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18/10/2018 05:03:26 PM

How people make decisions in the economy- P2

3. Principle 3: Rational People Think at the Margin

       Economists generally assume that people are rational. Rational people that systematically and purposefully doing the best you can to achieve your objectives. In economic, consumers want to purchase the goods and services that allow them the greatest level of satisfaction given their incomes and the prices they face. Firm want to produce the level of output that maximizes the profits the firms earn.

       Many decisions in life involve incremental decisions: Should I remain in school this semester? Should I take another course this semester? Should I study another hour for tomorrow’s exam? Economists use the term marginal changes to describe a small incremental adjustment to a plan of action. Rational people often make decisions by comparing marginal benefits and marginal costs.

       For example, consider an airline deciding how much to charge passengers who fly standby. Suppose that flying a 200-seat plane across the United States costs the airline $100,000. In this case, the average cost of each seat is $100,000/200, which is $500. One might be tempted to conclude that the airline should never sell a ticket for less than $500. In fact, a rational airline can often find ways to raise its profits by thinking at the margin. Imagine that a plane is about to take off with ten empty seats, and a standby passenger waiting at the gate will pay $300 for a seat. Should the airline sell the ticket? Of course it should. If the plane has empty seats, the cost of adding one more passenger is tiny. Although the average cost of flying a passenger is $500, the marginal cost is merely the cost of the bag of peanuts and can of soda that the extra passenger will consume. As long as the standby passenger pays more than the marginal cost, selling the ticket is profitable.

       A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost. This principle can explain why airlines are willing to sell a ticket below average cost and why people are willing to pay more for diamonds than for water. It can take some time to get used to the logic of marginal thinking, but the study of economics will give you ample opportunity to practice.

4. Principle 4: People Respond to Incentives

       An incentive is something that induces a person to act. Because rational people make decisions by weighing costs and benefits, their decisions may change in response to incentives. Incentives are crucial 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 for 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, therefore, 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 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. Sometimes policymakers fail to understand how policies alter incentives and behavior and a policy may lead to unintended consequences. Example: Seat belt laws increase the use of seat belts but lower the incentives of individuals to drive safely. This leads to an increase in the number of car accidents. This also leads to an increased risk for pedestrians.

MBA. Nguyen Thi My My