Economic Way of Thinking

Economic way of thinking is defined as a way of looking at, and analysing, the way the world works by comparing the costs of an action with the benefits generated

Let us look at how an economist thinks and goes about seeking answers to his questions. There are six key ideas that define the economic way of thinking, given below:

Economic Way of Thinking

1. Trade Off

In today’s world the major problem is scarcity of resources, because of this scarcity there will never be enough of everything to satisfy everyone completely, a choice is a trade-off.

Whenever you choose one thing over another, you are making a tradeoff. You are giving up one thing to get another that you want even more. We have to choose the best alternative amongst the available alternatives. For example, you have INR 25; you have to decide what you will buy with that a snack for a cold drink. Whatever choice you make, you get one and loose one.

Trade-Off is an exchange i.e. letting of one thing for another.

2. Rational Choices

Any choice you make will be a rational choice; a rational choice is a choice which compares cost and benefit. In our earlier example if you are hungry you will choose snacks over cold drink as it will give you more satisfaction than a cold drink.

This point gives rise to a question of what goods and services should be produced and in what quantity. The answer to this question is those goods which people will rationally chose to buy. Example, why are people now purchasing more Samsung phones then Nokia? Answer is more benefit and cost.

3. Benefits

Benefit is measured by economist as ‘the most that a person is willing to give up to get something.” For example, how much are you willing to pay for a pizza by Dominos? Each one of us has in reserve somewhere or the other in our mind a sense of what thing sare really worth. Their maximum value or benefit, and the maximum price we are willing to pay for it.

Benefit is something that is gained or any pleasure derived by an individual; it is determined by the likes and preferences of an individual. For example, an individual might get a kick listening to Heavy Metal, it brings him more satisfaction then a Hip-Hop.

Below grid gives a lighter view on cost and benefits of sleeping an hour late.

Benefits

4. Opportunity Cost

Opportunity cost is the foregone value associated with the current rather than next-best use of an asset. In other words, cost is determined by the highest-valued opportunity that must be foregone to allow current use.

In our first example of INR 25; cold drink was the opportunity cost of snacks i.e. with rupees 25 you could either buy cold drink or snacks.

5. Margin

Let’s understand this with an example; you have to allocate your next two hours between studying and helping your brother in his project, the choice if not all or nothing. To make this decision you will compare the benefits and allocate the time accordingly. You decide how much time will you allocate to study and how much to help your brother on his project based on margin.

We all know what marginal utility, on similar lines marginal benefit is the additional benefit which a person derives from an increase in activity. For example, you have completed preparing for your exams a day in advance, however the marginal benefit will be derived by you if you revise a night before exams. The marginal benefit here would be better grades.

6. Incentives

Self-interest is what is pursued by every individual on this planet, be it you me or any doctor, politician, civil servant, etc… Incentives are the key forces which drive self-interest amongst every individual. Self-interest does not means selfishness, it is to decide how will you use your resources so that they bring the maximum benefit not only to others but also you.

The idea in economics is to predict self-interested choices people make by looking at the incentive. People take those activities which provide them marginal benefits.

 

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