4 economic concepts consumers need to know

Although a basic understanding of economic theory is not as important as balancing a family budget or learning how to drive, the power that underpins economic research affects every moment of our lives. At the most basic level, economics tries to explain how and why we make purchasing choices.

Four key economic concepts—scarcity, supply and demand, costs and benefits, and incentives—can help explain many decisions that humans make.

Key points

  • Four key economic concepts—scarcity, supply and demand, costs and benefits, and incentives—can help explain many decisions that humans make.
  • Scarcity explains a basic economic problem, that is, the world has limited or scarce resources to meet seemingly infinite demand, and this reality forces people to make decisions on how to allocate resources in the most efficient way.
  • Due to scarcity of resources, human beings continue to make choices based on their costs and benefits as well as the incentive decisions provided by different action plans.

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Everyone understands scarcity, whether they are aware of it or not, because everyone has experienced the effects of scarcity. Scarcity explains a basic economic problem, that is, the world has limited or scarce resources to satisfy seemingly infinite demand. This reality forces people to decide how to allocate resources in the most efficient way in order to meet their highest priorities as much as possible.

For example, only so much wheat is grown every year. Some people like bread, some people like beer. Due to the scarcity of wheat, only a certain number of commodities can be manufactured. How do we decide how much flour should be made for bread and beer? One way to solve this problem is to establish a market system driven by supply and demand.

supply and demand

The market system is driven by supply and demand. Take beer as an example. If many people want to buy beer, they think that beer is in great demand. Therefore, compared with the use of wheat to make flour, the use of wheat to make beer can charge higher fees for beer and make more money on average.

Hypothetically, this may cause more people to start brewing beer, and after a few production cycles, too much beer on the market—an increase in beer supply—causes beer prices to fall.

Although this is an extreme and oversimplified example, at a basic level, the concept of supply and demand helps explain why last year’s hot products were half of the following year’s.

Costs and benefits

The concepts of cost and benefit are related to the rational choice (and rational expectation) theory on which economics is based. When economists say that people behave rationally, they mean that people try to maximize the ratio of benefits to costs in their decisions.

If the demand for beer is high, the brewery will hire more employees to produce more beer, but only if the price of the beer and the quantity of beer they sell justify their wages and the additional cost of the materials needed to brew more beer Is reasonable. Similarly, consumers will buy the best beer they can afford, but may not buy the best beer in the store.

The concepts of cost and benefit apply to other decisions that are not related to financial transactions. College students conduct daily cost-benefit analysis by choosing to focus on certain courses that they believe are more important to their success. Sometimes, this even means reducing the time they spend on courses they consider less necessary.

Although economics assumes that people are usually rational, many human decisions are actually very emotional and do not maximize our own interests. For example, the advertising field uses the tendency of human irrational behavior. Commercial advertisements try to activate the emotional centers of our brains and trick us into overestimating the benefits of certain items.

Everything is motivating

If you are a parent, boss, teacher, or anyone with supervisory responsibilities, you may already be in a situation where you provide rewards or incentives to increase the likelihood of a particular outcome.

Economic incentives explain how supply and demand encourage producers to provide the goods consumers want, and how consumers save scarce resources. When consumer demand for a commodity increases, the market price of the commodity will rise, and producers will have the incentive to produce more commodities because they can obtain higher prices. On the other hand, when the increasing scarcity of raw materials or inputs for a given commodity leads to rising costs and producers cutting down on supply, the prices they charge for the commodity will rise, and consumers have the incentive to save money and keep it for their best use. Use of value.

Take a brewery as an example. The owners want to increase production, so they decide to provide a bonus-bonus for the shift that produces the most bottles of beer in a day. The brewery has two sizes of bottles: a 500-ml bottle and a 1-liter bottle. Within a few days, they saw production increase from 10,000 bottles to 15,000 bottles per day. The problem is that the incentives they provide focus on the wrong thing-the number of bottles rather than the number of beer. They began to receive calls from suppliers, wondering when the order for a liter bottle would arrive. By offering rewards for the number of bottles produced, the owner allows the competing shifts to gain an advantage by bottling only smaller bottles.

When incentives are correctly aligned with organizational goals, the benefits can be very good. These practices include profit sharing, performance bonuses, and employee stock ownership. However, if the criteria for determining whether the incentives are met are inconsistent with the original goals, these incentives may go wrong. For example, the unreasonable structure of performance bonuses has prompted some executives to take measures to improve the company’s financial performance in a short period of time-just to get the bonus. In the long run, these measures have proven to be detrimental to the company’s healthy development.

Economics is a frustrating science

Scarcity is the foundation of all economics, which is an explanation of why economics is sometimes called a frustrating science. Humans continue to make choices determined by their costs and benefits. On the individual level, scarcity means that we must make choices based on the incentives given to us by different courses of action. At the market level, the influence of millions of people’s choices creates a force of supply and demand.

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