This is “End-of-Chapter Material”, section 3.4 from the book Theory and Applications of Microeconomics (v. 1.0).
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We all make economic decisions every day, often without giving them very much thought. In this chapter, we highlighted two fundamental decisions: allocating income and allocating time. You (and everyone else) generally make choices over income and time allocations in a manner that makes you happy. Thus we predict that you will not throw income away. Further, whatever combinations of goods and services and time allocations you choose, economic theory presumes that these are the best ones available to you. Remember also that even though it is usually easier to focus on one decision at a time, your spending and time allocation decisions are interconnected. Changes in the prices of goods and services affect how you spend your time, and changes in the real wage affect your consumption choices.Chapter 7 "Why Do Prices Change?" has more to say on the connections among different markets in the economy.
Economics is often defined as the study of how we allocate scarce resources that have alternative uses. In this chapter, we saw this idea at work at the individual level. Your income is a scarce resource; you don’t have enough income to buy everything that you would like. Your income has alternative uses because there are lots of things you might want to buy.
Perhaps the most fundamental idea of this chapter is that of opportunity cost. Given that you have limited income to allocate across goods and services, the opportunity cost of consuming one good or service is the amount of another good or service you give up. Given that you have limited time to allocate across activities, the opportunity cost of spending time on one activity is the value of the time you could have spent on another. The budget and time budget constraints are graphical representations of this central economic principle. And the interaction between these budget constraints and people’s wants and desires is at the heart of the economic analysis of decision making.
Which statements are prescriptive? Which statements are descriptive?
(Advanced) Look at Table 3.7 "Preferences over Downloads and Chocolate Bars". The top part of the table lists four different bundles of downloads and chocolate bars. The bottom part of the table shows which bundle is preferred when we compare any two bundles. Look at bundle 1. The top part of the table tells us it contains 0 downloads and 20 chocolate bars. The first row of the bottom part of the table shows how this bundle compares to the other bundles. So this individual prefers bundle 1 to bundle 2 but also prefers both bundle 3 and bundle 4 to bundle 1. Do these preferences satisfy “more is better”? Are they consistent or can you find some contradictions?
Table 3.7 Preferences over Downloads and Chocolate Bars
|Bundle||Downloads Consumption||Chocolate Bar Consumption|
|Bundle||Which Bundle Is Preferred When Comparing Bundles?|
|Bundle 1||Bundle 2||Bundle 3||Bundle 4|