Walking through Harvard Square one day Professor Sen asked me, “What should you do if you see a person trying to cut his fingers off with a pair of dull scissors?”
My response: stop him from cutting off his fingers, call the police for help, etc.
“Offer him sharper scissors,” was Professor Sen’s answer. Standard (a.k.a. “neoclassical”) economics assumes that people know what they want. [Source]
This tale outlines well the lesson that humans are not always rational consumers of utility. When economists utilize marginal analysis without accounting for our beliefs, social expectations, and distribution of resources, how often are we lead astray!
If we transfer this lesson from insane self-mutilators to captains of industry we can begin to see a range from the calculated oilman who coldly forecasts the cost/benefit of drilling another well vs. a reckless mortgage banker who bases his decisions more on the collective group-think of his peers more than a rational analysis of economic fundamentals.
Or we can look at the common man. Why does he pay a certain price for a vehicle or a home? Is it because it is the best he can afford on the income he has or is it because of an honest assessment of the economic inputs required to build and maintain his purchase? Why do wage-earners rarely use their surplus wages to purchase capital? Why do they buy vacations and fast food and televisions when these purchases depreciate so much at the moment of purchase?
It seems that we ought to consider marginal analysis as one of many tools when considering the science of economics.