[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

your favorite café will have milk and espresso for your morning latte? And how
can you be sure that the grocery store won’t charge you $20 for that loaf of bread or
that your espresso won’t cost $10?
The answer can be given in one word—competition. When firms compete
with one another for customers, they will offer customers the desired products
at the lowest possible price. Consumers also compete with one another. Only a
limited number of goods are available, and they come at a price. Consumers who
are willing to pay that price can enjoy the goods, but others are left empty-handed.
This picture of competitive markets, which economists call the basic competitive
model, provides the point of departure for studying the economy. It consists
of three parts: assumptions about how consumers behave, assumptions about how
firms behave, and assumptions about the markets in which these consumers and
firms interact. Consumers are assumed to be rational, firms are assumed to be
profit maximizing, and the markets in which they interact are assumed to be highly
competitive. The model ignores the government, because we first need to see how
an economy without a government might function before we can understand the
role of the government.
RATIONAL CONSUMERS AND
PROFIT-MAXIMIZING FIRMS
Scarcity, which we encountered in Chapter 1, implies that individuals and firms face
trade-offs and must make choices. Underlying much of economic analysis is the
basic assumption of rational choice: that is, people weigh the costs and benefits of
each possibility whenever they must make a choice. This assumption, in turn, is
based on the expectation that individuals and firms will act consistently, with a reasonably
well-defined notion of what they like and what their objectives are, and with
a reasonable understanding of how to attain those objectives.
In the case of individuals, the rationality assumption is taken to mean that they
make choices and decisions in pursuit of their own self-interest. Of course, different
people will have different goals and desires. Sarah may want to drive a Porsche, own
a yacht, and have a large house; to attain those objectives, she knows she needs
to work long hours and sacrifice time with her family. Andrew is willing to accept
a lower income in return for longer vacations and more leisure time throughout
the year.
Economists make no judgment about whether Sarah’s preferences are “better”
or “worse” than Andrew’s. They do not even spend much time asking why different
individuals have different views on these matters, or why tastes change over time.
These are important issues, but they are more the province of psychology and sociology.
Economists are concerned with the consequences of these different preferences.
What decisions can they expect Sarah and Andrew to make when each is rationally
pursuing her or his respective interests?
In the case of firms, the rationality assumption is taken to mean that firms
operate to maximize their profits.
26 ∂ CHAPTER 2 THINKING LIKE AN ECONOMIST