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18/10/2018 05:01:54 PM

How people make decisions in the economy- P1

There is no mystery to what an economy is. Whether we are talking about the economy of Los Angeles, the United States, or the whole world, an economy is just a group of people dealing with one another as they go about their lives. Because the behavior of an economy reflects the behavior of the individuals who make up the economy, we begin our study of economics with four principles of individual decision making.

1. Pinciple 1: People Face Trade-offs

       “There ain’t no such thing as a free lunch.” To get one thing that we like, we usually have to give up another thing that we 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 her time studying economics, spend all of it studying psychology, or divide it between the two fields. And for every hour she spends studying, she gives up an hour that she could have spent napping, bike riding, watching TV, or working at her part-time job for some extra spending money.

       Consider parents deciding how to spend their family income. They can buy food, clothing, or a family vacation. When they choose to spend an extra dollar on one of these goods, they have one less dollar to spend on some other good. Society faces trade off between spends on national defense (guns) to protect its shores from foreign aggressors, the less it can spend on consumer goods (butter) to raise the standard of living at home. Also important in modern society is the trade-off between a clean environment and a high level of income.

       Another trade off that society faces is the trade-off between efficiency and equality. Efficiency means that the property of society getting the maximum benefits from its scarce resources. In other words, efficiency refers to the size of the economic pie. Equality means that the property of distributing economic prosperity uniformly among the members of society. It refers to how the pie is dividual slices. When government policies are designed, these two goals often conflict. Consider, for instance, policies aimed at equalizing the distribution of economic well-being. Some of these policies, such as the welfare system or unemployment insurance, try to help the members of society who are most in need. Others, such as the individual income tax, ask the financially successful to contribute more than others to support the government. While achieving greater equality, these policies reduce efficiency. When the government redistributes income from the rich to the poor, it reduces the reward for working hard; as a result, people work less and produce fewer goods and services. In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.

2. Principle 2: The Cost of Something Is What You Give Up to Get It

       Because people face trade-offs, making decisions requires comparing the costs and benefits of alternative courses of action. In many cases, however, the cost of 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. We cannot count room and board (at least all of the cost) because the student would have to pay for food and shelter even if he was not in school. We would want to count the value of the student’s time because he could be working for pay instead of attending classes and studying.

       The opportunity cost is whatever must be given up in order to obtain some item. When making any decision, decision makers should be aware of the opportunity costs that each accompany possible action.

MBA. Nguyen Thi My My

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