What motivates people as they make choices?
Choices made in Pursuing Self-Interest
Perhaps more than anything else, it is the economist’s answer to this question that distinguishes economics from other fields. Economists assume that individuals make choices that they expect will create the maximum value of some objective, given the constraints they face. Furthermore, economists assume that people’s objectives will be those that serve their own self-interest. Economists assume, for example, that the owners of businesses seek to maximize profit. Given the assumed goal of profit maximization, economists can predict how firms in an industry will respond to changes in the markets in which they operate. Due to relatively higher labour costs in the West, for example, economists are not surprised to see firms moving some of their manufacturing operations overseas. Similarly, in studying consumers, economists assume that individual consumers make choices aimed at maximizing their level of satisfaction.
Choices, Opportunity Cost, and Trade–Off
It is within the context of scarcity that economists define, perhaps the most important concept in all of economics, the concept of opportunity cost. Opportunity cost is the value of the best alternative forgone in making any choice.
The opportunity cost is the value of the best other use to which you could have put your time. If you choose to spend $20 on a potted plant, you have simultaneously chosen to give up the benefits of spending the $20 on pizzas or a paperback book or a night at the movies. If the book is the most valuable of those alternatives, then the opportunity cost of the plant is the value of the enjoyment you otherwise expected to receive from the book.
The concepts of scarcity, choice, and opportunity cost are at the heart of economics. A good is scarce if the choice of one alternative requires that another be given up. The existence of alternative uses forces us to make choices. The opportunity cost of any choice is the value of the best alternative forgone in making it. This is the trade-off that individuals face in making choices. As decision-makers, we have to make trade-offs on what we do with finite resources.
Choices and Marginal Thinking
Economists argue that most choices are made “at the margin.” The margin is the current level of activity. Think of it as the edge from which a choice is to be made. A choice at the margin is a decision to do a little more or a little less of something. Assessing choices at the margin can lead to extremely useful insights.
Consider, for example, the problem of curtailing water consumption when the amount of water available falls short of the amount people now use. Economists argue that one way to induce people to conserve water is to raise its price. A common response to this recommendation is that a higher price would have no effect on water consumption because water is a necessity. But choices in water consumption, like virtually all choices, are made at the margin. Individuals do not make choices about whether they should or should not consume water. Rather, they decide whether to consume a little more or a little less water.
Household water consumption in Canada totals about 329 litres per person per day (McGill University, 2020). Think of that starting point as the edge from which a choice at the margin in water consumption is made. Could a higher price cause you to use less water brushing your teeth, take shorter showers, or water your lawn less? Could a higher price cause people to reduce their use, say, to 328 gallons per person per day? To 327? When we examine the choice to consume water at the margin, the notion that a higher price would reduce consumption seems much more plausible. Prices affect our consumption of water because choices in water consumption, like other choices, are made at the margin.
Marginal Benefit and Marginal Cost
Most decisions involve doing a little more or a little less of something. Such as: should you watch an extra hour of TV, or study instead? Marginal cost and benefit (MC and MB): the additional cost or benefit associated with a small addition to some action. Comparing MC and MB is known as Marginal Analysis.
Marginal analysis is the process of breaking down a decision into a series of ‘yes or no’ decisions. More formally, it is an examination of the additional benefits of an activity compared to the additional costs incurred by that same activity. If benefits > costs, this is the right choice for a rational thinker.
Marginal analysis is an essential concept for everything we learn in economics because it lies at the core of why we make decisions. We have just scratched the surface of it now but will go more in-depth in Chapter 2.
“1.2 The Field of Economics” Principles of Macroeconomics by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.
McGill University. (2022). Water is Life! How much are we using? https://www.mcgill.ca/waterislife/waterathome/how-much-are-we-using