Difficulty: Introductory | Prerequisites: None. This is the starting point of the course.
Chapter 1 introduces the foundational logic of economics: how people make decisions when they cannot have everything they want. Every concept in this chapter, from opportunity cost to marginal analysis, reappears throughout the rest of the course. If you understand the cost-benefit framework here, the supply-and-demand material in Chapter 2 and everything that follows will make far more sense.
The core question is simple: given that resources are scarce, how should a rational person decide what to do? The answer is built on comparing marginal costs and marginal benefits, not averages, and on recognising which costs are genuinely relevant to a decision (hint: sunk costs are not).
Economics is the study of choices under scarcity. Chapter 1 teaches you how to evaluate any decision by comparing its marginal benefit to its marginal cost, ignoring sunk costs, and thinking in terms of opportunity cost. A rational person keeps doing an activity as long as the next unit's benefit exceeds its cost.
Economics
The study of how people make choices under conditions of scarcity and of the results of those choices for society.
In simple terms, this means: everything has a cost because resources are limited, and economics is the study of how we navigate that reality.
Microeconomics
The study of individual choice under scarcity and its implications for the behaviour of prices and quantities in individual markets.
Think of it as zooming in on one market, one firm, or one consumer, rather than looking at the whole economy.
Macroeconomics
The study of the performance of national economies and the policies that governments use to try to improve that performance.
Think of it as zooming out to look at GDP, unemployment, and inflation across an entire country.
Scarcity
The condition in which wants exceed the resources available to satisfy them. This is the foundational concept that makes economics necessary in the first place.
Rational person
Someone with well-defined goals who tries to fulfil those goals as best he or she can.
In simple terms, this means: someone who weighs costs and benefits and makes consistent choices, not someone who is emotionless or never makes mistakes.
Opportunity cost
The value of what must be forgone to undertake an activity.
Think of it as the next-best thing you gave up. If you spend an hour studying, the opportunity cost is whatever else you would have done with that hour.
Economic surplus
The benefit of taking an action minus its cost.
In simple terms, this means: the net gain from a decision. If the benefit is larger than the cost, the surplus is positive and the action is worth taking.
Marginal benefit
The increase in total benefit that results from carrying out one additional unit of an activity.
Think of it as asking: what do I gain from doing one more?
Marginal cost
The increase in total cost that results from carrying out one additional unit of an activity.
Think of it as asking: what does one more cost me?
Average benefit
The total benefit of undertaking n units of an activity divided by n.
In simple terms, this means: the per-unit benefit across all units so far, not the benefit of the next one.
Average cost
The total cost of undertaking n units of an activity divided by n.
In simple terms, this means: the per-unit cost across all units so far.
Sunk cost
A cost that is beyond recovery at the moment a decision must be made.
Think of it as money already spent that you cannot get back. A rational decision-maker ignores sunk costs because they do not change what happens next.
Buyer's reservation price
The largest dollar amount the buyer would be willing to pay for a good.
In simple terms, this means: the absolute maximum you would hand over before walking away.
Normative economic principle
One that says how people should behave.
Think of it as a value judgement or policy recommendation ("the government should raise the minimum wage").
Positive (or descriptive) economic principle
One that predicts how people will behave.
Think of it as a testable claim about the world ("raising the minimum wage will reduce employment among teenagers"). It can be right or wrong, but it is not a matter of opinion.
A rational person takes an action if, and only if, the benefit of that action is at least as great as its cost.
"Benefit" and "cost" here include everything: money, time, pleasure, inconvenience. Opportunity cost captures the full picture.
Economic surplus (benefit minus cost) is the measure of whether a decision was worthwhile.
Decisions at the margin ask: should I do one more unit of this activity?
The answer depends on comparing marginal benefit to marginal cost, not on averages.
Key rule: keep expanding an activity as long as its marginal benefit exceeds its marginal cost. Stop when they are equal.
A common error is to use average benefit or average cost to make this decision. Averages blend the profitable early units with the less profitable later ones and can mislead badly.
Opportunity cost is not the same as money spent. It is the value of the best alternative you did not choose.
Example: the opportunity cost of attending university is not just tuition. It includes the salary you could have earned by working full-time instead.
Opportunity cost forces you to recognise hidden costs that do not show up on a receipt.
A sunk cost is gone. It cannot be recovered regardless of what you decide next.
Rational decision-making ignores sunk costs entirely. The only costs that matter are those that change with the decision at hand.
Example: you bought a non-refundable concert ticket for $50 but feel ill on the night. The $50 is sunk. The decision to go or stay should depend only on whether you will enjoy the concert more than resting at home.
Positive principles describe or predict behaviour. They can be tested against evidence.
Normative principles prescribe behaviour. They rest on value judgements.
Distinguishing the two is critical in economics. Policy debates often mix them up, which muddies the argument.
Students often confuse marginal cost with average cost. Average cost tells you the per-unit cost so far. Marginal cost tells you the cost of the next unit. Decisions should be based on marginal cost.
Students often think opportunity cost is just the money you spend. It is not. Opportunity cost is the value of the best alternative you forgo, which may include time, enjoyment, or other non-monetary factors.
Students often honour sunk costs by reasoning "I already paid for it, so I should use it." A rational decision-maker ignores what has already been spent and asks only what the options look like from this point forward.
Students sometimes believe that a positive economic statement is one that is "good" or optimistic. In economics, "positive" simply means descriptive or testable. A positive statement can describe something deeply unpleasant.
⚠️ Expect questions that test whether you can distinguish marginal from average. A classic format: "Should the firm produce one more unit?" The answer always depends on marginal cost vs marginal benefit, never on averages.
⚠️ Sunk-cost problems appear frequently. You will be given a scenario where money has already been spent and asked whether it should influence the next decision. The answer is always no.
⚠️ Opportunity cost questions often include non-obvious alternatives. Read carefully for what the person could have done instead, including the value of their time.
⚠️ Know the difference between normative and positive statements cold. Exam questions may present several statements and ask you to classify each one.
True or false: A rational person should continue an activity as long as the average benefit exceeds the average cost.
False. The decision depends on marginal benefit vs marginal cost.
Fill in the blank: The value of the next-best alternative you give up when making a choice is called your ________.
Opportunity cost.
True or false: A sunk cost should influence your decision about what to do next.
False. Sunk costs are irrelevant to forward-looking decisions.
True or false: "The government should lower taxes" is a positive economic statement.
False. It is a normative statement (a value judgement about what should happen).
Fill in the blank: The increase in total cost from producing one more unit of output is called the ________.
Marginal cost.
Q: You have already spent $200 on repairs for your car. It now needs another $300 in repairs to run. A replacement car of equal quality costs $400. Should the $200 you already spent influence your decision?
A: No. The $200 is a sunk cost. The relevant comparison is $300 (repair) vs $400 (replace). You should repair.
Q: You run a lemonade stand. Your average cost per cup across 100 cups is $0.50. The marginal cost of cup 101 is $0.80. A customer offers $0.60 for a cup. Should you sell it?
A: No. The marginal cost of the next cup ($0.80) exceeds the price offered ($0.60). The average cost ($0.50) is irrelevant to this decision.
Q: Maria can earn $15 per hour babysitting. She chooses to spend an evening studying for her economics exam instead. What is the opportunity cost of studying?
A: The opportunity cost is the income she forgoes by not babysitting, which is $15 per hour multiplied by the number of hours she studies, plus any other value she would have gained from her next-best alternative.
Q: Classify the following statement: "A higher minimum wage leads to higher unemployment among teenagers."
A: This is a positive (descriptive) economic principle. It makes a testable prediction about behaviour, regardless of whether one thinks a higher minimum wage is desirable.
Q: What is the difference between economic surplus and buyer's surplus?
A: Economic surplus is the benefit of an action minus its cost, a general concept for evaluating any decision. Buyer's surplus is a narrower concept used in markets: it is the difference between the buyer's reservation price and the price actually paid.
This connects to Chapter 2 (supply and demand) because the concepts of reservation price, marginal cost, and surplus reappear as the building blocks of demand curves, supply curves, and market equilibrium.
Opportunity cost comes back in later chapters on comparative advantage and trade. The marginal-analysis framework extends to production decisions, pricing, and welfare analysis throughout the course.
The normative vs positive distinction matters whenever you encounter policy discussions later in the course, from price controls to taxation.
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