- Effective
decision-making requires comparing the additional (marginal) costs
of the alternatives with the additional (marginal) benefits. Most
choices involve doing a little more or a little less of something;
few choices are all or nothing decisions. Furthermore, people respond
predictably to positive and negative incentives.
- To
make decisions that provide the greatest possible return from the
resources available, people and organizations must weigh the benefits
and costs of using their resources to do a little more of some things,
and little less of others. For example, to use their time effectively,
students must weigh the benefits and costs of spending another hour
studying economics, rather than listening to music or talking with
friends. School officials must decide whether to use some of its funds
to buy more books for the library, more helmets for the football team,
or more equipment for teachers to use in their classrooms. Company
managers and directors must choose which products to make and whether
to increase or decrease the amount that they produce. The President,
Congress, and other government officials must decide which public
spending programs to increase, decrease, or leave unchanged resource
levels devoted to different activities.
Economic incentives are additional rewards or penalties people receive
from engaging in more or less of a particular activity. Understanding
rewards and penalties help people make the choices they need to make
to achieve their goals. Prices, wages, profits, subsidies and taxes
are common economic incentives, e.g. subsidizing an activity usually
leads to more of it being provided; taxing or penalizing normally
leads to less of it. Most choices are made "at the margin"
and involve getting a little more of one thing by giving up a little
of something else.
- An
opportunity cost is what you give up when you decide to do something.
For economists, that is the true cost of anything.
- To
determine the best level of consumption of a product, people must
compare the additional benefits with the additional costs of consuming
a little more or a little less.
- Marginal
benefit is the change in total benefit resulting from an action. As
long as the marginal benefit of an activity exceeds the marginal cost,
people are better off doing more of it. When the marginal cost exceeds
the marginal benefit, they are better off doing less of it.
- To
produce the profit-maximizing level of output and hire the optimal
number of workers and other resources, producers must compare the
marginal benefits and the marginal costs of producing a little more
with the marginal costs and benefits of producing a little less.
- To
determine the optimal level of a public policy program, voters and
government officials must compare the marginal benefits and marginal
costs of providing a little more or a little less of the programs'
services.
- People's
views of rewards and penalties differ because people have different
values. Thus, an incentive can influence different individuals in
different ways. However, responses to incentives are predictable,
because people usually pursue their self-interest. Incentives can
be monetary or non-monetary.
- Acting
as consumers, producers, workers, savers, investors, and citizens,
people respond to incentives in order to allocate their scarce resources
in ways that provide the highest possible returns to them.
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