I. Principles of Decision Making
There are four economic principles of individual decision making:
1. People Make Tradeoffs
Economic goods and services are limited, while the need to use services of these goods and services seem limitless. There are simply not enough goods and services to satisfy even a small fraction of everyone's consumption desires. Thus, societies must decide how to use these limited resources and distribute them among different people. This means, to get one thing that we like, we usually have to give up another thing that we also like. Making decision requires trading off one goal against another.
Consider a society that decides to spend more on national defense to protect its shores from foreign aggressors: the more the society spends on the national defense, the less it can spend on personal goods to raise its standard of living at home. Or consider the trade-off between a clean air environment and a high level of income. Laws that require firms to reduce pollution have the cost of reducing the incomes of the firm's owners, workers, and customers, while pollution regulations give the society the benefit of a cleaner environment and the improved health that comes with it.
Another trade off society faces is between efficiency and equity. Efficiency deals with a society's ability to get the most effective use o its resources in satisfying people's wants and needs. Equity denotes the fair distribution of benefits of those resources among society's members.
2. When People Choose One Thing They Give Up Something Else
Scarcity of economic resources forces people to make tradeoffs. That is, people must always consider how to spend their own limited incomes or time because resources are limited to satisfy their unlimited needs and wants. Tradeoffs or choosing a one thing means giving up something else. When we give up an item, we lose the benefits of its services to us or incur costs to obtain the benefits of the thing we decided to choose. Thus, making decisions requires comparing the costs and benefits of alternative courses of action. In economics, the term used to reflect whatever must be given up to obtain some item is called opportunity cost.
3. Rational People Think at the Margin
In many situations, decisions in life are made in small incremental or decremental adjustments to the existing plan of action or status quo. Economists call these marginal changes. Imagine a student who is pondering whether she should add one more course next semester. She, as a rational decision-maker, will add the extra course as long as her marginal benefits from carrying one more course exceeds her expected marginal costs. Generally speaking, an individual can make better decisions by thinking at the margin. Likewise, a rational decision-maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.
4. People Respond to Incentive
Since individuals make decisions by comparing costs or benefits, their behavior may change when the costs or benefits change. That is, people respond to incentives. As an example of this, consider public policy toward seat belts and auto safety. In the 1960s, Ralph Nader's book (Mr. Nader is a well-known personality as an advocate for a consumer's interest and a Green Party presidential candidate in 2000 ) Unsafe at Any Speed influenced the Congress to pass a legislation requiring car companies to make seat belts standard equipment on all cars. The direct effect of this law is to save lives. It is this direct impact that motivated Congress to require seat belts.
II. HOW PEOPLE INTERACT
It is so obvious that individuals' decisions affect not only themselves but other people as well. The following three principles state how people interact with one another.
5. Trade Can Make Everyone Better Off
Consider a situation in which a family isolates itself from all other families. That particular
family would need to grow its own food, make its own clothes, and build its own home. Clearly
any family gains much from its ability to trade with others. Trade allows each person to
specialize in the activities he or she does best, whether it is farming, sewing, or home building.
By trading with others, people can buy a greater variety of goods and services at lower cost.
Just as a family would not be better off isolating itself from all other families, a country too would not be better off if it does not exchange goods and services with the rest of nations. Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services.
6. Markets Are Usually a Good Way to Organize Economic Activity
The market possesses the power of resource allocation. Most nations of the world have adopted the use of the market power as a tool for allocating resources rather than other alternatives such as central planning. This is because the market allocates resources through the decentralized decisions of many