How People Make Economic Decisions Debra Phelps Principles of economics/ECO212 May 09, 2010 John Hebert How People Make Economic Decisions People make economic decisions every day. There are four principles of individual decision-making (Mankiw), people face trade-offs, the cost of something one gives up to get it, rational people think at the margin, and people respond to incentives. The principle of economics does affect decision-making, interaction, and workings of the economy as a whole. The first principle is that people face trade-offs.
This means that a person may have to give up something to get something else. Time is a good example of this principle. A person can chose to spend his or her time studying for an exam to ensure a good grade or spend the time having fun with friends and face the possibility of failing the class. The second principle is the cost of something one gives up to get it. A person may have to give up something now to get what one wants in the future. An example of this principle is giving up time and wages to go to school to gain education for higher pay in the future.
The third principle is rational people think at the margin. Rational people are people who systematically and purposefully do the best they can to achieve their objectives. Marginal change is small incremental adjustments to a plan of action, so margin means edge. An example of this principle is a cruise line charged $1300 for a cabin on this ship yet the closer the time gets to boarding the ship the cruise line has not met the objective of having enough people to fill the ship. The line may choose to offer the cabins at a discounted price rather than sail off with the ship being half full of customers.
The fourth principle is people respond to incentives. An incentive is something that induces a person to act, such as the prospect of a punishment or a reward. An example is an airline that has overbooked passengers may offer a $200 voucher for volunteers to take the next flight out. A decision I had to make that compared the marginal benefits and the marginal cost happened three years ago. My family asked if I wanted to go on an Alaskan cruise in three years. My immediate response was “of course I would love to go. ” However, I had to weigh out my final decision.
First part was that I needed to put a down payment of $3000 by next month and the second part was that I would not see the benefit for three years. Three years ago I was not attending college so I had the time, but I did not have the money. I could spend the money on the trip and be short on my bills, food, and gas for the next year trying to catch up, or I could spend the money now and see results now by paying off my bills and having food in my belly and gas in my car. My family is now on the Alaskan cruise and I am attending school with money in my savings and planning my next vacation.
The only incentive that could have led to me going on the trip is if the trip were completely paid for. I did not have the money three years ago and was trying to pay off my credit card. Putting that amount on my credit card was not an option for me because it would lead to an even deeper debt. The principles of economic affect decision making people face trade-offs among alternative goals and people change their behavior in response to the incentives they face. Trade can be mutually beneficial and government can potentially improve markets outcomes if there are some market failures.
The economy as a whole are that productivity is the ultimate source of living standards and that society faces a short-run trade-off between inflation and unemployment. In conclusion when we make economic decision we have to give up something to receive another we compare the cost and benefit when we make our decision and we tend to think rational and incentives play a strong role in our decisions. Reference Mankiw, N. G. (2007). Principles of economics (4th ed. ). : Thomson Learning, Inc.