Core Principles¶
There's always Trade-offs¶
When choosing an option, you're always giving up on something else; ie there is always an opportunity cost
It is due to scarcity of resources; every resource is finite; nothing comes free
Eg: when i want to study, i'm giving up sleep
Real Cost¶
Cost of something is what you sacrifice to get it
Real Cost = relative price = opportunity cost
Fraction that shows what is to be sacrificed to pick an option A instead of B.
This can be incorporated into daily life instead of regular pros/cons list, by adding a cost/benefit associated with every factor for a decision.
It's not just monetary cost
Rational people think at Margin¶
Rationality: making a decision considering all possibilities to obtain best outcome with minimal input and losses.
Marginality: making decisions considering incremental benefits/costs associated with an action; not at total benefit/cost
marginal profit (net benefit) = marginal benefit - marginal cost Proceed incrementing production as long as marginal net benefit 0
People respond to incentives¶
Incentive: instrument to induce an individual to act/react tool to change behavior
Subsidies = +ve incentive Taxes = -ve incentive
Trade¶
Voluntary transaction between parties, resulting in their betterment.
Trade offs are there as everything has pros/cons, gains/costs; other options could have been chosen, but did not as the customer takes the best option
Trade benefits everyone¶
- Reduces cost of production through specialization Specialists require lower resources for production, because they are really good at it; hence they can increase output
- Both parties gain a greater variety of goods and services
Overall trade gains depends on
- choice set
- cost minimization
Individual gains depends on
- Terms of trade basically means the exchange rate
- Bargaining power
- nature of the product (Shelf life / perishability) The one with the greater shelf life product will have greater bargaining power because they don't have to sell in a hurry
- elasticity of demand
Benefits of scale¶
You get larger benefits with lower costs if you focus on specialization at large scale
Larger systems are more productive per unit input
The average cost reduces when the volume of production increases
eg: college mess cooking $$ \text{Cost}(y) = y^\alpha $$ Where \(y =\) output quantity
Benefits of scale exists if \(\alpha < 1\)