Introduction to the Economic Decision-Making

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Basically, there are four principles to individual decision making. The first principle is that of scarcity. Economic decisions are characterized by tradeoffs. Individuals face tradeoffs when they have to decide to have one thing in place of another because resources are scarce.

The second principle is that of opportunity cost. Opportunity cost simply means the cost of what must be given up in order to get what you want (Frank, Bernanke & Kaufman, 2007). Making economic decisions involves evaluating and comparing the cost and benefits of alternatives for the chosen course of action.

The third principle is rationality. Rationality means that, every economic decision made must be evaluated on the basis of its marginal benefits over its associated marginal costs (Hubbard & O’Brien, 2010). This principle recognizes that, even very small (marginal) adjustments to a decision can bring about very great changes eventually.

It is assumed that rational people will always go for that alternative that yields the highest marginal benefits. Fourth and final, is incentives. This principle means that, economic decisions must have incentives to make them convincing.

A perfect example is probably the study time of at least an hour a day I have put forth to be doing my own private studies on this particular subject. In making this decision, I considered two things; time and the relevance of a better grade to my future career. In this case, the one hour a day is the marginal cost and better grade is the marginal benefit.

I would have however opted for a different decision, should the grade I scored on this subject never mattered a great deal to my final grade and future career.

Principles of economics basically work two ways; on one hand are producers and on the other hand the consumers. As relates producers, economics tries to answer these three questions; what to produce, how to produce it and how much, and for whom.

As relates consumers, economics tries to answer these three questions; what to consume, how much of it, and from whom. Producers must compare the marginal benefits against the marginal costs to decide what to produce. Consumers on the other hand must evaluate the value they get against what they chose to give it up for be it money or other resources.

It is therefore the interaction on one hand the producers and on the other hand consumers that determines how the economy works to achieve equilibrium. It basically is the application of economic principles on one hand by consumers and on the other producers that the forces of demand and supply are founded and hence a market economy.

The main attributes of a market economy is that buyers and sellers are the main participants in the market and that there is no outside interference by the government. In a centrally planned economy, a central agency such as the government is involved in planning and making major economic decisions. A mixed economy is where there is a mix of buyers and sellers allowed to make some decisions as well as the government (Mankiw, 2008).

The type of economic system in place to larger extent affects the economic interactions. In purely market system, the forces of supply and demand fully define economic interactions. The planned economy on the other hand, supply and demand forces play a very minimal role in market interactions as it is the government or central agency that determines the questions of what, how, and by whom. In a mixed economy, supply and demand forces play a significant role but the central agency comes in to correct the imperfections brought about for instance by information asymmetry.

References

Frank, R. H., Bernanke, B. and Kaufman, R. T. (2007. )Principles of economics, 3rd ed., New York: McGraw-Hill/Irwin

Hubbard, R. & O’Brien, A. (2010). Economics (3rd ed.). Boston, MA: Pearson Hall.

Mankiw, N. G. (2008). Principles of economics, 5th ed., New York: Cengage Learning

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