Economics is generally based on the assumption that people are able to make rational decisions based on weighing all the costs and benefits of something. An individual may take into account things like fixed costs and variable costs. There are opportunity costs. For example, if I decide to go to a concert instead of study for an exam then I probably think that the benefit I get out of going to that concert outweighs the costs of getting a poor grade on the exam. But what if there are costs that I don’t factor into my decision-making? Am I still making a rational choice based on the information available to me? Or am I choosing to ignore certain costs because they’re too abstract or too difficult to quantify?
Very often this kind of problem is the result of external costs, those costs that one doesn’t consider when making decisions, as opposed to internal costs or out-of-pocket costs. Continue reading