Principle I - People Face Trade-offs, Principles of Economics

How People Make Decisions
• There is no mystery to what an economy is.
• Whether we are talking about the economy of Kerala, the India, or the whole world,
an economy is just a group of people dealing 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
Principle 1: People Face Trade-offs
• To get something that we like, we usually have to give up something else that we also like. Making decisions requires trading off one goal against another.
• Consider a student who must decide how to allocate her most valuable resource-
her time. She can spend all of her time studying economics, spend all of it studying psychology, or divide it 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 she could have spent
napping, bike riding, watching TV, or working at her part-time job for some extra
spending money.
• One classic trade-off is between “guns and butter.” The more a society spends on
national defense (guns) to protect its shores from foreign aggressors, the less it can
spend on consumer goods (butter) to raise the standard of living at home.
• Also important in modern society is the trade-off between a clean environment and
a high level of income.
• Another trade-off society faces is between efficiency and equality. Efficiency means
that society is getting the maximum benefits from its scarce resources. Equality
means that those benefits are distributed uniformly among society’s members.
• In other words, efficiency refers to the size of the economic pie, and equality refers
to how the pie is divided into individual slices.
• Recognizing that people face trade-offs does not by itself tell us what decisions they
will or should make.
• A student should not abandon the study of psychology just because doing so would
increase the time available for the study of economics.
• Society should not stop protecting the environment just because environmental regulations reduce our material standard of living.
• The poor should not be ignored just because helping them distorts work incentives.
• Nonetheless, people are likely to make good decisions only if they understand the
options that are available to them.
• Our study of economics, therefore, starts by acknowledging life’s trade-offs