Overview: Logic of Choice

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A central idea of economics is that people respond to incentives, or that they make decisions by weighing costs and benefits. This group of readings explains how comparing costs and benefits can explain the amount of an activity that a person chooses. The key is break the how-much decision into a series of small decisions. To decide how much to buy, for example, a person should consider the costs and benefits of buying one item and then the costs and benefits of buying the second, etc. Much of economic theory is based on this simple but vital idea.

This group of readings begins by looking at goals as the source of benefits and constraints of scarcity as the source of costs. It then shows how one can arrange information obtained from goals and constraints so that one can make decisions based on costs and benefits. It does this by introducing two rules, the maximization principle and the equimarginal principle. These rules can be derived mathematically and are in fact nothing but applied calculus. However, they also make common sense and these readings stress the common-sense approach to these rules.

After you complete this unit, you should be able to:

  • Define utility, tradeoff, cost, and law of diminishing marginal utility.
  • Given income and prices, be able to form a budget constraint.
  • Explain what a production-possibilities frontier shows and what factors can move it.
  • If given a table of total costs or benefits, be able to compute marginal costs or benefits, and vice versa.
  • When given a table or graph showing costs and benefits for various levels of activity, use the maximization principle to find an optimum position.
  • When given an income and a table showing marginal utilities and prices of two items, use the equimarginal principle to find an optimum position.
  • Explain why the marginal cost curve measures the slope of the total cost curve.
Copyright Robert Schenk