Economic Reasoning Principles

• PEOPLE FACE TRADEOFFS

Scarcity exists and it doesn’t go away.

Because resources are limited, people must make choices.

• PEOPLE ECONOMIZE

People choose the alternatives that they perceive to offer the greatest excess of benefits over costs.

• ALL CHOICES INVOLVE COSTS

The opportunity cost of a choice is the foregone alternative, the (benefits of the) alternative that was given up.

• Don’t ask:  “What could I have done?” Ask:  “What would I have done?”

It’s only the “next-best” alternative that matters.

• THE CONSEQUENCES OF CHOICES LIE IN THE FUTURE

Decisions are made in light of an unknown future, based on expected costs and expected benefits.
Information, experience, and knowledge inform decision-making but do not eliminate uncertainty.

• RATIONAL DECISIONS OCCUR AT THE MARGIN

All-or-nothing decisions are extremely rare. Most decisions are best made by weighing the expected benefits and expected costs of the next increment:  For example, the decision is not “Should we paint the house?” but  “Should we paint the house this summer or wait a year?” or “Should we paint the house ourselves or hire someone to do it?”

• PEOPLE RESPOND TO INCENTIVES

Incentives are rewards or punishments that influence people’s decisions.

When incentives change, people’s behavior changes in predicable ways.
Incentives are shaped by a society’s institutions, the formal and informal “rules of the game.”

• PRICES ARE EXTREMELY POWERFUL INCENTIVES

Prices change in dynamic economies as the relative demands for and supplies of goods, services, and resources changes.  The changing prices change people’s opportunity costs and thus, the choices they make.

• VOLUNTARY TRADE CREATES WEALTH

Voluntary trade occurs only when both parties expect to benefit from the exchange.
Giving up things of lesser value for things of greater value makes all parties to the exchange better off.

Specialization allows people to produce more by concentrating on what they do best and trading their surplus goods or services to obtain other goods and services.  Society benefits as producers specialize in what others value.

• MARKETS FACILITATE EXCHANGE AND INCREASE INDIVIDUAL FREEDOM

Market institutions, the written and unwritten rules governing exchange in the economy, enhance personal freedom by allowing people to make decisions in light of their perceptions of the expected costs and expected benefits they face.

• GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES

Externalities, lack of competition, defining and enforcing property rights, free-rider problems, and the desire to promote social goals like equity, bring the government into the economy. The pertinent question when considering government action is “Do the benefits outweigh the costs?”

• INDIVIDUAL AND NATIONAL STANDARDS OF LIVING DEPEND ON THE ABILITY TO PRODUCE GOODS AND SERVICES

Increased labor productivity raises incomes and standards of living.  Productivity levels can be changed over time, with improvements in education and technology.