Question

Each statement below is part of an economic model. Indicate whether the statement is a prediction of cause and effect or an assumption. [LO 1.6] a. People behave rationally. b. If the price of a good falls, people will consume more of that good. C. Mass starvation will occur as population outgrows the food supply. d. Firms want to maximize profits.

Short answer

a. Assumption b. Prediction c. Prediction d. Assumption

Step-by-step solution

Identify the Nature of the First Statement

Consider the first statement: 'People behave rationally.' This statement outlines a characteristic thought to be true about human behavior. In economic models, such statements are usually assumptions because they set a foundational belief about how individuals make choices.

Identify Cause and Effect in the Second Statement

Examine the second statement: 'If the price of a good falls, people will consume more of that good.' This statement describes a relationship between two variables—price and consumption—in which a change in one (the price) causes a change in the other (consumption). Such statements are predictions of cause and effect.

Analyze the Third Statement for Assumptions or Predictions

Consider 'Mass starvation will occur as population outgrows the food supply.' This statement proposes an outcome based on a projected scenario, where one factor (population growth) exceeds another (food supply). This is a prediction of cause and effect because it suggests what will happen under certain circumstances.

Determine the Type of the Fourth Statement

Evaluate 'Firms want to maximize profits.' This describes a goal or behavior expected of firms within economic models. It is used as a foundational idea in many economic analyses, therefore, it is an assumption.

Key concepts

Assumptions

In economic models, assumptions are foundational ideas that help simplify the complexity of real-world behaviors and interactions. An assumption is something we accept as true without proof, creating a baseline for further analysis.
A typical example of an assumption is the belief that "people behave rationally." This means economists assume people weigh their choices carefully to achieve the best possible outcomes.
These assumptions often enable economists to predict future trends and develop strategic plans. While assumptions are useful, they can sometimes be oversimplifications of real life.

Cause and Effect

Economic models often use cause and effect to understand and predict how changes in one aspect can influence another. This relationship helps economists determine how and why things happen in the economic world.
For instance, the statement "if the price of a good falls, people will consume more of that good" illustrates a cause (falling prices) leading to an effect (increased consumption). This allows economists to understand pricing strategies and market dynamics.
Cause and effect predictions are essential because they offer insights into likely outcomes, helping policymakers and businesses make informed decisions.

Rational Behavior

Rational behavior is a key assumption in many economic models, positing that individuals strive to maximize their utility.
This idea suggests that when making any decision, people consider available information, potential benefits, and possible costs to achieve their goals.
Rational behavior assumes individuals act logically and with self-interest to fulfill their needs efficiently.
While in reality, people may not always act rationally due to emotions or biased information, the assumption provides a simplified framework for economic analysis.

Profit Maximization

Profit maximization is a core motive for firms in economic models. It posits that firms are driven primarily by the desire to increase their profits, which is often assumed rather than proven.
Maximizing profits involves making decisions that increase the difference between revenues and costs. This can involve strategies like cost reduction, pricing optimizations, or increasing sales volume.
While this assumption holds in many situations, real-world business goals can sometimes include other factors like corporate responsibility or market share growth. However, the focus on profit provides a clear and measurable objective for businesses.