Question

Discuss each of the economic ideas: People are rational, people respond to incentives, and optimal decisions are made at the margin. Please give an example of each.

Answer 1

The economic idea of people are rational is driven by rational choice theory of economics that says that people make rational choices and buy goods that can maximize their benefits. For example, an individual buying different goods, always go for the marginal benefits and cost. Here, the person will opt for marginal utility per unit of dollar spent and then decide the level of consumption. So, a rational choice is used in taking decisions for the consumption.

The economic idea of people responding to incentive is driven by the fact that additional benefits or incentives act as a motivation to work hard or bring more efforts so that different types of needs are fulfilled. For example, offering of reward of additional 5% of the base salary if a work target is achieved, makes people to work hard and drive them to achieve the stated goals. It is a case of people driven by incentive.

Economic idea of optimal decisions being made at the margin is driven by the fact that at margin level only, net benefit or cost is identified. For example, a person buying more quantity at lower cost per unit is preferred to the lower quantities at higher cost. It is on the basis of margin, where people want to pay the lowest cost per unit and for this sake, they buy bigger quantities or buy in bulk. This tendency is capitalized by the supermarkets where best discounts are given on products of higher quantity.