Week 1 How People Make Economic Decisions Paper How People Make Economic Decisions Paper The science of economics consists of constantly analyzing the choices which consumers and producers make when deciding how to use the limited resources available to society with the objective of achieving their goals (Hubbard & O’Brien, 2010, p. 4). This constant analysis is important for society because of scarcity, which basically means that unfortunately the resources available to people are not infinite so it is in everyone’s best interest that these limited resources are used in the most efficient way possible.
What economics does is provide a mean to measure how efficient individual consumers, private organizations and government agencies are at using these valuable resources in pursuit of their individual goals. This paper will look to illustrate the three main assumptions behind the science of economics which explain how people make their economic decisions. The principles to be discussed are: people are rational, people respond to economic incentives, and that optimal decisions are made at the margin.
When economists say that they assume that people are rational, they are not making the statement that all people always make the right decisions that is best for them or that they know everything there is to know about said decision. They are saying that they believe consumers and private and public entities make their decisions after using all available information to them and analyzing what the costs and benefits of these decisions will be.
Since a rational person should always weigh the costs and benefits of their decisions and act according to what should result more beneficial, economists like to assume that people in general are and act rationally as far as economics is concerned. For example, from an economist’s point of view when someone thinks about purchasing some product they will first use the information available to them of how much money they have available and how much the product costs.
Then they will analyze the benefits of purchasing this product with the costs, which in this case could be not being able to purchase something to eat later or put gas in the car for the ride home. Ultimately they would make a rational decision based on this analysis, proving the assumption. The second assumption from which economic principles are based on is that people respond to economic incentives.
People in general will only act if there is something in it for them, be it because of “religious belief, envy, or compassion” (Hubbard & O’Brien, 2010, p. 5), however economists believe that people (consumer and firms) act mostly on economic incentives. For example, upon purchasing a high definition flat screen television often times one is offered an extended in store warranty of one year for a certain price, where if anything should happen to the television set within that time frame it is simply replaced for a new one by the store.
Even though the chances of it breaking down within the first year of purchase and use are small, many people decide to pay the warranty which can come out to several hundred dollars, because of the economic incentive that if it was to break for whatever reason the customer could just trade it in for a brand new one. The third assumption made in economics is that optimal decisions are made at the margin. In the realm of economics the word marginal is used to mean “extra” or “additional” (Hubbard & O’Brien, 2010, p. ), and this is important because economists believe that all decisions consumers and firms make carry with them a marginal benefit and marginal cost. A marginal benefit would be the additional benefit received from a certain decision while marginal cost would be the additional costs to making the same decision. For example, if the author of this paper desired the marginal benefit of impressing the professor he could have made the essay ten pages long with a full page of references.
However, this decision would have had the marginal cost of dedicating so much time to this one essay that he might have to sacrifice the quality of his work for the discussion questions and the learning team essay which also had to be sent. Economists believe that if the best or optimal decision is to be made then a middle ground must be found where the marginal benefit of a decision is equal to the marginal cost of making it. As can be seen many of the assumptions used by economists for creating the principles of economics are concepts which are used in everyday life of rdinary people, not just large private firms or by the government. The three key economic ideas of people are rational, people respond to economic incentives, and optimal decisions are made at the margin may seem like common sense after analysis, but they are still important to know and keep in mind because they are the basis on which the social science known as economics was formed. Without the study of economics there would be no way to ensure that society is putting its highly valuable yet scarce resources to its best use. References Hubbard, R. & O’Brien, A. (2010). Economics (3rd ed. ). Boston, MA: Pearson Hall.