The Four Principles of Individual Decision-Making in Economics
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. Mankiw has articulated these principles in a series of economics textbooks. The four principles are: "people face trade-offs," "the cost of something is what you give up to get it," "rational people think at the margin" and "people respond to incentives."
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People Face Trade-offs
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This principle describes the decision-making process a person must go through prior to an activity. When a consumer goes to purchase a product, he must take into account the fact that the dollar that he spends for the product represents a dollar that can not be used to fill another need or desire. This creates an important check on the consumer's spending power and tends to forcefully prioritize his spending practices. He is limited to first meeting his needs before fulfilling non-necessary desires. Marketeers are very aware of this principle and will often market materials to consumers with an emphasis on or by attempting to create a perception of the consumer's need for the product.
The Cost of Something Is What You Give Up to Get It
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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 associated with a given action or purchase. For instance, an item that costs less but 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.
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Rational People Think at the Margin
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Mankiw describes a rational person's willingness to purchase a good as being 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 will rarely come at a significant cost to the person. However, a marginal increase in diamonds is extremely valuable.
People Respond to Incentives
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There is a reason why consumers will hold onto their hard-earned money until the next big sale. Retailers often use marketing to incentivize consumer behavior, convincing them that to spend money now is to save or earn a reward for later.
Controversy
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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.
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References
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