Every economic issue involves, at its most basic level, individual choice—decisions by an individual about what to do and what not to do. In fact, you might say that it isn’t economics if it isn’t about choice.

Step into a big store like Walmart or Hudson’s Bay. There are thousands of different products available, and it is extremely unlikely that you—or anyone else—could afford to buy everything you might want to have. And anyway, there’s only so much space in your dorm room or apartment. So will you buy another bookcase or a mini-refrigerator? Given limitations on your budget and your living space, you must choose which products to buy and which to leave on the shelf.

The fact that those products are on the shelf in the first place involves choice—the store manager chose to put them there, and the manufacturers of the products chose to produce them. All economic activities involve individual choice.

Four economic principles underlie the economics of individual choice, as shown in Table 1-1. We’ll now examine each of these principles in more detail.

You can’t always get what you want. Everyone would like to have a beautiful house in a great location (and have help with the housecleaning), a new car or two, and a nice vacation in a fancy hotel. But even in a rich country like Canada, not many families can afford all that. So they must make choices—whether to travel by train through the Rockies this year or buy a better car, whether to make do with a small backyard or accept a longer commute in order to live where land is cheaper.

Limited income isn’t the only thing that keeps people from having everything they want. Time is also in limited supply: there are only 24 hours in a day. And because the time we have is limited, choosing to spend time on one activity also means choosing not to spend time on a different activity—spending time studying for an exam means forgoing a night spent watching a movie. Indeed, many people are so limited by the number of hours in the day that they are willing to trade money for time. For example, convenience stores normally charge higher prices than a regular supermarket. But they fulfill a valuable role by catering to time-pressured customers who would rather pay more than travel farther to the supermarket.

This leads us to our first principle of individual choice:

People must make choices because resources are scarce.

A resource is anything that can be used to produce something else. Lists of the economy’s resources usually begin with land, labour (the time of workers), capital (machinery, buildings, and other manufactured productive assets), and human capital (the educational achievements and skills of workers). A resource is scarce when there’s not enough of the resource available to satisfy all the ways a society wants to use it. There are many scarce resources. These include natural resources—resources that come from the physical environment, such as minerals, lumber, and petroleum. There is also a limited quantity of human resources—labour, skill, and intelligence. And in a growing world economy with a rapidly increasing human population, even clean air and water have become scarce resources.

Just as individuals must make choices, the scarcity of resources means that society as a whole must make choices. One way a society makes choices is by allowing them to emerge as the result of many individual choices, which is what usually happens in a market economy. For example, Canadians as a group have only so many hours in a week: how many of those hours will they spend going to supermarkets to get lower prices, rather than saving time by shopping at convenience stores? The answer is the sum of individual decisions: each of the millions of individuals in the economy makes his or her own choice about where to shop, and the overall choice is simply the sum of those individual decisions.

But for various reasons, there are some decisions that a society decides are best not left to individual choice. For example, the authors live in areas that until recently were mainly farmland but are now being rapidly built up. Most local residents feel that the community would be a more pleasant place to live if some of the land was left undeveloped. But no individual has an incentive to keep his or her land as open space, rather than sell it to a developer. So, a trend has emerged in many communities across Canada of governments either purchasing undeveloped land, or putting restrictions on its use, to preserve it as open space. For example, the federal government created Rouge Park, Canada’s first urban national park, in the Greater Toronto area, to protect about 40 square kilometres of wilderness. The Agricultural Land Reserve was created by the provincial government of British Columbia to protect about 47 000 square kilometres of agricultural land. The Ontario government established the 7300 square kilometre greenbelt surrounding the Golden Horseshoe region to protect farmland and natural space from urban development. Similar greenbelts are proposed for Montreal and Quebec City.

We’ll see in later chapters why decisions about how to use scarce resources are often best left to individuals but sometimes should be made at a higher, community-wide, level.

It is the last term before you graduate, and your class schedule allows you to take only one elective. There are two, however, that you would really like to take: Intro to Computer Graphics and History of Jazz.

Suppose you decide to take the History of Jazz course. What’s the cost of that decision? It is the fact that you can’t take the computer graphics class, your next best alternative choice. Economists call that kind of cost—what you must give up in order to get an item you want—the opportunity cost of that item. This leads us to our second principle of individual choice:

The opportunity cost of an item—what you must give up in order to get it—is its true cost.

So the opportunity cost of taking the History of Jazz class is the benefit you would have derived from the Intro to Computer Graphics class.

The concept of opportunity cost is crucial to understanding individual choice because, in the end, all decisions dealing with scarcity involve opportunity costs. That’s because every choice you make means forgoing some other alternative and these costs can be both monetary and non-monetary.

Let’s consider two cases for our elective course example. First, suppose that taking any elective class involves a tuition fee of $750. In this case, you would have to spend that $750 no matter which class you take. So what you give up to take the History of Jazz class is still only the benefit derived from the computer graphics class, period—you would have to spend that $750 either way. But suppose there isn’t any fee for the computer graphics class. In that case, what you give up to take the jazz class is the benefit from the computer graphics class plus the benefit you could have gained from spending the $750 on other things.

So the opportunity costs of taking the History of Jazz class are both monetary (any additional tuition you paid over the computer graphics class) and non-monetary (the benefits derived from taking the computer graphics class). In other words, the real cost of taking your preferred class is everything you must give up (by not choosing your next best alternative) to get it. As you expand the set of decisions that underlie each choice—whether to take an elective or not, whether to finish this term or not, whether to drop out or not—you’ll realize that all costs are ultimately opportunity costs.

Sometimes the money you have to pay for something is a good indication of its opportunity cost. But many times it is not. One very important example of how poorly monetary cost alone can indicate opportunity cost is the cost of attending college or university. Tuition and housing are major monetary expenses for most post-secondary students; but even if these things were free, attending school would still be an expensive proposition because most college and university students, if they were not in school, would have a job. That is, by going to college or university, students forgo the income they could have earned if they had worked instead. This means that the opportunity cost of attending a post-secondary institution is what you pay for tuition and housing plus the forgone income you would have earned in a job.

It’s easy to see that the opportunity cost of going to a post-secondary institution is especially high for people who could be earning a lot during what would otherwise have been their university or college years. That is why star athletes like Sidney Crosby, entertainers like Celine Dion, and entrepreneurs like Mike Lazardis, founder of BlackBerry, often skip or drop out of college. Other famous people who left school early include Mark Zuckerberg, Bill Gates, Steve Jobs, and Mick Jagger.

Some important decisions involve an “either–or” choice—for example, you decide either to go to college or university or to begin working; you decide either to take economics or to take something else. But other important decisions involve “how much” choices—for example, if you are taking both economics and chemistry this semester, you must decide how much time to spend studying for each. When it comes to understanding “how much” decisions, economics has an important insight to offer: “how much” is a decision made at the margin.

Suppose you are taking both economics and chemistry. And suppose you are a premed student, so your grade in chemistry matters more to you than your grade in economics. Does that therefore imply that you should spend all your study time on chemistry and wing it on the economics exam? Probably not; even if you think your chemistry grade is more important, you should put some effort into studying economics.

Spending more time studying chemistry involves a benefit (a higher expected grade in that course) and a cost (you could have spent that time doing something else, such as studying to get a higher grade in economics). That is, your decision involves a trade-off—a comparison of costs and benefits.

How do you decide this kind of “how much” question? The typical answer is that you make the decision a bit at a time, by asking how you should spend the next hour. Say both exams are on the same day, and the night before you spend time reviewing your notes for both courses. At 6:00 P.M., you decide that it’s a good idea to spend at least an hour on each course. At 8:00 P.M., you decide you’d better spend another hour on each course. At 10:00 P.M., you are getting tired and figure you have one more hour to study before bed—chemistry or economics? If you are pre-med, it’s likely to be chemistry; if you are pre-MBA, it’s likely to be economics.

Note how you’ve made the decision to allocate your time: at each point the question is whether or not to spend one more hour on either course. And in deciding whether to spend another hour studying for chemistry, you weigh the costs (an hour forgone of studying for economics or an hour forgone of sleeping) versus the benefits (a likely increase in your chemistry grade). As long as the benefit of studying chemistry for one more hour outweighs the cost, you should choose to study for that additional hour.

Decisions of this type—whether to do a bit more or a bit less of an activity, like what to do with your next hour, your next dollar, and so on—are marginal decisions. This brings us to our third principle of individual choice:

“How much” decisions require making trade-offs at the margin: comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less.

The study of such decisions is known as marginal analysis. Many of the questions that we face in economics—as well as in real life—involve marginal analysis: How many workers should I hire in my shop? After how many kilometres of driving should I change the oil in my car? What is an acceptable rate of negative side effects from a new medicine? Marginal analysis plays a central role in economics because it is the key to deciding “how much” of an activity to do.

One day, while listening to the morning financial news, one of the American-based authors of this textbook heard a great tip about how to park cheaply in Manhattan. Garages in the Wall Street area charge as much as $30 per day. But according to the newscaster, some people had found a better way: instead of parking in a garage, they had their oil changed at the Manhattan Jiffy Lube, where it costs $19.95 to change your oil—and they keep your car all day!

It’s a great story, but unfortunately it turned out not to be true—in fact, there is no Jiffy Lube in Manhattan. But if there were, you can be sure there would be a lot of oil changes there. Why? Because when people are offered opportunities to make themselves better off, they normally take them—and if they could find a way to park their car all day for $19.95 rather than $30, they would.

In this example economists say that people are responding to an incentive—an opportunity to make themselves better off. We can now state our fourth principle of individual choice:

People usually respond to incentives, exploiting opportunities to make themselves better off.

When you try to predict how individuals will behave in an economic situation, it is a very good bet that they will respond to incentives—that is, exploit opportunities to make themselves better off. Furthermore, individuals will continue to exploit these opportunities until they have been fully exhausted. If there really were a Manhattan Jiffy Lube and an oil change really were a cheap way to park your car, we can safely predict that before long the waiting list for oil changes would be weeks, if not months, long.

In fact, the principle that people will exploit opportunities to make themselves better off is the basis of all predictions by economists about individual behaviour. If the earnings of those who get MBAs soar while the earnings of those who get law degrees decline, we can expect more students to go to business school and fewer to go to law school. If the price of gasoline rises and stays high for an extended period of time, we can expect people to buy smaller cars with better fuel efficiency—making themselves better off in the presence of higher gas prices by driving more fuel-efficient cars.

One last point: economists tend to be skeptical of any attempt to change people’s behaviour that doesn’t change their incentives. For example, a plan that calls on manufacturers to reduce pollution voluntarily probably won’t be effective because it hasn’t changed manufacturers’ incentives. In contrast, a plan that gives them a financial reward to reduce pollution or a penalty for not doing so is a lot more likely to work because it has changed their incentives.

So are we ready to do economics? Not yet—because most of the interesting things that happen in the economy are the result not merely of individual choices but of the way in which individual choices interact.