Chapter 2.
Accounting for Prudent Choice

"Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood. . . .
Two roads diverged in a wood, and I -
I took the one less traveled by,
And that has made all the difference.

Robert Frost, "The Road Not Taken"


  • Three roads diverging in a suburban town
  • The "opportunity cost" to you of buying a Gibson guitar
  • How to account for the choices of individuals, firms, and even countries
  • A theory of rational fools

Why do people do what they do? The economist answers, unsurprisingly, "They choose." More specifically, they economize. They try to make the most of their lives by choosing carefully how to spend their time, money, and other scarce resources. That's not just random "choosing." They exercise what Adam Smith called prudence, or "the faculty of reason." The economist's contribution is to point out that every choice is a compromise (a gain and a loss; a benefit and a cost). Basic principles of accounting play an important role here. The simple but powerful principles of accounting can be applied to the decisions of individuals, businesses, and entire nations. They are a cornerstone of micro- and macroeconomic analysis.