People Respond to Incentives

An incentive is something ( such as the prospect of a punishment or a reward) that induces a person to act . Because rational people make decisions by comparing costs and benefits, they respond to incentives. Incentives are crucial to analyzing how markets work. For example, when the price of an apple rises,people decide to eat more pears and fewer apples because the cost of buying an apple is higher. At the same time, apple orchards decide to hire more workers and harvest more apples because the benefit of selling an apple is also higher. As we will see, the effect of a good's price on the behavior of buyers and sellers in a market-in this case, the market for apples-is crucial for understanding how the economy allocates scarce resources.

Rational People Think at the Margin

Rational people know that decisions in life are rarely black and white but usually involve shades of gray. At dinnertime, the decision we face is bot between fasting of eating like a pig but whether to take that extra spoonful of mashed potatoes. When exams roll around, our decision is not between blowing them off or studying 24 hours a day but whether to spend an extra hour reviewing our notes instead of watching TV. Economists use the term marginal changes to describe small incremental adjustments to an existing plan of action. Margin means "edge," so marginal changes are adjustments around the edges of what we are doing. Rational people often make decisions by comparing marginal benefits and marginal costs.Marginal decision making can help explain some otherwise puzzling economic phenomena.

The Cost of Something Is What You Give Up to Get It

Because people face trade-offs, making decisions requires comparing the costs and benefits of alternative courses of action, In many cases, however, the cost of some action is not as obvious as it might first appear.
The opportunity cost of an item is what you give up to get that item. When making any decision, such as whether to attend college, decision makers should be aware of the opportunity costs that accompany each possible action. In fact, they usuaslly are. College athletes who can earn millions if they drop out of school and play professional sports are well aware that their opportunity cost of college is very high. It is not surprising that they often decide that the benefit is not worth the cost.

People Face Trade-offs

"There is no such thing as a free lunch." To get one thing we like, we usually have to give up another thing that we like. Making decisions requires trading off one goal against another. When people are grouped into societies, they face different kinds of trade-offs. The classic trade-off is between "guns and butter." The more we spend on national defense (guns) to protect our shores from foreign aggressors, the less we can spend on consumer goods (butter) to raise our standard of living at home. For example parents deciding how to spend their family income. They can buy  food, clothing, or a family vacation. Or they can save some of the family income for retirement or the children's college education.