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How People Make Economic Decisions

Essay by   •  March 12, 2012  •  Essay  •  513 Words (3 Pages)  •  1,925 Views

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How People Make Economic Decisions

In this paper I will discuss the four principles of decision-making, and the marginal benefits and marginal costs from everyday decisions using personal experience and articles.

The Four Principles of Decision-Making

Principle One: People Face Tradeoffs. An example of facing a tradeoff would be how they manage they're time. They can either spend all their time focusing on work, or focusing on recreation. They could also split time evenly on both. Every minute they spend on one, is a minute they give up on the other.

Principle Two: The Cost of Something Is What You Give Up to Get. An example of this would be deciding whether or not to take a higher paying job in another country. The benefits are better pay, and the experience of living abroad. The costs could be airfare, leaving loved ones, learning a new language and a higher cost of living. It's all about what you'd give up to get what you want.

Principle Three: Rational People Think at the Margin. Rational people try to reach their goals using the opportunities presented them. An example of rational thinking is deciding to spend an extra hour with your children instead of being at work. There are also small incremental changes to an existing plan called marginal change. I will go into more detail about marginal change in the next section.

Principle Four: People Respond to Incentives. Incentives are what cause people to act. For instance, most people don't break the law because they don't want to go to jail. Their incentive for keeping the law is the punishment of losing their freedoms. Now I will discuss marginal change.

Marginal Change

As discussed briefly in Principle three, marginal change is a change in a plan of action. When a rational person is making decisions they do so by comparing the marginal benefits with the marginal costs. In the next section I will give a personal example of how I've compared marginal benefits and marginal costs on a regular basis.

Marginal Benefits and Marginal Costs

Every day I have to make the decision of how many hours I should work. I make $30 an hour. I also value my time. I would say I value my time at $5 an hour. So if I were to work a normal 8 hour day my marginal benefit would be $240. My marginal cost would be $40 for a grand total of $200. Some incentives to make me work more would be if I was offered overtime.

Conclusion

In conclusion, the principles of decision making help people to not only manage their time wisely, but to understand how and why people spend their money. Decision making is an invaluable tool in the economy tool box. The principles of decision making are what drive our economy, because that's what

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