The Thinking Process from the Economics Perspective

The ‘Thinking Process’ from the Economics Perspective

Sam Choon Yin (2003)

 

Economics is a subject that predicts the behavior of an average person. Facing limited resources, the individuals are required to make hard choices to see how these limited resources can be allocated in maximizing their satisfaction. Since choices have to be made, sacrificing alternatives is inevitable. It is therefore in the interest of the individuals to make choices that aim to maximize the satisfaction while at the same minimizing the opportunity costs of making those choices. This essentially tells us that an economic agent is one who maximizes his or her net benefits. In Economics, such behavior is deemed to be rationale.

A rational individual is one who, when confronted with a problem, assesses the various alternatives available to him or her in challenging the problem. The net benefits of each of these alternatives are computed, usually in monetary terms. A rational individual then chooses the alternative with the highest expected net benefit. It is important to recognize that it is virtually not possible for an individual to consider all the alternatives. It is also not possible for the individual to compute the net benefits in an accurate manner. It is all in the mind of the individual concerned. Making decisions is highly personal. It is simply not possible for someone else to know the net benefits of the alternatives computed by one. Even the individual himself or herself will not be able to tell the value of all the alternatives in a confident manner. What is possible though is for the individual to rank the choices discretely and then choose the one that is most beneficial.

This however does not belittle the importance of the rational assumption of human behavior. Instead, one should recognize that the assumption essentially empowers us to understand the thinking process of the individuals rather than trying to predict the behavior of the individuals. Predicting the behavior of the individuals is not an easy thing to do. This is why the issue on policy acceptance is normative in nature. A policy initiative may be successful in some places, but not in others. Some individuals may be influenced to some extent by the policies while some may not. What influences the behavior of an individual lies in the person. In other words, only the individual himself or herself can determine the costs and benefits of the alternatives. Personality and cultural values matter for they can, to some extent, explain how the individuals make decisions. Institutional factors must therefore supplement the normative considerations (like personality issues and culture) to better influence how things are done in the society.

The other thing to note is that it is virtually impossible for the individuals to assess the alternatives in the ‘full’ manner. Doing so requires the information to be made fully available and provided at a reasonable cost. Two issues need to be considered here. First is the issue on the availability of information. The information may not be available perhaps due to the fact that the information is not assessable to one. The second issue pertains to costs. Costs are incurred in obtaining the information. In comparison to the value of the information, an individual may find it impractical to search for the information should the value of the information is exceeded by the costs of gathering the information. An example is in the area of political information. Having additional information about the policy initiative may bring about values to the voter in the sense that he or she better understands the way politicians make decisions and the reason for them to do so. However, the individual is also likely to recognize that his or her vote does not really count very much in influencing the overall results of the election. This essentially downgrades the value of the additional information. As a result, the individual may find it not worthwhile to acquire the information after weighing the benefits and costs of gathering the information. The individual may feel contented with having less information and making choices that may not be optimal from the social point of view (although, after accounting for the searching cost, the ultimate decision-made could be optimal from the individual’s perspective). The late Herbert Simon termed such behavior satisficing.

The other important assumption used in the study of Economics concerns the concept of marginality. Marginal analysis is adopted in specifying how the individuals behave and make decisions. Here, economists assume that individuals think marginally. This essentially means that what concerns the individuals in their decision-making process is not the past, but the present and the future. It is often the case that individuals assess the situation in the marginal sense. A person who has encountered bad luck for the last two days may find it relieving should he or she encounters something positive the next day although on the average, the additional ‘luck’ enjoyed is less than the average ‘luck’ of previous days. Also, it is not uncommon for couples to break up as a result of a recent quarrel without considering the past enjoyments/times that they had together. These examples show that what matters is the ‘future changes relative to the present situations’ rather than the reminiscing the past events.

Consider another example. In the demand analysis, the individuals are required to make the decisions regarding the number of units of the goods that they are willing to purchase at different price levels. For example, one may be willing to pay $1.00 each to purchase six hamburgers. The reason why the individual is willing to pay $1.00 each for six hamburgers involves the concept of marginality. Assuming that the individual has five hamburgers in his or her hand, the sixth hamburger is likely to generate some positive values to the individual. The additional benefit from having an extra unit of the hamburger is termed as the marginal benefit. The fact that he or her is willing to pay $1.00 per unit for six hamburgers must imply that the marginal benefit of having the sixth hamburger is equivalent to $1.00. That is, the reason why the individual is willing to pay $1.00 each for six hamburgers is due to the fact that the sixth hamburger provides a marginal benefit of $1.00. It is therefore relatively straightforward in estimating the marginal benefit derived from consuming a good. What is relatively more difficult to estimate is the satisfaction derived from the previous units of the hamburgers for doing so requires historical information to be taken into consideration, something that is more difficult to ascertain.

The fact that only the marginal benefit is considered in the decision-making makes things easier for one to assess the individual’s willingness to pay. In general, the predictive power of the individuals’ choices becomes more robust. This however does not imply that it is easy to predict the behavior of the individuals. On the contrary, this is not true. Like the case of rationality, the marginal benefits are accrued to the individuals themselves. They are known only to the individuals concern (in some cases, even the individuals concern may not be able to place a monetary value to the additional satisfaction derived). Being personal in nature, it is difficult for the external parties to accurately predict the marginal value placed on the goods consumed. The problem is exemplified in the case of the public goods. As a result of the fact that the public goods are non-rival and non-excludable, it does not pay for the individuals to reveal their true preferences for the goods therefore creating problems to the private sector organizations in providing the public goods to the society. This essentially calls for the government to intervene and supply these goods.

Combining the two concepts of rationality and marginality provides us with a solid understanding on how individuals think. It may be appropriate to reiterate that the intention is not so much of predicting the behavior of the individuals but more into understanding the thinking process of the persons. A rational person essentially considers the alternatives that are available to him or her in solving a person; assessing the net benefits for each of the alternatives; and choosing the option that yields the maximum net benefit. Since an individual is likely to think marginally, it is the additional benefits and additional costs that matter. In other words, the optimal choice is one that yields that additional net benefit that is highest, at least as perceived by the individual concern.