Discuss the 3 important ideas or assumptions that are present in economics and which are used to analyze how people make choices and interact in markets.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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There are a number of different assumptions that go into describing how people make choices and interact in markets.  I have seen more than one set of three such assumptions.  Therefore, the one I use might not be the one your book uses.  Please check your book and/or your class notes to see if this is the list that your instructor wants to see.

The first assumption is that people are rational in their economic decision-making.  What this means is that people will only act in a given way if they believe that the benefits of doing so outweigh the costs.  This seems like a logical assumption to make most of the time, but it also seems likely to me that there are many times when people do not act rationally.  Emotions are a very strong motivator in human beings and there will be times when we make economic decisions based as much on emotion (say, for example, the decision to spend tens of thousands of dollars on funeral expenses for a loved one) as on rationality.

The second assumption is that people respond to economic incentives.   That is to say that people will tend to change their behaviors based on the costs and benefits of such changes.  For example, some economists argue that giving people health insurance makes them more likely to engage in unhealthy behaviors.  This is because they know that they will not have to pay the full cost of any treatment that they might need because of their unhealthy behaviors.  While it does seem logical that people will respond to economic incentives (for example, if you pay me to coach a sport, I am more likely to do so than  if you ask me to do it for free), it does not seem to me that this is as prevalent as economists think.  To use the above example, I find it hard to believe that people would consciously choose to become obese simply because they have health insurance and will not have to pay the financial costs of obesity.

Finally, economists assume that the best choices are made at the margins.   This means that it is better for people to make small decisions rather than large ones.  It is better for people to reduce a category of spending a little, for example, than to cut it out completely.   I have no problem with this assumption in general, though there will surely be times when it is important to make big economic decisions.  For example, if you have been spending a lot of money on something worthless like gambling, it might  be best to completely stop rather than to simply ease back on your expenditures.

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