This is “Everyday Decisions”, chapter 3 from the book Theory and Applications of Microeconomics (v. 1.0).
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Economics is about you. It is about how you make choices. It is about how you interact with other people. It is about the work you do and how you spend your leisure time. It is about the money you have in your pocket and how you choose to spend it. Because economics is about your choices plus everyone else’s, this is where we begin. As far as your own life is concerned, you are the most important economic decision maker of all. So we begin with questions you answer every day:
Economists don’t presume to tell you what you should do with your time and money. Rather, studying economics can help you better understand your own choices and make better decisions as a consequence. Economics provides guidelines about how to make smart choices. Our goal is that after you understand the material in this chapter, you will think differently about your everyday decisions.
Decisions about spending money and time have a key feature in common: scarcity. You have more or less unlimited desires for things you might buy and ways that you might spend your time. But the time and the money available to you are limited. You don’t have enough money to buy everything you would like to own, and you don’t have enough time to do everything you would like to do.
Because both time and money are scarce, whenever you want more of one thing, you must accept that you will have less of something else. If you buy another game for your Xbox, then you can’t spend that money on chocolate bars or movies. If you spend an hour playing that game, then that hour cannot be spent studying or sleeping. Scarcity tells us that everything has a cost. The study of decision making in this chapter is built around this tension. Resources such as time and money are limited even though desires are essentially limitless.
We tackle the two questions of this chapter in turn, but you will see that there are close parallels between them. We begin by looking at spending decisions. Although we have said that money is scarce, a more precise statement is that you have limited income. (Economists usually use the term “money” more specifically to mean the assets, such as currency in your wallet or funds in your checking account, that you use to buy things.) Because your income is limited, your spending opportunities are also limited. We show how to use the prices of goods and services, together with your income, to analyze what spending decisions are possible for you. Then we think about what people’s wants and desires look like. Finally, we put these ideas together and uncover some principles about how to make choices that will best satisfy these desires.
Your decisions about what to buy therefore depend on how much income you have and the prices of goods and services. Economics summarizes these decisions in a simple way by using the concept of demand. We show how demand arises from the choices you make. Demand is one of the most useful ideas in economics and lies at the heart of almost everything we study in this book.
Finally, we turn to the decision about how to spend your time. Again, we begin with the idea that your resources are limited: there are only so many hours in a day. As with the spending decision, you have preferences about how to spend your time. We explain the principles of good decision making in this setting. Based on this analysis, we introduce another central economic idea—that of supply.
Economics is both prescriptive and descriptive. Economics is prescriptive because it tells you some rules for making good decisions. Economics is descriptive because it helps us explain the world in which we live. As well as uncovering some principles of good decision making, we discuss whether these are also useful descriptions of how people actually behave in the real world.