Introduction to Economizing and Incentives

Core Rule: People respond to incentives. This means their decisions are systematically guided by a specific evaluative rule.
The Decision Rule: An individual will choose an action or item as long as its Expected Additional Benefit (EAB) is higher than its Expected Additional Cost (EAC).
Marginal Notation: This same principle can be expressed using marginal terminology: * $\text{Marginal Benefit (MB)} \geq \text{Marginal Cost (MC)}$ * In this context, $\text{MB}$ is synonymous with $\text{EAB}$ .

Definition: Economizing is the idea that individuals compare the expected additional costs and the expected additional benefits for any given choice.
Utility of the Rule: This rule serves as a template for making everyday decisions, such as determining if it is worth driving to a more distant store to save money on household items like toilet paper.

Context: You have decided to buy a book titled Economics at the Wheel (priced at $\$20$ at a local bookstore).
Trade-off: You can drive $3$ miles to a different location to purchase the book for $\$10$ .
Expected Additional Benefit (EAB): The EAB of making the drive is the $\$10$ saved. * Note: The value of reading the book itself is NOT part of the EAB of the drive because you have already decided to buy the book regardless of location.
Expected Additional Cost (EAC): The cost of the $3$-mile drive, represented as the variable $c$ . This includes: 1. Gasoline: The physical fuel used for the $3$-mile trip. 2. Parking: Any fees associated with stopping at the destination. 3. Wear and Tear: The physical depreciation of the vehicle over $3$ miles. 4. Opportunity Cost of Time: The value given up of whatever else you could have done with the time spent driving.
Application: If you choose to drive, you are implying that $c \leq \$10$ . If you do not drive, you are implying that c > \$10.

Context: You are buying a computer priced at $\$1,000$ .
Trade-off: You can drive $3$ miles to buy it for $\$990$ .
Expected Additional Benefit (EAB): The EAB is $\$10$ (the difference between $\$1,000$ and $\$990$ ).
Expected Additional Cost (EAC): Since the distance is the same $3$ miles as the book scenario, the cost is identical, represented as $c$ .

The Consistency Principle: Because the trade-offs in both scenarios are identical (a $\$10$ benefit vs. a cost of $c$ ), a rational actor must be consistent.
Decision Matrix: * If you drive for the book, you must driving for the computer. * If you do not drive for the book, you must not drive for the computer.
The Danger of Irrationality: Driving for one but not the other when the EAB and EAC are identical is essentially "shooting yourself in the foot" and failing to optimize your own well-being.

Common Error: Many people believe they should drive for the book because it represents a $50\%$ savings ( $\frac{\$10}{\$20}$ ), but not for the computer because it only represents a $1\%$ savings ( $\frac{\$10}{\$1,000}$ ).
The Economic Correction: Economists argue that percentages are irrelevant in this decision. What matters is the absolute value of the gain and loss.
Absolute Terms: A $\$10$ saving is exactly $\$10$ in your pocket regardless of whether it came from a book or a computer. The purchasing power of that $\$10$ on future items remains the same.

The Trap of "Persistence": Advertising companies use percentages and original prices to manipulate consumer perception of value.
Case Study: Jos. A. Bank Shoe Advertisement: * Visual Strategy: An ad might show a shoe for $\$79$ , but it will also feature a larger number like $\$120$ "scratched off" or "slashed." * The Hook: It claims a "substantial discount" of $60\%$ off to make the consumer feel they are saving $\$41$ . * Economizing Approach to Shopping: 1. Ignore the "Original" Price: Cross out the $\$120$ entirely. It is a marketing anchor designed to influence you. 2. Evaluate EAC: The true Expected Additional Cost is the current price of $\$79$ . 3. Evaluate EAB: Determine the expected additional benefit you personally derive from wearing the shoes. 4. Compare: Buy only if $\text{EAB} \geq \$79$ .
The Logic of Sales and Market Signaling: * Consumers often fear that if they don't buy during a sale, they will have to pay the higher "regular" price later. * Market Reality: If a store could actually sell the shoe for $\$120$ , they would not offer it for $\$79$ . * The sale price exists because the market has signaled that the product is not worth $\$120$ . * The price is unlikely to return to the higher amount; if the item continues not to sell, the price will likely drop even further in the future.

Opportunity Cost: The opportunity cost of any resource is the value given up of whatever else could have been done with that resource.