Principles of economics/ECO212
May 09, 2010
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...