How People Make Decisions
1. People face tradeoffs: To get one thing, you have to give up something else. You may have heard economists say “there is no such thing as a free lunch”. What they mean by this is that, for example, you might get a free bowl of soup at the student co-op, but the soup is not free because you have to give up 35-minutes waiting in line to be served. 2. The cost of something is what you give up to get it: Making a decision requires comparing the costs and benefits of alternative courses of action. The cost of one option is not how much it will cost in dollar terms, but rather the value of your second best alternative. For more explanation, see understanding the cost benefit analysis. 3. Rational people think at the margin: People make decisions by comparing the marginal benefit with the marginal cost. For example, you might buy one cup of coffee in the morning because it helps you start the day, but you might not buy a second cup because this gives you no extra benefit (and costs another $3). 4. People respond to incentives: Behaviour changes when costs or benefits change. For example, if your hourly wages increase then you are likely to work more (unless of course your income is already too high).
How People Interact
5. Trade can make everyone better off: Trade allows people to specialise in what they do best. By trading, each person can then buy a variety of goods or services. For example, you may be a skilled management consultant. Money you earn through your consulting work might be used to build a house even though you may not have the skills to build the house yourself. 6. Markets are usually a good way to organise economic activity: Individuals and firms that operate in a market economy respond to prices and thereby act as if guided by an “invisible hand” which leads the market to allocate resources efficiently. For example, if there is an oversupply of wheat on the world market then...