Mar 19, 2017
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How People Make Decisions

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There is no mystery to what an “economy” is. Whether we are talking about the economy of Los Angeles, of the United States, or of the whole world, an economy is just a group of people interacting with one another as they go about their lives. Because the behavior of an economy reflects the behavior of the individuals who make up the economy, we start our study of economics with four principles of in-individual decision making.

The first lesson about making decisions is summarized in the adage: “There is no
such thing as a free lunch.” To get one thing that we like, we usually have to give
up another thing that we like. Making decisions requires trading off one goal
against another.
Consider a student who must decide how to allocate her most valuable re-source—her time. She can spend all of her time studying economics; she can spend
all of her time studying psychology; or she can divide her time between the two
fields. For every hour she studies one subject, she gives up an hour she could have
used studying the other. And for every hour she spends studying, she gives up an
hour that she could have spent napping, bike riding, watching TV, or working at
her part-time job for some extra spending money.

Because people face tradeoffs, making decisions requires comparing the costs and
benefits of alternative courses of action. In many cases, however, the cost of some
action is not as obvious as it might first appear.
Consider, for example, the decision whether to go to college. The benefit is in-tellectual enrichment and a lifetime of better job opportunities. But what is the
cost? To answer this question, you might be tempted to add up the money you spend on tuition, books, room, and board. Yet this total does not truly represent
what you give up to spend a year in college.
The first problem with this answer is that it includes some things that are not
really costs of going to college. Even if you quit school, you would need a place to
sleep and food to eat. Room and board are costs of going to college only to the ex-tent that they are more expensive at college than elsewhere. Indeed, the cost of
room and board at your school might be less than the rent and food expenses that
you would pay living on your own. In this case, the savings on room and board
are a benefit of going to college.
The second problem with this calculation of costs is that it ignores the largest
cost of going to college—your time. When you spend a year listening to lectures,
reading textbooks, and writing papers, you cannot spend that time working at a
job. For most students, the wages given up to attend school are the largest single
cost of their education.
The opportunity costof an item is what you give up to get that item. When
making any decision, such as whether to attend college, decisionmakers should be
aware of the opportunity costs that accompany each possible action. In fact, they
usually are. College-age athletes who can earn millions if they drop out of school
and play professional sports are well aware that their opportunity cost of college
is very high. It is not surprising that they often decide that the benefit is not worth
the cost.

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