When the price of something falls people usually demand more of it. This happens because you can now afford to buy more of it and also more people can afford it now. This is called the law of demand.
This means the higher the price, the lower the demand is, and the lower the price, the higher the demand for any normal good or service. Undeniably, a change in people’s tastes, income, and preferences can affect the demand for something, but we will assume that these other factors don’t change, so we can only focus on the relationship between price and quantity demanded.
The Law of demand is a key economic concept and has many uses and implications in our daily lives. The demand curve slopes downward when you plot the price on y-axis and the quantity demanded on the x-axis.
But does it happen to every single item and is there a way to find out by how much?
The answer to this is yes, and this brings us to another important topic, which is the price elasticity of demand.
By how much does the demand change with a change in its price?
The answer to this question depends on how responsive or sensitive the demand is to a change in price.
Economists call it elasticity of demand. Similar to the concept of a stretch of an elastic, we can look at how much does the demand stretches (changes) in response to a change in the price.
Many factors affect the elasticity of demand. Whether there are any substitutes for that good, if the good is a necessity or not, loyalty to a specific brand of good, time duration, and how much income you spend on that good all play a role in determining its elasticity.
In economics, if the percent change in the quantity demanded is more than the percent change in the price, we call it elastic. Going with the same logic, if the percent change in the quantity demanded is less than the percent change in the price, we call it inelastic.
Just if you are interested, here’s the formula to calculate elasticity.
So if the value is greater than 1, it means the good is elastic and is sensitive to price change.
So, those goods where a small change in price creates a big change in the quantity people demand, we call them having an elastic demand.
Similarly, those goods and services, where a change in price do not cause a change in demand, have inelastic demand.
Who uses this calculation anyway?
Businesses and corporations use this calculation to see whether their total revenue will increase or decrease, due to a decrease or increase in price. This also helps them in deciding how much discount to give you during the holiday season.
The government also uses price elasticity to select goods and services on which to impose excise duty for maximum revenue.
If you are interested in knowing more uses, here is another article that lists some other ones.
Let’s look at some real-life goods and services to understand this concept better.
Inelastic goods
A classic example of inelastic demand is gasoline in the short run. Anyone going to work every day needs gasoline to drive. Even if there is a rise in the price of gasoline, people will still need it. Some of us might find a carpool or use public transport, but for most of us, we will still need to fill up our gas tanks despite the high price.
Addictive things like tobacco have inelastic demand as well. Smokers still use it even if there is rise in its price. Similarly, certain prescription drugs, like insulin, because of their limited substitute availability also have inelastic demand.
Elastic goods
Now, let’s look at some things which have elastic demand. If the price of Pepsi goes up, a lot of people can switch to a close substitute like Coke, unless they are die-hard Pepsi fans. So Pepsi has a very elastic demand. So any item that has a perfect substitute, will have an elastic demand.
The duration of a price change and the category of the good or service also makes it more elastic. Too complicated! Let me example this with an example.
In my example above, over the short run, people may not find alternatives to going to work if the gas price goes up, so the demand is inelastic in the short run. However, over the long run, people can find alternative options, like using electric cars or working from home. Thus, the demand for gas will be elastic in long run.
A specific brand of milk can have elastic demand if people can substitute it with other brands, but milk in general will have more inelastic demand, as there are not many substitutes for dairy lovers. So here you saw the broad category of food has inelastic demand, meaning its demand won’t change if the price of milk goes up. However, a specific brand of milk can see a decrease in demand if its price increases.
The first chart shows price elasticity > 1, the second shows price elasticity < 1, and the third shows price elasticity close to 1.
Are there other types of elasticities as well?
Yes, there are two other types – cross elasticity, which looks at the effect of a change in the price of a substitute or complementary good or service), and income elasticity (which looks at the effect of change in income on quantity demanded. These are important because changes in demand can also happen due to changes in income level and price of other supplements or complementary goods.
But to not make the post overly long, I only focused on price elasticity in today’s post, as we wanted to see the effect of a change in price only.
Hope you found this microeconomics post helpful, to see my other microeconomics posts, please click here. And, yes, if you can think of another elastic or inelastic good or service, please write in the comment below.
Who doesn’t like to see some extra money in their savings without having to sacrifice their living standard?
Saving is the money left after subtracting all our expenses from all our income. This is, after all, the money you can ultimately invest and grow. Well, there are two ways to save money.
Yes, you guessed it right, either you increase your income or reduce your expenses. In this post, I will focus on the latter.
I will share some easy ways for you to reduce your monthly expenditures, without even feeling it. While some of these may seem common sense, it is still good to read this article. Maybe, you will find one particular option, which I am going to list below.
I am combining personal finance and human psychology with my favorite economics knowledge to come up with some doable changes we all can implement. So without further ado, let’s get into it!
Cut Down on Streaming services
To start with, please cancel any unnecessary online streaming subscriptions. Many times, we take too many streaming services that we don’t even use much. Honestly, on average, if you are working or studying full time, how much TV do you get to watch every day? Maybe a couple of hours, max?
So, yes most people do not get the time to watch that much TV and we often end up paying too much for each service. So you should consider how many of these you can’t live without. Even though their monthly fees don’t seem that much individually, together they all add up.
Is Gym membership worth it?
Think about marginal benefit vs. marginal cost of Gym membership
Unless you use the gym 4-5 times a week, paying $20 or so per month isn’t worth it. We get tempted by their deals and may use them for some time in the beginning, but most of us are not able to continue for whatever reason.
I am totally in favor of exercising and maintaining a healthy lifestyle. And there are free resources for that. You can always start with walking or jogging outside or jump roping. You can also do yoga and make use of many free online exercise videos or free cardio classes. These will all give you the same results if done 3-4 times a week for 30 minutes a day.
Do you still use Cable TV?
In a world where there are so many streaming services, I honestly think we don’t need cable TV anymore.
I find that a lot of time is taken by the ads shown, and we don’t have the option to skip ads, in cable TV. Honestly, most people just flip between channels waiting for the ads to finish. What a waste of time!
Consume less electricity during peak hours
For most places, peak hours are between 4 to 9 PM. This is when you get charged the most. So try not to use your dishwashers and washers during this time if you can. Also, Having an app like Nest will help you monitor how much your AC is running and how to control it. I found some additional ways to reduce your electricity bill in this post in case you are interested.
Refinance your loans
If you follow my posts and the news, you must be aware that the Fed has (indirectly) raised all the interest rates that affect us. This includes our home loans as well. The Fed has clearly stated that to fight inflation, it will further raise interest rates. So there is still time for you to refinance some of your loans for a lower rate.
So anytime, you find interest rates lower than usual, don’t miss the opportunity to refinance your mortgage.
Eat out less
Well, this goes without saying, right? I understand everyone can’t have a home-cooked meal every single day. We also need a break and eating out provides us with that happy feeling. But if you can, try to slowly decrease the number of times you go out to eat. For example, start by reducing it by 25% and gradually increase it.
There will be two advantages to it. Not only you will save money on restaurant bills, but you will also be able to have a healthier life. To get to this, you will certainly need better meal planning (esp. since we all live very busy lives). Nevertheless, it is doable if you incorporate simple and healthy options to cook. One way to do it, which I sometimes do is to make extra servings of the food in an instant pot and use my freezer to save it for the future.
Avoid instant online shopping temptations
When we pay with credit card or debit card, often times we don’t know how much money we have spent. We easily fall prey to online shopping deals and offers. Studies have found that the pleasures of online shopping release dopamine, a happy hormone.
Oftentimes, we just want to buy something because we see others using it. Here, we need to stop and think if we really need it. Is this really adding value to our life?
An additional tip is while buying clothes, shoes, and accessories, try not to do too many one-time-use purchases. Buy something that you can use more often. We all need a few party wear and special occasions outfits but just choose the number wisely. We work hard for the money and we need to use our judgment while making any purchase.
Most of the time the pleasure we get by making any purchase is very short-lived. We suffer from something called “shiny object syndrome”. So always think before giving to this instant online need to splurge. One tip is to leave the item in a shopping cart for a few days and then decide if you still need to buy it.
Return options
Many of the companies we buy from these days, offer return services, some up to 90 days or more with a receipt. We procrastinate returning because of this long window and may forget to return the item. I am sure it has happened to some of you. So either set up reminders or do it as quickly as you can to avoid sitting with that item.
Be cautious of free trial magazines and other services
Sometimes, we take a service, which is free for a trial period. Usually, these services require us to give the payment information even though they don’t charge for the trial period. They also give the option to cancel the service anytime during the trial period. But life happens and we may forget to cancel it.
Then unknowingly, we get charged for a whole year. Be cautious of these. I would suggest not falling for these offers unless you are very disciplined and can keep track of all your free trial subscriptions. One way to avoid getting charged is to set reminders on your phone to cancel before the free trial period ends.
So, these were some of my tips for reducing your expenses without substantially affecting your lifestyle. I am sure there are many more, so feel free to share those in the comments section below. In my other post, I will also cover some ways to increase your income.
I hope you learned something from this personal finance post series. Please leave your comments on what type of posts you would like to read, it will help me connect with my readers more. I hope you are having an amazing day and I will be back soon with another topic. Thank you for reading till the end!
These are all examples of externalities. Sorry, if this sounds too complicated at the beginning, it will all make sense as you read along. Externalities can happen when the after-effects of certain actions can spill over to other people not directly involved in it. These could be either positive or negative spillovers.
Externalities can arise between producers, between consumers or between consumers and producers. Externalities can be negative when the action of one party imposes costs on another, or positive when the action of one party benefits another.
Let’s look at an example of a positive externality. Vaccination for any infectious disease would be a positive externality because vaccination will reduce the overall severity, symptoms, and thus the possibility of spread of infection of that particular disease. This will also benefit people who are not vaccinated through positive spill overs by others who are. People who didn’t receive the vaccine are less likely to get an infection if more and more people around them are vaccinated. Vaccination also reduces the burden on a country’s healthcare and benefits society. Most recent example of this is the Covid 19 vaccine, which was provided mainly by the government in many countries to stop the spread of infection.
In both positive or negative externalities, government intervention is required to make sure the businesses that create externalities get the benefits for positive externalities or pay the price for negative externalities.
If a factory is producing toys but at the same time polluting the environment, people are bearing the cost of pollution. This is a negative externality. From an economic perspective, the business is transferring some of its cost of production to society. Without any tax on pollution, that business factory’s actual cost of production is less than what it should be, so it can charge lower prices from the people for the toys it produces. This reduced price creates more demand for toys, making the business produce more and more toys and thus polluting the air more.
In our first example above, the factory will find ways to reduce its chimney smoke from polluting air if it has to pay the price for its pollution. Government can impose taxes in these cases. Tax will also increase the overall cost of production for the business. The business will be forced to charge higher prices from the consumers, which will, in turn, reduce the demand for it and the over-pollution problem will be solved to some extent. Similarly, water pollution that is caused by industrial effluents can harm ocean life, other plants, animals, and humans. The government imposing a tax on factories creating water pollution can limit it to some extent. In economics, the use of tax to limit negative spillovers is known as internalizing the externality.
Another type of negative externality is caused by smoking. The government wants to discourage smoking and thus impose heavy duties and taxes on cigarette manufacturers because active or passive smoking both are harmful to society. Thus, cigarettes sell at a fairly expensive price. People who can’t afford to buy can refrain from consuming it. Also, smoking is banned in public places and to minors, these are all attempts to reduce the consumption of smoke.
Similarly, to encourage businesses with positive externalities, government can provide subsidies to those producers. When producers get subsidy it lowers their cost of production and it encourages them to produce more. Also, the subsidy is a government expenditure, which government meets through taxation on general public. This taxation on general public is either form of direct tax (like income tax) or indirect taxes (like those paid on goods and services when we buy them.) Thus, the society who is reaping the fruits of a positive externalities ultimately ends up paying the price of subsidy.
One example of this is public (government funded) education, when the government subsidizes public education, a greater quantity of education (more schools and colleges) is made and the society as a whole reaps the spillover benefits of more educated people. Also, parks, the police force, and public hospitals provided by the government provide benefits to any person who lives in the neighborhood. These are called public goods with positive externalities that are nonexcludable and benefit the larger public who indirectly pay for them through taxation.
The answer to this complex question is simpler than you might think.
Do you think a business can charge whatever price it wants, to get the highest possible profit? But consumers who demand those products would like to buy them at the cheapest price, so how do they come to a consensus? In markets that are highly competitive (see footnote)*, meaning there are many producers and consumers of a specific good or service, the price of that product or service gets determined by the interaction of supply and demand forces. These forces work together in the same manner as the blades of the scissors cutting the paper.
Wait, but what are these supply and demand forces?
First, let’s understand them individually, and later we will see how they interact to set the “right” price.
Demand
In economics, we assume that people buy more of something when its price is lower. This negative or inverse relationship between price and quantity demanded is called the law of demand. This means the higher the price, the lower the demand is, and the lower the price, the higher the demand is for any normal good or service. Undeniably, a change in people’s tastes, income, and preferences can affect the demand for something, but we will assume that these other factors don’t change, so we can only focus on the relationship between price and quantity demanded.
Let me explain this with a simple example of the demand for bread. The prices are shown on the Y-axis and the quantity that people are demanding is on the X-axis. You can see this inverse relationship in the graph below that slopes downward.
If the price of one loaf of bread is $10 there is going to be very less demand for it, let’s say only 10 loaves of bread will be demanded. Once the price is lowered to $6, a few more people will be willing to buy it, so the quantity demanded increases to 20. And if the price is further lowered to $2, more people would be willing to buy it, as more can afford it, so the quantity demanded now is 40.
Supply
Now let’s look at the supply pattern. For a producer, if he gets a higher price for bread, he will be willing to make more bread and supply more of it. A higher price or reward encourages producers to supply more, and you can see this positive relation in the graph below as an upward-sloping supply curve. So, the law of supply states that there is a positive relationship between the price of a good and quantity supplied. This means the higher the price, the more businesses or producers are willing to supply, and the lower the price, the less they would like to supply. In the graph below, we can see at $2, producers are only willing to supply 10 loaves of bread, at $4, 20 loaves, and at $10, 40 loaves of bread will be supplied.
Now when we plot both of them together in one graph, we will see there is one price, where both these curves meet. In economics, we call it an equilibrium point, where the price is just right for the producer/seller and the consumers. In the graph below, this happens at point A, where demand and supply meet or cross each other. The price is set at $4 and the quantity demanded and supplied is 25 loaves of bread. Thus, we saw no one individually impacted the price, but producers’ supply and consumers’ demand worked together to set the price that makes everybody happy.
You understood how prices can influence how much people want to buy and produce. Now, let’s understand also, how it works the other way round, meaning how much people demand and businesses supply can influence the prices as well.
If there’s more demand than supply for something (such as point B above), this will send a signal to the producers to increase the price from $2 to $6, because they understand that people are prepared to pay more to receive that good or service. In this case, there is an incentive for the producers to increase the price. If the price goes up to $6, some consumers will drop out as they won’t be able to afford bread at price $6.
On the other hand, if there is more supply than demand (shown as point C above), this is a signal to the producers to lower the price from $6 to $2, because the price at $6 was too high and there is a very limited number of people who are willing to buy it. Now some producers, might drop out and can’t lower the price to $2, because they can’t cover their cost of production.
Over time the price will keep moving upwards or downwards until it reaches a point where demand is equal to the supply, at point A ($4).
Today, you learned two fundamental concepts in economics: the law of demand and the law of supply.
If you are wondering about whether it is possible to plot these demand and supply curves in real life, the answer is, yes? In economics, a graph is just a simple representation of economic principles or behavior observed. Economists survey people and collect data and plot that data using easy-to-understand graphs. In the demand and supply curves we looked at today, the slope could be steeper or flatter. In order to learn what decides how steep or flat (demand or supply) curve will be, we will have to look into another important principle in economics called elasticity. More on that will be in my future posts. For now, if you just want to know why economists use models and graphs to solve real-world economic problems, please read my post here.
*In non-competitive markets, like monopolies, where one company controls the market, it gets more control in setting the price. The demand and supply forces don’t work very well here. Producers want to get the maximum profits by setting the price higher and can do that as well. In the absence of other competing businesses, consumers who want to buy their product or use their service, don’t get other options. Hence, they end up paying a higher price than they would have paid if more companies were in the market for that product or service. Usually, to prevent businesses from exploiting consumers, some government intervention is required so these monopolies don’t create artificial barriers to entry.
It is worth noting that, some monopolies can happen naturally and not all monopolies are bad. We will look at this more in detail with real-world examples in another post.
We know economics is all about putting resources to their best use, so we get the most out of it. Economists use a fancy term called “allocative efficiency” to describe it. By resources, we mean land, labor, capital, entrepreneurial ability, and time.
Now, you may ask could there be different types of economies or economic systems to make the best use of limited (scarce) resources? Yes, indeed. These economic systems help to answer the three essential economic questions of what to produce, how to produce, and for whom to produce?
Let’s take a quick look at the three most common economic systems around the world: they are 1. free market, also called the market economy, 2. centrally planned economy also called the command economy, and 3. mixed economy or Keynesian economy
I don’t want to bore you with lots of text, so briefly I will explain these. But before you leave, make sure to scroll down to check an interesting chart comparing different countries in 2022. I know we all like visuals to better understand something.
So here are the three famous systems:
Market economy: In this type of economy, goods and services exchange freely through market supply and demand forces. In economics, it’s called Laizzes Faire, which means a policy of letting things happen their way, without interference. So, in this system consumers and firms interact freely and maximize their incentives without government intervention. Now, you as a consumer should typically act to satisfy your utility by demanding products you want or need. Similarly, all consumers will do the same. So, consumers signal the producers in the market about what to make and what not to make based on their demand. This helps to answer the question of what goods and services to produce.
Firms act to satisfy their profit motives by producing products at a minimal cost. Because businesses want to get maximum profits, they will adjust the production process to minimize costs so there’s less wastage of resources. This helps to answer the question of how to produce goods and services. Also, no single producer is required to know all the information in terms how many competing producers are there, and what is alternative use of his resources. Prices set by demand of consumers, and supply of every other producer can give him that signal to produce in the best possible way. Because if he charges more than others or don’t make the products people demand, people will not buy his product and go to the one next to him, given the other producer is local and they sell identical products. This has become easier with so many online shops now a days. Thus, the invisible hand or natural market forces will answer the question for whom goods and services are produced.
Let’s take an example, if more people demand more of a specific good, like iPhone, its price tends to rise as well. This happens because we as consumers are willing to pay more for that good. Acting in response, producers wanting more profit, will increase production to satisfy the demand of people. As a result, a market economy tends to naturally balance itself.
Whenever we see a rise in prices in one sector of an industry due to high demand, the scarce resources, such as land, labor, capital, and entrepreneurship shift to those areas where they’re needed the most. In the free market economy., the role of the government is only limited to protecting property rights, this way there is a guarantee of fair competition in the marketplace. People can protect their ideas through patents and copyrights, and this encourages innovation. Thus, a free-market economy is the one with the least amount of government intervention.
Command economy: On the opposite spectrum is the command economy, where the entire price set up and distribution of goods and services are controlled by a central planner or the government. All economic and political decisions are taken by the government or a central committee of very limited people. They decide how to allocate the country’s limited resources. North Korea is one example of this type of economic system. This type of economy is commonly seen in communist countries. Natural market forces of supply and demand can’t decide the price and quantity of goods and services produced and consumed.
Generally, people living in these countries don’t have a high standard of living and don’t enjoy economic freedom. By “economic freedom” we mean the ability to choose to produce something or consume something based on your ability and need. Since the government fails to collect all the information correctly about what to produce and how to produce, a lot of wastage happens. People who advocate a command economy think this system is more equitable because everybody gets an equal share. But at the core of economics is the belief that people want to act for their self-interest. As a result, there is less incentive for businesses to work hard and employ better production techniques to maximize profits. Because if someone doesn’t get to keep the extra share, why work hard for it?
There are flaws in both pure market economy and command economy
Let’s investigate, why both these economic systems are not perfect. We just discussed why the command economy is not a great system, but we also need to know what the limitations of a free-market economy are as well.
In a free market, sometimes, markets can waste scarce resources by producing products at higher than necessary costs. This usually happens when there is very less competition or if one producer displays a monopoly. Due to a lack of competition, there’s no real pressure to bring down costs as a result, prices are inflated. The second type of market failure happens in the case of public goods. Private businesses don’t want to produce these public goods, even though we all collectively enjoy these, and are very necessary for the safety and well-being of our people. Since these types of investments are usually not profitable for private firms to produce, they don’t do that. Services like infrastructure or military, police services or fire departments, parks, basic k-12 education and healthcare for the poor. So, if we are only left to the free market, the people would go without these goods and services and not have basic needs and wants met. Also, there will be more unequal distribution of income and people may have extreme inequalities. So, to solve this problem, some role of government is vital. This type of system is called a Mixed economy.
Mixed economy: Thus in the real world, pure market economies rarely exist because there is usually some government regulation or intervention needed for smooth function. In most countries, like the US, public education, security, law and order, nuclear energy, social security benefits, public goods like parks, and defense are provided by the government. The government also provides regulation, so businesses don’t create monopolies and exploit people by charging very high prices. The government also invests in scientific research to develop future businesses and industries. Additionally, when the economy is not behaving optimally, ie. when a lot of people are unemployed (as in a recession) or if the prices are too high (inflation), government intervention is needed to get the economy back to full employment and achieve stable prices.
How much role the government plays in an economy can vary between countries, but in countries with higher real GDP per capita, there has been less government intervention and more free-market play. In this economic system, the government or the public sector and the free market also known as the private sector, work together to meet social needs. The free-market system is allowed to work independently, but the government intervenes to avoid market failures. Thus, we see this mixed economic system as the most common economic system around the world today.
Here’s a chart from Heritage Index showing how different countries enjoy economic freedom. In their study, they used twelve economic freedom categories. Within these categories, they graded the freedom of doing it on a scale of 0 to 100. It’s interesting to see the twelve economic freedom indicators, which they use to calculate a country’s overall score. Here is the list, I got from their website. https://www.heritage.org/index/about
Rule of Law (property rights, government integrity, judicial effectiveness)
Government Size (government spending, tax burden, fiscal health)
Open Markets (trade freedom, investment freedom, financial freedom)
The study gives equal weight to each of the above factors.
Economic systems and economic freedom experienced in countries of the world
As you can see, countries with the highest score in economic freedom from 80-to 100, are in darker green. Countries with the least economic freedom are in red.
From the chart, you can see China, North Korea, Zimbabwe, Cuba, and Venezuela have the least economic freedom because of a command economy.
On the other hand, Singapore, New Zealand, Ireland, Switzerland, Luxembourg, Taiwan, and Estonia have the most economic freedom. When we look at the real GDP per capita of these countries, the people living there mostly have a higher standard of living. All these countries are highly advanced, free-market economies, mainly because of their open and corruption-free business environment. In all these countries, there is a well-secured property right to stimulate entrepreneurship and innovation. There is also a very high level of transparency and government accountability.
Many other countries, like India, Mexico, Brazil, and Russia show poor to moderate levels of economic freedom. Even though countries like India are opening from their initial planned structure, there is still a lot of bureaucratic red tape that hinders setting up new businesses easily there. In addition, there is a lot of political corruption and scandals. Unfortunately, many of them are not even reported.
Originally from India, I can’t stop noticing the score India got in this ranking. Unfortunately, it still got very low score in the economic freedom index. Despite considerable liberalization since 1990s, India still has a lot of government controlled sectors and capital market. International participation in many industries is still limited compared to many other countries that rank higher in the economic freedom index. Also, In India, property rights are not very well established, which hinders free enterprise and technological innovation. Reservation system based on cast, instead of socio economic status is another deterrent in its economic performance. All of this combined has caused the infamous brain-drain, where a lot of highly skilled class move to other countries for a better lifestyle. Unless all these changes are made, India is still has a long way to catch up in the economic freedom score.
The US and the UK and many advanced countries are mixed economies. They are under the “mostly free category” denoted in the light green color. According to their report, the US economic freedom score is 72.1, which makes it the 25th freest country in the world to do business in. The US private property rights are secured, and contracts are protected and enforced.
It’s interesting to note that countries with higher economic freedom also have higher GDP per capita and higher happiness indexes. So, we can conclude that, overall, less government intervention (only limited to areas where the market fails), is needed for countries to do better economically.
A lot of people think economics is all about money, banks, complicated graphs, and mathematical modeling, but truly speaking it is much more interesting than that.
So, what exactly is Economics?
Economics is a study of human behavior, understanding the choices people make with their limited resources. By resources, we mean the tools needed to produce goods and services for humans consumption for a comfortable life. These resources are usually classified into 1)land, 2)labor, 3)capital such as tools and machinery, 4)human capital or entrepreneurship, and 5)our precious time.
We don’t usually have an infinite amount of these resources, so how do we allocate the limited resources to make us better off and happier? In short, Economics deals with our struggle to achieve happiness in a world full of constraints and limitations.
The word Economics comes from the Greek word oikonomia, which means household management. It starts with an individual making a tradeoff, choosing the best option that satisfies their wants, and forgoing the other best alternative use of their resources. From individual households, it moves to businesses, deciding what and how much to produce and sell. And lastly, government and the central bank decide when and how to intervene to ensure maximum happiness for its citizens.
We are making choices every single day. For example, if you are reading this, you have chosen to gain some knowledge vs. maybe, watching a TV Show or doing something else.
While reading this, you think you are making the best use of your time. (or at least I hope you do 😉 In short, you apply economics every minute (even when you don’t know it).
What does the field of Economics cover?
As you learn Economics, you can find answers to some fascinating questions such as:
How the price of anything is set?
How do we measure a country’s prosperity?
Why are some countries rich, while others are still poor?
What is inflation?
How do we understand business cycles?
What tools do the central bank and government use when the economy is facing inflation or a recession?
Is international trade a good thing?
And is reading this article even worth my time?
Trust me, the list is endless. There is a wide variety of areas that economics can cover. Economists try to solve many of these problems our world is facing today by simply understanding human behavior and the choices people make. I might have used the word choice a lot here, but hope you got the idea?
You will understand our rapidly evolving complex economies and how the economic fundamentals can still explain the changes.
You can apply Economics in your day-to-day life, such as while analyzing the cost and benefits of a particular decision you are going to make and managing your finances.
Similarly, you will also understand how economic principles apply to the businesses around us from a small local donut shop to a big company like Apple.
Understanding economics will enable you to evaluate the feasibility of promises made by politicians to get your vote.
Believe it or not, Economics can also help us understand the best strategy to deal with environmental issues, such as global warming and pollution.
Last but not least, since Economics is based on human behavior, there can be more than one view on any economic issue. It’s not an absolute science and many times economists differ on how a certain situation should be handled.
When you study Economics, you can acquire the necessary skills to argue why a specific viewpoint makes more sense to you.
Some key principles of economics are:
Everything has an opportunity cost and experiences diminishing returns.
People are rational (for the most part) and act in their self-interest (even charity is considered self-interest since it gives you some happiness).
Supply and demand interact through an invisible hand.
Comparative advantage fosters trade.
People think on the margin.
I will explain the above points in detail in my other posts. We will also dig into the two main subdivisions of economics: macroeconomics and microeconomics. We are only getting started!
