Decision Making At The Margin

Lillian Hood wants to visit her grandmother. She can take a public bus, or she can call a taxi. The bus trip will cost her $1 and will take about an hour. The cab will cost $4 and will take about 15 minutes. Lillian decides to take the bus. She figures that the comfort and speed of the cab is not worth the additional cost. But on her return that evening, Lillian travels by cab. At that hour the benefit of a fast, direct trip is worth the extra expense.

Economists describe decision making at the margin as the process of choosing on the basis of cost vs. the potential benefits of a decision. Lillian's decision to use the bus was made at the margin. She weighed the cost of spending an hour on the bus in the after­noon against spending more money to be with Grandma 45 additional minutes. She decided to take the bus. But at night, the cab's safety and speed was worth $3.00 extra to Lillian.

Marginal decisions are useful to government and business, as well as to individuals. For example, if the government wants to raise more money by increasing sales taxes on luxury items, its econo­mists will predict how a 1-percent, 2-percent, or 3-percent change in the tax rate will affect revenues. If economists estimate a tax increase will cause sales to decline so much that total taxes also decline, the government would probably recommend a lower tax rate. Is it possible to increase tax revenues by lower­ing the tax rate?

Similarly, businesses use marginal analysis to make decisions.

A major airline found that, on average, 20 seats on its weekday afternoon flight to Chicago were unsold. Last week the company announced that it would set aside 20 seats on that flight for sale at half the regu­lar fare.

The airline's decision was made "at the margin." It found that the income these lower fares would bring was more than the cost of 20 additional passengers at half price.

Technically, the margin, as it is used in economics, refers to the very next unit. For example, the govern­ment is concerned about the effect of increasing taxes 1 percent, the airlines want to know the cost of carrying one more passenger on a flight, and you try to determine the benefit of buying one more CD.

Throughout the remainder of this book you will be exploring how consumers, businesses, and govern­ments use marginal analysis to decide how to solve the central problem of economics—determining the most efficient ways to allocate resources to solve the problem of scarcity facing all societies.

Factors Of Production

Economists are so concerned with understanding how individuals, businesses, and nations use their resources that they have developed specific terms for different economic resources. Economists call all the resources that go into creating goods and services the factors of pro­duction.

The factors are natural resources, human resources, capital, and entrepreneurship. Each factor of production has a place in an economic sys­tem, and each has an important function. In the American economic system, individuals and compa­nies are able to own productive resources. As own­ers, they are entitled to a "return" or "reward." This generates income which, as it is spent, becomes the fuel that drives the economy.

Natural Resources or "Land." Natural resources are what nature provides to create goods and ser­vices. They include mineral, wildlife, and timber resources, as well as the air we breathe. Our country is especially rich in natural resources. Economists also use the term land when they speak of natural resources as a factor of production.

• The price paid for the use of land is called rent. Rent is income to the owner of the land.

Human Resources or "Labor." Economists call people's physical and mental effort to create goods and services labor.

• The price paid for the use of labor is called wages. Wages represent income to workers, who own their labor.

Capital. To economists, physical capital is some­thing people create to produce other goods and ser­vices. A factory, tools, and machines are capital resources because they can be used to produce other goods and services. So, too, is the truck that deliv­ered gasoline to the local service station. The term capital often is used by business people to refer to money they can use to buy factories, machinery, and other similar productive resources.

• Payment for the use of someone else's money, or capital, is called interest.

Entrepreneurship. Closely associated with labor is the concept of entrepreneurship, the risk-taking, managerial, and organizational skills most firms need to produce goods and services. The entrepreneur combines the other factors of pro­duction. When entrepreneurs are successful, they earn profits. When they are unsuccessful, they suffer losses.

• The reward to entrepreneurs for the risks, innova­tive ideas, and efforts that they have put into the business are profits—whatever remains after the owners of land, labor, and capital have received their payments.