How People Make Economic Decisions

How People Make Economic Decisions

ECO/212

May 10, 2010

How People Make Economic Decisions

People make economic decisions every day whether they realize it or not. For example, most people have had a decision relating to gas, are they going to stop at the first gas station on the way home or are they going to check for lower prices along the way. There are four principles to making an individual economic decision. They are trade offs, cost of something, rational thinking and incentives.

Four Principles of Economic Decision-Making

People face trade-offs by having to give up something to get what they want or need. For example, people give up spending time with family and friends to work overtime to make extra money. Because of trade-offs, making decisions require comparing the costs and benefits of alternative courses of action (Mankiw, 2007).

Then there is the cost of something, which is what a person gives up to attain it comparing the costs and benefits of alternative courses of action (Mankiw, 2007). Let’s say you wanted to go to the movies with your friends but you cannot because you have too much homework. The cost is that you gave up the movie to focus on school work.

A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost (Mankiw, 2007). For example, I decided to sell my car; I had to make a decision to sell my car fully intact or for parts. If I sold the car fully intact I could probably make about $1500 or if I sold the car for parts I may make more or less and would take a lot longer to sell off. In the end I sold the car fully intact and did not take a chance on selling it for parts not knowing exactly how much money I would make and the length of time it would take to sell all the parts.

Lastly we have incentives, people like incentives. An incentive is something (such as the prospect of a punishment or a reward) that induces a person to act...