How People Make Economic Decisions

How People Make Economic Decisions

The four principles of individual decision-making are "people face trade-offs," "the cost of something is what you give up to get it," "rational people think at the margin" and "people respond to incentives" which is a set of concepts posited by Harvard economics professor and economic textbook author N. Gregory Mankiw. These principles enable students to understand some of the motivational factors which guide consumers in their interactions with other consumers in the market.

People Face Trade-offs

This principle describes the decision-making process a person must go through prior to an activity. When a consumer goes to purchase a product, he must take into account the fact that the dollar that he spends for the product represents a dollar that can not be used to fill another need or desire. This creates an important check on the consumer's spending power and tends to forcefully prioritize his spending practices. He is limited to first meeting his needs before fulfilling non-necessary desires. Marketeers are very aware of this principle and will often market materials to consumers with an emphasis on or by attempting to create a perception of the consumer's need for the product.

The Cost of Something Is What You Give Up to Get It

A consumer who simply compares the price of items may not be correctly calculating the true cost. Wise consumers will also take into account less-than-tangible costs associated with a given action or purchase. For instance, an item that costs less but requires long-term manual maintenance may be more expensive in the long term, as the owner will have to give up his time and effort to maintain it. His time could be better spent earning money at his job.

Rational People Think at the Margin

Mankiw describes a rational person's willingness to purchase a good as being based on the marginal benefit that one more element of that good will bring to the person. Mankiw points to the difference in value...