Overview: Personal Decision-Making and Shopping

What It Means

Individuals make hundreds, if not thousands, of personal economic decisions over the course of a year, including whether to buy generic or brand-name groceries, whether to splurge on a Hawaiian vacation or take an inexpensive camping trip, whether to send children to private or public school, whether to spend a tax refund (the money returned to a person when she has overpaid on her income taxes) on a new television or save it for an emergency (such as a car repair), and countless others.

In all of these decisions, two basic economic principles apply: scarcity and opportunity cost. They underpin the decisions of multimillion-dollar corporations, subsistence farmers (those who grow only enough to feed their own families), governments—indeed, every economic entity you can think of.

Scarcity has to do with the fact that resources are limited: no one has an infinite amount of money, or time, or land, or water, or energy. Choices—our decisions to buy or do one thing and not another—are necessary because we cannot have everything at once. If we have a week of vacation time to spend, we cannot fly to Hawaii and also drive to the state park in Oregon. If we do choose to treat ourselves to the Hawaiian vacation, then we probably should not spend that tax refund to treat ourselves to a new TV. Every time we make a choice, we say “yes” to one thing and “no” to another (or several others). It is not that we do not also want all of those things we say “no” to; it is just that we cannot have it all, and we decide that the thing we say “yes” to is the best choice.

In economics, the things we say “no” to are called opportunity costs. More precisely, the opportunity cost of a given choice is the value of the next-best alternative, which we sacrifice, or say “no” to. So, for example, if you choose to spend the weekend with friends, the opportunity cost is that you do not get to spend the weekend alone (cleaning the house, or catching up on e-mails, or studying for a test).

The choices we make about how to spend our resources (time, money, and energy) involve costs and benefits, or trade-offs. The benefit of spending the weekend with friends is that you will likely have fun and be rejuvenated by human contact; but the cost of this choice might be facing Monday with a dirty house and an in-box full of unanswered e-mails, or it might be that you are not fully prepared for an important biology test. In addition to weighing the various costs and benefits associated with our decisions, we must also try to anticipate possible consequences. The consequence of living another week in a dirty house is fairly insignificant; but what if the consequence of doing poorly on the biology test is that you do not qualify for that summer internship? And what if that summer internship could make or break your chances of getting into your first-choice university? These potential consequences probably outweigh the amount of fun you could have in a single weekend.

Understanding the principles of scarcity and opportunity cost are critical to our ability to make good decisions about how to spend our time, money, and energy. As consumers in a society where the allure of goods and services can exert a powerful pull on our psyches, it is particularly important to be able to weigh the costs and benefits of how we spend (or choose not to spend) our money, because for most us, the more money we choose to spend, the more time and energy we must devote (or sacrifice) to the project of earning money.

When Did It Begin

Scarcity and opportunity costs were a fact of human existence long before they were articulated as central concepts of economic theory.

Adam Smith (1723–90), David Ricardo (1772–1823), and other economists of the so-called classical school (which emerged in the eighteenth century) were primarily concerned with high-level economic workings such as the rise of commercial industry, price dynamics, and the benefits of trade. The next wave of economic theory (which emerged in the late nineteenth century and became known as the neoclassical school) began to focus more attention on the value of goods and services to individual consumers.

The German statistician Ernst Engel (1821–96) and the French sociologist and economist Pierre Guillaume Frédéric Le Play (1806–82) both produced important studies relating to family budgets, and the turn of the twentieth century in United States saw a proliferation of popular literature concerning economic advice for individuals and families, with titles such as How to Get Ahead, Thrift and Success, and A.B.C. of Home Saving.

In spite of such prudent-sounding titles, however, at the start of the twentieth century there was the beginning of a societal move away from the age-old moral edict to work hard, be thrifty, and save, save, save. With the rise of advertising came a new kind of consumer culture in which people desired material goods and services as never before. As consumerism has continued to grow and flourish, it has had a profound impact on the way individuals make economic decisions.

More Detailed Information

Making good personal economic decisions requires planning, levelheadedness, and the ability to weigh the costs and benefits of one’s various options.

Every person needs to figure out how to make the money he or she earns pay for housing, transportation, food, and clothing. Most people also need to pay for health care, education, and a few haircuts per year and would like to have something left over for entertainment, such as movies, concerts, cable television, and miniature golf. And we know that we are supposed to be saving a little bit every month, too. In economics, the process of dividing up your paycheck to cover your monthly expenses is called resource allocation: the money you have earned is the resource, and you must portion it out as best you can to cover your needs and wants. A budget is a kind of map, or plan for how to do this. It helps you establish your financial priorities and make your spending habits predictable.

Making a list before you go shopping is also a good way to plan. It is a way of reminding yourself what your purpose is in going to a given store, so that you do not come home with an armload of things you never intended to buy. These spur-of-the-moment purchases are called “impulse buys,” because people buy them impulsively, without thinking their way through the cost-benefit scenario. Say, for example, you have budgeted $125 for clothing this month and you plan to spend it on a pair of jeans and a pair of sneakers. At the mall you go to the shoe store first and find the sneakers you want for $60. You plan to spend the remaining $65 on jeans, but when you get to the cash register at the shoe store, there is a whole rack of socks that are 50 percent off. You actually have enough socks, but these are a great bargain. Before you know it, you have spent $15 on socks. (How could you pass them up for $3 per pair?) At the time, it did not occur to you that part of the cost of buying the socks would be not having enough for the jeans. Now you only have $50 left over for jeans, but when you get to the jeans store, the pair you want is $70. Of course, you could forego the jeans and resolve to buy them next month, but if you are like most American consumers, you will buy them anyway, vowing to borrow that extra $20 from somewhere else in your budget. One or two impulse buys may not seem like a big deal, but if you are not careful they can turn your budget into a real juggling act.

Unfortunately for modern consumers, the forces of advertising and marketing are constantly appealing to our impulses and emotions, beckoning us to throw our best-laid plans and our rational thinking out the window for the instant gratification of an irresistible purchase.

Another major pitfall for budgeters everywhere is the availability of consumer credit. Consumer credit is a form of loan extended by banks and other financial institutions that enables consumers to “buy now and pay later” with an electronic-payment card called a credit card. The consumer receives a statement (or bill) at the end of the month, at which time he or she can pay off the entire balance of his or her purchases or make a small minimum payment and allow the balance to carry over to the next month. If the consumer carries a balance on the card, the money owed (also called the debt) is subject to interest charges (a percentage of the balance, which may be thought of as a fee for owing the money).

Consumer credit seems to alleviate the problem of scarcity: instead of having to choose between this or that purchase, we are suddenly able to have both. This makes it easy for millions of individuals and families to live beyond their means (that is, to spend more than they earn). Many of them gradually build up thousands of dollars worth of debt that can take years, or even a lifetime, to pay off. Indeed, while credit cards grant us the temporary illusion that we can have it all, in fact they may carry one of the heftiest opportunity costs of all, because if we constantly avoid making hard choices at the cash register, allowing ourselves to slip into debt, the thing we are saying “no” to, or sacrificing, is our financial freedom.

Recent Trends

During the 1990s and through the first five years of the twenty-first century, the most alarming financial trend among American consumers was the skyrocketing level of credit card debt. In 2006 Clear Point Financial Solutions, a credit-repair company (which helps consumers get out of debt and restore their financial reputations) presented some staggering statistics:

• The average American spends $1.22 for every dollar earned.
• The average American carries more than $11,000 in credit card debt.
• Americans owe a combined total of $2 trillion in credit card debt.
• Americans owe more in credit card debt than they do for education loans.
• In 2000 American undergraduate students carried an average credit card balance of $2,748; graduate students carried an average balance of $4,776.

In light of these troubling trends, many educators were placing new emphasis on teaching high school students basic economic concepts and skills for making responsible personal economic decisions.