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The Basic Assumptions of Economics

By Mike Moffatt
Updated December 28, 2018

A basic assumption of economics begins with the combination of unlimited wants and limited
resources.

We can break this problem into two parts:

1. Preferences: What we like and what we dislike.

2. Resources: We all have limited resources. Even Warren Buffett and Bill Gates
have limited resources. They have the same 24 hours in a day that we do, and
neither is going to live forever.

All of economics, including microeconomics and macroeconomics, comes back to this basic
assumption that we have limited resources to satisfy our preferences and unlimited wants.

Rational Behavior
In order to simply model how humans attempt to make this possible, we need a basic
behavioral assumption. The assumption is that people attempt to do as well as possible for
themselves—or, maximize outcomes—as defined by their preferences, given their resource
constraints. In other words, people tend to make decisions based on their own best interests.

Economists say that people who do this exhibit rational behavior. The benefit to the individual
can have either monetary value or emotional value. This assumption does not necessarily
mean that people make perfect decisions. People may be limited by the amount of
information they have (e.g., "It seemed like a good idea at the time!"). As well, "rational
behavior," in this context, says nothing about the quality or nature of people's preferences
("But I enjoy hitting myself on the head with a hammer!").

Tradeoffs—You Get What You Give

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The struggle between preferences and constraints means that economists must, at their core,
deal with the problem of tradeoffs. In order to get something, we must use up some of our
resources. In other words, individuals must make choices about what is most valuable to
them.

For example, someone who gives up $20 to buy a new bestseller from Amazon.com is
making a choice. The book is more valuable to that person than the $20. The same choices
are made with things that don't necessarily have monetary value. A person who gives up
three hours of time to watch a professional baseball game on TV also is making a choice. The
satisfaction of watching the game is more valuable than the time it took to watch it.

The Big Picture

These individual choices are only a small ingredient of what we refer to as our economy.
Statistically, a single choice made by a single person is the smallest of sample sizes, but
when millions of people are making multiple choices every day about what they value, the
cumulative effect of those decisions is what drives markets on national and even global
scales.

For example, go back to the single individual making a choice to spend three hours watching
a baseball game on TV. The decision is not monetary on its surface; it's based on the
emotional satisfaction of watching the game. But consider if the local team being watched is
having a winning season and that individual is one of many choosing to watch games on TV,
thus driving up ratings. That kind of trend can make television advertising during those games
more appealing for area businesses, which can generate more interest in those businesses,
and it becomes easy to see how collective behaviors can start to have a significant impact.

But it all starts with small decisions made by individuals about how best to satisfy unlimited
wants with limited resources.

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