The Four Principles of Individual Decision-Making in Economics

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The four principles of individual decision-making are a set of concepts posited by Harvard economics professor and economic textbook author N. Gregory Mankiw. These principles enable students to understand some of the motivational factors which guide consumers in their interactions with other consumers in the market.

People Face Trade-offs

  • This principle describes the decision-making process a person must go through before an activity. When a consumer goes to purchase a product, he must consider that the dollar he spends for the product represents a dollar that cannot be used to buy another need or desire. This creates an important check on spending power and tends to forcefully prioritize the consumer's spending practices. He first meets his needs before fulfilling non-necessary desires. Marketeers are very aware of this principle and will often market materials to consumers based on need.

The Cost of Something Is What You Give Up to Get It

  • A consumer who simply compares the price of items may not be correctly calculating the true cost. Wise consumers will also take into account less-than-tangible costs of a given action or purchase. For instance, an item that costs less but that requires long-term manual maintenance may be more expensive in the long term, as the owner will have to give up his time and effort to maintain it. His time could be better spent earning money at his job.

Rational People Think at the Margin

  • Mankiw describes a rational person’s willingness to purchase a good as based on the marginal benefit that one more element of that good will bring to the person. Mankiw points to the difference in value between water and diamonds. A marginal increase in a person’s water supply rarely comes at a significant cost. However, a marginal increase in diamonds is extremely valuable.

People Respond to Incentives

  • There is a reason why consumers hold onto their hard-earned money until the next big sale. Retailers often use marketing to incentivize consumer behavior, convincing them to spend money now to save or earn a reward for later.

Controversy

  • Writing in his 2009 essay “Toxic Textbooks," writer Edward Fullbrook argues that Mankiw fails to describe how his four principles were discovered and is asking students to accept them on faith.

References

  • Photo Credit leaf/iStock/Getty Images
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