CHAPTER 1 TEN PRINCIPLES OF ECONOMICS thinking at the margin. Imagine that a plane is about to take off with ten empty seats, and a standby passenger is waiting at the gate willing to pay $300 for a seat Should the airline sell it to him? Of course it should. If the plane has empty seats, the cost of adding one more passenger is minuscule. Although the average cost of flying a passenger is $500, the marginal cost is merely the cost of the bag of peanuts and can of soda that the extra passenger will consume. As long as the standby pas- As thes more than the marginal cost, selling him a ticket is Profitable As these examples show, individuals and firms can make better decisions by thinking at the margin. A rational decisionmaker takes an action if and only if the marginal benefit of the action exceeds the marginal cost PRINCIPLE #4: PEOPLE RESPOND TO INCENTIVES Because people make decisions by comparing costs and benefits, their behavior may change when the costs or benefits change. That is, people respond to incen- tives. When the price of an apple rises, for instance, people decide to eat more pears and fewer apples, because the cost of buying an apple is higher. At the same time, apple orchards decide to hire more workers and harvest more apples, be- cause the benefit of selling an apple is also higher. As we will see, the effect of price on the behavior of buyers and sellers in a market-in this case, the market for apples-is crucial for understanding how the economy works Public policymakers should never forget about incentives, for many polici change the costs or benefits that people face and, therefore, alter behavior. A tax gasoline, for instance, encourages people to drive smaller, more fuel-efficient cars It also encourages people to take public transportation rather than drive and to live closer to where they work. If the tax were large enough, people would start driving electric cars When policymakers fail to consider how their policies affect incentives can end up with results that they did not intend. For example, consider icy regarding auto safety. Today all cars have seat belts, but that was not true 40 BASKETBALL STAR KOBE BRYANT years ago. In the late 1960s, Ralph Nader's book UNsafe at Any Speed generated UNDERSTANDS OPPORTUNITY COST AND much public concern over auto safety. Congress responded with laws requiring car INCENTIVES.DESPITE GOOD HIGH SCHOOL companies to make various safety features, including seat belts, standard equip- GRADES AND SAT SCORES, HE DECIDED ment on all new cars TO SKIP COLLEGE AND GO STRAIGHT T How does a seat belt law affect auto safety? The direct effect is obvious. With THE NBA, WHERE HE EARNED ABOUT S10 MILLION OVER FOUR YEARS. seat belts in all cars, more people wear seat belts, and the probability of surviving a major auto accident rises. In this sense, seat belts save lives. But that's not the end of the story. To fully understand the effects of this law, we must recognize that people change their behavior in response to the incentives they face. The relevant behavior here is the speed and care with which drivers op- erate their cars. Driving slowly and carefully is costly because it uses the driver's time and energy. When deciding how safely to drive, rational people compare the marginal benefit from safer driving to the marginal cost. They drive more slowly and carefully when the benefit of increased safety is high. This explains why peo ple drive more slowly and carefully when roads are icy than when roads are clear Now consider how a seat belt law alters the cost-benefit calculation of a ratio- nal driver Seat belts make accidents less costly for a driver because they reduce the probability of injury or death. Thus, a seat belt law reduces the benefits to slow and careful driving. People respond to seat belts as they would to an improvementCHAPTER 1 TEN PRINCIPLES OF ECONOMICS 7 thinking at the margin. Imagine that a plane is about to take off with ten empty seats, and a standby passenger is waiting at the gate willing to pay $300 for a seat. Should the airline sell it to him? Of course it should. If the plane has empty seats, the cost of adding one more passenger is minuscule. Although the average cost of flying a passenger is $500, the marginal cost is merely the cost of the bag of peanuts and can of soda that the extra passenger will consume. As long as the standby pas￾senger pays more than the marginal cost, selling him a ticket is profitable. As these examples show, individuals and firms can make better decisions by thinking at the margin. A rational decisionmaker takes an action if and only if the marginal benefit of the action exceeds the marginal cost. PRINCIPLE #4: PEOPLE RESPOND TO INCENTIVES Because people make decisions by comparing costs and benefits, their behavior may change when the costs or benefits change. That is, people respond to incen￾tives. When the price of an apple rises, for instance, people decide to eat more pears and fewer apples, because the cost of buying an apple is higher. At the same time, apple orchards decide to hire more workers and harvest more apples, be￾cause the benefit of selling an apple is also higher. As we will see, the effect of price on the behavior of buyers and sellers in a market—in this case, the market for apples—is crucial for understanding how the economy works. Public policymakers should never forget about incentives, for many policies change the costs or benefits that people face and, therefore, alter behavior. A tax on gasoline, for instance, encourages people to drive smaller, more fuel-efficient cars. It also encourages people to take public transportation rather than drive and to live closer to where they work. If the tax were large enough, people would start driving electric cars. When policymakers fail to consider how their policies affect incentives, they can end up with results that they did not intend. For example, consider public pol￾icy regarding auto safety. Today all cars have seat belts, but that was not true 40 years ago. In the late 1960s, Ralph Nader’s book Unsafe at Any Speed generated much public concern over auto safety. Congress responded with laws requiring car companies to make various safety features, including seat belts, standard equip￾ment on all new cars. How does a seat belt law affect auto safety? The direct effect is obvious. With seat belts in all cars, more people wear seat belts, and the probability of surviving a major auto accident rises. In this sense, seat belts save lives. But that’s not the end of the story. To fully understand the effects of this law, we must recognize that people change their behavior in response to the incentives they face. The relevant behavior here is the speed and care with which drivers op￾erate their cars. Driving slowly and carefully is costly because it uses the driver’s time and energy. When deciding how safely to drive, rational people compare the marginal benefit from safer driving to the marginal cost. They drive more slowly and carefully when the benefit of increased safety is high. This explains why peo￾ple drive more slowly and carefully when roads are icy than when roads are clear. Now consider how a seat belt law alters the cost–benefit calculation of a ratio￾nal driver. Seat belts make accidents less costly for a driver because they reduce the probability of injury or death. Thus, a seat belt law reduces the benefits to slow and careful driving. People respond to seat belts as they would to an improvement BASKETBALL STAR KOBE BRYANT UNDERSTANDS OPPORTUNITY COST AND INCENTIVES. DESPITE GOOD HIGH SCHOOL GRADES AND SAT SCORES, HE DECIDED TO SKIP COLLEGE AND GO STRAIGHT TO THE NBA, WHERE HE EARNED ABOUT $10 MILLION OVER FOUR YEARS