Principles of Economy and Decision-Making
The four principles applied in decision making within economics were posited by Gregory Makiw to explain the motivations behind decision-making. These principles try to explain the action and process of decision-making and how and why individuals make certain decisions (Mankiw, 2008). The first principle is based on the concept of trade-offs. This principle states a consumer always prioritizes whatever is of utmost importance, because of the limited resources available. Therefore, the consumer always chooses to spend on what is necessary and needed before they can spend on un-necessary things.
The second principle deals with cost, and it posits that a consumer will always pay for a good at a price which s/he deems is worth its value (Mankiw, 2008). According to this principle, a good or service that has more associated expenses may actually make its cost higher than the initial buying cost and thus make it less preferable. The third principle posits that consumers’ willingness to buy a good or pay for a service is dependent on the marginal benefit that the good has on the buyer. Therefore, the lesser the marginal benefit, the lesser the payment that the buyer will be willing to pay for the good or service and vice-versa (Mankiw, 2008). The fourth principle states that consumers will always hold on to their money until they get an incentive to spend on a certain item. These incentives may include a reward or saving for a later time through present expenditure.
The principles of decision-making go hand-in-hand with concepts of marginal costs and benefits-marginal benefit is the extra value that a consumer gets when s/he purchases an extra unit of an good, whereas, the cost associated with the extra unit of good or service is the marginal cost (Arnold, 2008). A typical example would be the purchase of a bed at a discounted rate after acquiring the first unit. When I was shopping for a bed, I found an offer from a furniture store in which one bed cost $50 dollars, but a single purchase of two units of the bed would cost $80 dollars. This meant that the extra unit was offered at a discount of $20 dollars.
The deal was good, but I saw no point in buying an extra bed because I only needed one bed, and the second one would be of no value to me, because I can only sleep on one bed. In this instance the marginal benefit of getting an extra bed at $ 20 dollars less is low and thus making the marginal cost to be regarded high because the bed will offer no benefits of utility. In this instance the marginal benefit was the acquisition of an extra bed at a lower price- a benefit worth $20 dollars, whereas, the marginal cost was $30 dollars that would be spend on acquiring the extra unit. Despite the incentive offered the marginal benefits were low thus leading to no motivation of purchase. However, if other incentives were to be incorporated one would contemplate buying the bed. For example if buying the extra bed would be accompanied by getting a free ticket to a holiday, a bicycle, a raffle ticket or any other thing of value; then one may be attracted to buy the extra unit because of the extra value.
Principles of decision-making affect the economy and economic interactions in various ways. For example, there are limited resources and infinite needs, and as such every economy tries to balance its needs against its resources and as a result trade-offs have to be done and compromises reached so as to select the best and highest choice of value for application of the limited resources.
According to Lee and Doti (1991), market economies are economies in which market forces shape the price and level of production, through market incentives such as demand and supply. This kind of economy is under no control; instead it freely flows according to the market forces. On the other hand, a centrally planned economy is an economy in which control and regulation is exercised by a central body, mainly the government. The central body determines pricing and controls supply and availability of certain commodities. A mixed economy is actually an amalgam of a market economy and a centrally planned economy in which the production, distribution and pricing of certain commodities and services are regulated whereas, others are left to thrive in the market economy where the market forces shape their production and distribution (Lee & Doti, 1991).
In a market economy the production, distribution and pricing is mainly determined by two forces i.e. demand and supply. If the demand is high, then supply tends to adjust upwards and production increases as prices rise. But if the demand is low production reduces and supply tends to adjust downwards. In a controlled economy these factors play no role and demand and supply is kept constant and only adjusted through policy transformation, and as such market forces do not matter. In a mixed economy the forces of demand, supply and regulatory control influence production, distribution and pricing, but notably the free forces of the market tend to override the regulations in a mixed market (Lee & Doti, 1991).
References
Arnold, A. R. (2008),. Microeconomics, 9th edition, Cengage Learning
Lee, R. D. and Doti, L. J. (1991),. The Market Economy: A Reader, Oxford University Press, USA
Mankiw, G. N. (2008),. Principles of Macroeconomics, 5th edition, Cengage Learning
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