Hi, welcome to Economics. This is Kate. This lesson is called Decision Making Relationships, the Rational Consumer.
As always, you'll find your key terms in red, and any real world examples that I give you will be in green. Great, let's get started. So, what will you be able to do after listening to this tutorial?
Well, you'll be able to explain how we make rational decisions and we maximize something called utility by weighing costs and benefits. You'll also be able to understand that it's because of a concept called scarcity that we have to make decisions. And finally, you'll be able to give your own examples and understand mine of how every decision that we make involves an opportunity cost.
All right, so since we're talking today about the rational consumer, I figured we'd start with that key term. So the rational consumer is a consumer who considers choices based on factual information weighing opportunities and limited income or assets. We're basically going to be defining every part of that definition today, but that's what the rational consumer is going to do. All right, so let's talk first of all about the idea of scarcity or finite resources.
If you're anything like me, I don't know, I'm not great at making decisions. I get a little bit overwhelmed sometimes, and it stresses me out. Why is it that we have to make so many darn decisions every day? Well, it's because of this very important economic concept that we call scarcity.
And scarcity means something is limited and it's desirable. OK, so what's that even mean? Well, taking a step back, we as people are pretty greedy, right?
We have unlimited wants. No matter how much money we have, no matter how much stuff we have, we always want more. But there is a limit to the amount of stuff in the world to meet our unlimited wants.
What exactly is limited in the world? If you're anything like me, your income is certainly limited. I personally feel that time is actually my most valuable resource these days. And it's really, really in a limited supply.
But actually, all goods and services are limited. It might not always seem like it when you, let's say, walk into a grocery store in the United States. It seems like you could go on and on and on forever trying to make decisions. I mean, how many different kinds of yogurt could we possibly have? But there is a limit, right? So there's a finite amount of it.
So like I said, almost everything is limited or, what we call in economics, scarce. Another key term for you is a finite resource. It's a fixed amount of supply that's irreplaceable and non-recoverable. So that's what it means.
A limit to something means that it is a finite resource. So why is it we even care about this concept of scarcity or finite resources? Well, what it means for us is that everything has a cost.
And I'm going to come back to this quote in a little bit, but you'll find this quote in almost any economics textbook, and it says that there is no such thing as a free lunch. Basically, that means that nothing in this world is free. There's always a cost to it. And that is a fundamental idea in economics, so it's important that we understand it.
Any time you see the word cost in this course in economics, what we really mean is opportunity costs. So this is a very important key term for you. An opportunity cost is the sacrifice made by choosing one value or opportunity over another due to those limited resources that we were talking about before.
That's a great definition, but very simply put, how I like to think of opportunity cost is either the next best thing or what you give up. OK, so I have a few examples for you to help illustrate opportunity cost. If I buy a pair of genes for $120, what is it that I'm sacrificing? What am I giving up?
What's the next best thing I could do with that $120? If a student decides to go to college right out of high school-- let's say they go to a full-time, four-year college-- what are they giving up the opportunity to do? Most people think that the main cost of a college education is tuition, room, and board. But really, if we're talking about it in the economics framework, that's not the case.
What they're giving up the opportunity to do by going to college right out of school is to get a full-time job. So that's what we mean by opportunity cost. And then finally, back to that free lunch, what if my company does offer me a free lunch? Let's say, oh, if you listen to this seminar, we'll give you a free lunch.
Is that really free? Remember how I said that time is such a valuable resource for us? Maybe you wanted for your lunch to go out with a friend and just catch up.
Maybe you wanted to sit at your desk and have a little bit of alone time and some silence. You're giving up the opportunity to do something even though, yes, monetarily they're giving you a quote unquote free lunch. It's not free if we're looking at it in economics.
So how is it that we make decisions? Because now we know that there's a cost to every decision we make. Well, we're going to consider something called utility, another key term for you.
Utility is defined as the gratification received from consuming for buying a product or service. Again, how I like to think of utility is goodness or satisfaction. What am I getting out of this?
So, going back to my jeans example, you might really want them and you know you're going to get a lot from owning them. OK, so we're always looking to increase our utility. Definitely, if I buy those jeans, I am happier than if I hadn't bought them. So my utility increases.
But that's really not the bottom line. What we need to look at is, by how much is my utility actually increasing? And that's what will help us make our decision as to whether or not we buy the jeans.
It's not the same for every person, obviously. If you already have 50 pairs of jeans in your closet, you don't need them as badly as someone who, let's say, lost weight, and now they only have one pair of jeans that fits. How much disposable income do you have to spend on them?
A millionaire might not even blinking an eye at a $120 pair of jeans. I am certainly going to think long and hard before I spend that kind of money on a pair of jeans. So that's just showing not everyone obviously makes the same decisions because our costs are all very different.
The bottom line is, we have to look at what are we're getting up. And what did we say that is? What we're giving up is our opportunity cost.
So if you're like me and you have buyer's remorse sometimes and you know that you're going to feel more guilt than enjoyment, you probably shouldn't buy them. And that's going to lead us into this idea of a cost benefit analysis. If the benefit is greater than the cost of something that you're trying to purchase or something that you want to do, the rational consumer goes ahead with it because they're getting more utility or benefit out of it that it's costing them. But if the cost is greater than that additional utility or benefit, than more than likely, you're going to not make that purchase.
All right, so here's two people I want to talk about. Person A-- person A, if they buy this $120 pair of jeans, for her, the opportunity cost is not going out to dinner this weekend, let's say. But person B has a different situation.
If she purchases the $120 pair of jeans, that mean she's not going to be able to afford the birthday present that her daughter wants. Very different situations, right? They have very different opportunity costs.
And so probably, this will lead to different decisions. Person A might not mind at all not going to dinner this weekend and the jeans are going to provide more utility for her because she'll get to wear them all the time. I can go out to dinner anytime, she might say. Hopefully, person B thinks that her daughter is a little bit more important that a pair of jeans, but I'm not judging.
All right, so utility maximization is what this is all about. If we're weighing, that rational consumer is weighing the costs and the benefits, then we're trying to maximize our utility. We're trying to maximize how much we're getting out of things.
So your key utility, utility maximization, means achieving the highest amount of satisfaction while spending the least amount of money. OK, so here's a little chart for you. If that pair of genes that I keep talking about is $120, that's the cost. The utility is, what value or what do I think I'm going to get out of this? How much gratification will I get from purchasing these jeans?
If I think I'm going to get out of it $80 worth, do I purchase $120 pair of jeans? No, because the cost is greater than any potential increase in my utility. It doesn't justify the cost. However, if there's a half price sale and now those jeans are only $60, I'm absolutely going to purchase them.
My utility didn't change. I'm still saying those are worth $80 to me. They'll make me $80 happier. They're going to make me $80 happier, and I only have to shell out $60 for them. I'm going to purchase them as a rational consumer.
All right, so what did you learn today? Hopefully, you learned that there are limited resources in the world. So we have to make decisions because of that idea of finite resources or scarcity.
You learned that every decision we make involves giving up something, and that's what we refer to as an opportunity cost. And if we're going to make the best decision and be rational about it, what we do is we weigh our benefits and costs in order to maximize our utility. It make sense, right? OK, Thanks for listening. Have a great day.
A consumer who considers choices based on factual information weighing opportunities and limited income or assets.
A fixed amount of supply that is irreplaceable and non-recoverable.
The sacrifice made by choosing one value or opportunity over another due to limited resources.
Gratification received from consuming a product or service.
Achieving the highest amount of satisfaction while spending the least amount of money.