Key Economic Concepts: Budgeting, Efficiency, and Rationality

Fundamental Economic Definitions

Budget

Es el cálculo, exposición, planificación y formulación anticipada de los gastos e ingresos de una actividad económica.

Budget Constraint

All possible consumption combinations of goods that someone can afford, given the prices of goods, when all income is spent. It defines the boundary of the opportunity set (limits to the amount of money that is available to spend).

Sunk Costs

Costs that were incurred in the past and cannot be recovered.

The Budget Formula and Calculation

General Budget Formula

The budget formula calculates total expenditure based on prices and quantities:

Budget = P₁ × Q₁ + P₂ × Q₂ + ... + Pₙ × Qₙ

Where P and Q are the price and respective quantity of any number, n, of items purchased, and Budget is the total amount of income available to spend.

Example of a Budget Problem

Consider a scenario where the total budget is $10, and the consumer buys two items:

• Budget = $10
• P₁ = $2 (the price of a burger)
• Q₁ = quantity of burgers (variable)
• P₂ = $0.50 (the price of a bus ticket)
• Q₂ = quantity of tickets (variable)

For Charlie, the budget constraint equation is:

$10 = $2 × Q₁ + $0.50 × Q₂

This equation can then be simplified to determine the possible consumption combinations.

Production and Efficiency Concepts

Production Possibility Frontier (PPF)

A curve that shows the maximum possible output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed.

Law of Diminishing Returns

As additional increments of resources are devoted to a certain purpose, the marginal benefit derived from those additional increments will decline.

Types of Economic Efficiency

Allocative Efficiency

When the mix of goods being produced represents the mix that society most desires.

Productive Efficiency

Given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity of another good that is produced.

Rationality and Marginal Analysis

Assumption of Rationality

Also called the theory of rational behavior, it is the assumption that people will make choices in their own self-interest.

Components of Marginal Analysis

Marginal Analysis

The examination of decisions "on the margin," meaning comparing the costs and benefits of a little more or a little less of an activity.

Marginal Benefit

The difference (or change) in what you receive from a different choice.

Marginal Cost

The difference (or change) in the cost of a different choice.

Economic Statements

Normative Statement

Conclusions based on value judgments that cannot be tested empirically.

Positive Statement

Conclusions based on logic and evidence that can be tested empirically.