think of B(x) as the maximum dollar you are willing to pay to do x.
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Microeconomics and Behaviour ECON 290
Scarcity &Choice • Limited resources • Unlimited wants
1.1 The Cost –Benefit Approach to Decisions If B(x) > C(x), then do x; otherwise do not
Think of B(x) as the maximum dollar you are willing to pay to do x. And C(x) is the value of all resources you must give up to do x.
Reservation Price The reservation price of activity x is the price at which a person would be indifferent between doing x and not doing x.
1.2 A Note of the Role of Economic Theory Economists do not actually believe that people make calculations when making a decision. However, useful predictions can be made when the assumption is made.
1.3 Some Common Pitfalls in Decision Making • Ignoring implicit costs • Failing to ignore sunk costs • Measuring costs and benefits as proportions rather than absolute dollar amounts • Failure to understand the average-marginal distinction
1.5 The Invisible Hand Self -interested consumers behave as if they were guided by some “invisible hand’ to produce the greatest social good. Concept originated in Adam Smith’s Wealth of Nations.
“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages” • Adam Smith, 1776
Limits of the Invisible Hand Market Failures
1.6 Rationality and Self-Interest Decision-making based on cost-benefit analysis
Two refinements to the definition of rationality 1. The self-interest standard 2. The present-aim standard
1.7 Positive and Normative Questions • Values versus facts
