Principle 1:
People Face Trade-offs
You may have heard the old saying, "There ain't no such thing as a free lunch." Grammar aside, there is much truth to this adage. To get something that we like, we usually have to give up something else that we also like. Making decisions requires trading off one goal against another
Consider a student who must decide how to allocate her most valuable
resource-her time. She can spend all of her time studying economics, spend all
of it studying psychology, or divide it between the two fields. For every hour she studies one subject, she gives up an hour she could have used studying the other. And for every hour she spends studying, she gives up an hour she could have spent napping, bike riding, watching TV, or working at her part-time job for some extra spending money.
Principle 2:
The Cost of Something Is What You Give Up to Get it
Because people face trade-offs, making decisions requires comparing
sets and benefits to alternative courses of action. In many cases, however, the cost or an action is not as obvious as it might first appear.
Consider the decision to go to college. The main benefits are intellectual enrichment and a lifetime of better job opportunities. But what are the costs? To answer this question, you might be tempted to add up the money you spend on tuition, books, room, and board. Yet this total does not truly represent what you give up to spend a year in college. There are two problems with this calculation. First, it includes some things that are not really costs of going to college. Even if you quit school, you need a place
Principle 3:
Rational people Think at the Margin
Economists normally assume that people ate rational. Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.
Opportunity cost are are in this principle.
As you study economics, you will encounter firms that decide how many workers to hire and how much of their product to manufacture and sell to maximize profits. You will also encounter individuals who decide how much time to spend working and what goods and services to buy with the resulting income to achieve the highest possible level of satisfaction.
Rational people know that decisions in life are rarely black and white but use-
ally involve shades of gray. At dinnertime, the question you face is not "Should fast or eat like a pig?" More likely, you will be asking yourself "Should I take that extra spoonful of mashed potatoes?" When exams roll around, your decision is not between blowing them off and studying 24 hours a day but whether to spend an extra hour reviewing your notes instead of watching TV Economists use the term marginal change.to describe a small incremental adjustment to an existing plan of action Keep in mind that margin means "edge" so marginal changes are adjustments around the edges of what you are doing. Rational people often make decisions by comparing marginal benefits and marginal costs.
For example, suppose you are considering calling a friend on your cell phone.
You decide that talking with her for 10 minutes would give you a benefit that you value at about $7. Your cell phone service costs you $40 per month plus $0.50 per
minute for whatever calls you make. You usually talk for 100 minutes a month, so your total monthly bill is $90 ($0.50 per minute times 100 minutes, plus the $40
fixed fee). You might be tempted to reason as follows: "Because I pay $90 for 100 minutes of calling each month, the average minute on the phone costs me $0.90. So a 10-minute cash costs $9. Because that $9 cost is greater than the $7 benefit, I am going to skip the call." that conclusion is wrong, however. Although the average cost of a 10-minute call is marginal cost-the amount your bill increases if you make the extra call-is
only $5. You will make the right decision only by comparing the marginal banner and the marginal cost. Because the marginal benefit of $7 is greater than the marginal cost of S5, you should make the call. This is a principle that people innately understand: Cell phone users with unlimited minutes (that is, minutes that are tree at the margin) are often prone to making long and frivolous calls.
Thinking at the margin work.
Principle 4:
People Respond to Incentives
An incentive is something (such as the prospect of a punishment or reward) that induces a person to act. Because rational people make decisions by comparing costs and benefits, they respond to incentives. You will see that incentives play a central role in the study of economics. Ones economist went so far as to suggest that the entire field could be summarized as simply "People respond to incentives. The rest is Commentary."
Incentives are key to analyzing how markets work.
For example,
when the price of an apple rises, people decide to eat fewer apples. At the same time, apple orchards decide to hire more workers and harvest more apples. In other words, a higher price in a market provides an incentive for buyers to consume less and an incentive for sellers to produce more. As we will see, the influence of prices on the behavior of consumers and producers is crucial to how a market economy allocates scarce resources.
Public policymakers should never forget about incentives: Many policies change the costs or benefits that people face and, as a result, alter their behavior. A tax on gasoline, for instance, encourages people to drive smaller, more fuel-efficient cars. That is one reason people drive smaller cars in Europe, where gasoline taxes are high, than in the United States, where gasoline taxes are low. A higher gasoline tax also encourages people to carpool, take public transportation, and live closer to where they work. If the tax were larger, more people would be driving hybrid cars, and if it were large enough, they would switch to electric cars.
When policymakers fail to consider how their policies affect incentives, they often end up facing unintended consequences. For example, consider public policy regarding auto safety. Today, all cars have seat belts, but this was not true.
Quick Quiz
Describe an important trade-off you recently faced. Give an example of
some action that has both a monetary and nonmonetary opportunity cost.
Describe an incentive your parents offered to you in an effort to. influence your behavior.
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