2.1 The Principle of Opportunity Cost

• Opportunity cost incorporates the notion of scarcity; No matter what we do, there is always a trade-off.

• To determine the opportunity cost of an activity, we look at what you consider the best of these “other” activities.

• We can also apply the principle of opportunity cost to decisions about how to spend money from a fixed budget.

The Cost of College

• Instead of going to college, the student could have spent this money on a wide variety of goods, including housing, electronic devices, and world travel.

• To make an informed decision about whether to attend college, we must compare the benefits to the opportunity costs.

The Cost of Military Spending

• A policy question is whether the benefits from a war exceed its opportunity cost.

• We can measure the opportunity cost of war in terms of its implications for domestic security.

• The question for policymakers is whether money spent on domestic security would be more beneficial than money spent on war.

Opportunity Cost and the Production Possibilities Curve

• Production possibilities curve is the set of points on the border between the shaded and unshaded area. It separated the combinations that are attainable from those that are not.

• The attainable combinations are shown by the shaded area within the curve and the curve itself.

• The production possibilities curve illustrates the notion of opportunity cost. If an economy is fully utilizing its resources, it can produce more of one product only if it produces less of another product.

2.2 The Marginal Principle

• The marginal benefit of an activity is the additional benefit resulting from a small increase in the activity.

• The marginal cost is the additional cost resulting from a small increase in the activity.

Automobile Emissions Standards

• The U.S. government specifies how much carbon monoxide a new car is allowed to emit per mile.

• The marginal question is “Should the standard be stricter, with fewer units of carbon monoxide allowed?”

• Benefit: Reduces healthcare costs because there will be less pollution, so fewer people will have respiratory problems.

• Cost: More expensive control equipment on cars and may also reduce fuel efficiency

• Using the marginal principle, the government should make the emissions standard stricter as long as the marginal benefit exceeds the marginal cost.

2.3 The Principle of Voluntary Exchange

• The principle of voluntary exchange is based on the notion that people act in their own self-interest.

• Principle of Voluntary Exchange: a voluntary exchange between two people makes both people better off.

Exchange and Markets

• Adam Smith stressed the importance of voluntary exchange as a distinctly human trait.

• If participation in a market is voluntary and people are well informed, both people in a transaction-buyer and seller will be better off.

• The alternative to exchange is self-sufficiency. Each of us could produce everything for himself or herself.

• The exchange allows us to take advantage of differences in people’s talents and skills.

2.4 The Principle of Diminishing Returns

• Principle of Diminishing Returns: Suppose output is produced with two or more inputs, and we increase one input while holding the other input or inputs fixed. Beyond some point-called the point of diminishing returns- output will increase at a decreasing rate.

• This principle of diminishing returns is relevant when we try to produce more output in an existing production facility (a factory, a store, an office, or a farm) by increasing the number of workers sharing the facility.

• When we add a worker to the facility, each worker becomes less productive because he or she works with a smaller piece of the facility.

• Diminishing returns occur because one of the inputs to the production process is fixed.

• The principle of diminishing returns does not apply when a firm is flexible in choosing all its inputs.

2.5 The Real-Nominal Principle

• Real-Nominal Principle: What matters to people is the real value of money or income-its purchasing power- not its “face” value.

• The nominal value of an amount of money is simply its face value.

• The real value of an amount of money is measured in terms of the number of goods the money can buy.

The Design of Public Programs

• Government officials use the real-nominal principle when they design public programs.

• The government also uses the principle when it publishes statistics about the economy.

• The real wage is stated in terms of its buying power, rather than its face value or nominal value.

The Value of the Minimum Wage

• Because 1974 and 2015, the federal minimum wage increased from $2.00 to $7.25.

• Because prices increased faster than the nominal wage, the real value of the minimum wage actually decreased over this period.