How People Make Economic Decisions Paper - Essay Example

Type the company How People Make Economic Decisions Add People primarily make economic decisions based on four basic factors. These factors consist of the following: People confront trade-offs The cost of something acquired is what you give up in order to attain it People making rational decisions do so at the margin People are responsive to incentives The above mentioned four factors can be summarized to give an all encompassing picture of how people make economic decisions. When an individual goes out into the market, he will be faced with a lot of variety and hence options to choose from.

In order to spend a dollar on a particular good or service, an individual must realize he cannot spent the same dollar on another need or desire at the same time. The individual then has to prioritize and the decision making process comes into play. In regards to the second factor, in economics, the cost of a good or service is not necessarily the price at hand of that good or service. Cost as a concept of economics includes other intangible aspects also. For example, a machine may cost lesser than another appliance, however it may have high maintenance costs attached to it, which automatically will bump up the overall cost of the machine in the long run.

In such a situation, the decision making process is crucial as it will decide what costs the individual will ultimately agree to pay for the good or service. The third factor defines an underlying consumer behavior of marginal benefits and marginal costs. This simply means, an individual when making a decision, will compare the additional utility that consuming one more unit of a good will achieve (marginal benefit), to the additional utility that must be given up to obtain the said good (marginal cost).

A rational individual will only purchase the good or service if the marginal benefit exceeds the marginal cost. At optimum, marginal benefit will equal marginal cost. For example, when it came to whether I should take extra courses this year, promising to bring me one step closer to a college scholarship after graduation, I had to compare the marginal benefits to the marginal costs of carrying this decision forward. The marginal benefit included a better overall grade, extra credit, better reputation with the teachers, more knowledge and possibilities of a future scholarship for college.

The costs associated with the decision included more pressure, increased academic burden and stress, and a sacrifice to leisure time. Adding one more course meant, the marginal costs would be equal to marginal benefit and adding more than one meant marginal costs would potentially be higher than marginal benefit as the academic pressure would take a toll on everything else and result in a meltdown. The rational decision in this case was to take up one extra course, where marginal benefit equaled marginal cost.

The only incentives which could have led me to make a different decision and take up more than one course would have been a guaranteed scholarship and a course which was not too challenging, ensuring the marginal cost of this decision still equaled the marginal benefit associated with it. All the decisions which people make every day and the interactions they carry out with one another make up the economy. For economic activity to take place, a portion of the economy must demand goods and another must supply them.

The underling idea is that trade makes everyone better off and the production and purchase of goods is what primarily facilitates economic activity. There are three types of economic system; Market, centrally planned and mixed economies. A market economy is a system where all modes of production lie in the hands of the private sector, a centrally planned economy is one where all the modes of production lie in the hands of an authoritarian government and a mixed economy is a combination of the two, whereby governmental involvement is incorporated into a market economy.

In a market economy firms decide what to make and households decide what to buy with their incomes. When the two parties interact in the economy, their decisions are guided by prices of available goods, which are determined by demand and supply. A firm will try to produce a good or service as cost effectively as possible and households will demand more of that good if it’s at a lesser price. In the case of a planned economy interaction between suppliers and buyers is limited and prices are determined by the government, which do not take social costs and benefits into account, leading to ineffective allocation of resources and a lack of society welfare.

A mixed economy determines prices based on the rationale of demand and supply and hence allocates resources efficiently, while maximizing social welfare owing to government intervention. In this case interaction between suppliers and buyers is adequate with government intervention protecting the interests of both the parties. Reference Mankiw, N.G. (2006). Principles of Microeconomics. Cengage South Western.