10 Basic Economic Principles
To be able to comprehend economics without difficulty, it is imperative for one to know the basic economic principles. Economists rely on the following 10 principles when studying people’s behavior.
If you would like an in-depth understanding of what choice is and why people must make choices, then click below to read our other article.
If you would like an in-depth understanding of what choice is and why people must make choices, then click below to read our other article.
The following principles are often connected with other principles. Taking into consideration how closely the principles are related, economists have divided the ten principles of economics into 3 categories: how people make decisions, how people interact, and how the economy as a whole works.
To ensure that you understand the ten basic economic principles without difficulty, FME Finances will present them to you in the most reasonable order.
Since economics is all about decision-making, it is necessary that you first understand how people make decisions.
Since economics is all about decision-making, it is necessary that you first understand how people make decisions.
How People Make Decisions
Before delving into the principles, we will briefly explain the significance of this category. Economists study how people make decisions so that they can better understand how people will react to particular economic situations. You may be wondering why this is so important, right?
The reason why it is so important is because the economy is largely dependent on how people react and make decisions. In simple terms, people's decisions eminently contribute to an economy.
Examples of people making decisions are how much they choose to work, what they choose to buy, how much they choose to save, how much they choose to invest. The list is ongoing.
However, in all of the examples mentioned, do you notice a similarity? That's right, they all contain the word "choose." Anything that humans choose to do falls under this category.
The principles in this category relate to what happens when people make decisions and what factors influence them to make the decisions they do.
The reason why it is so important is because the economy is largely dependent on how people react and make decisions. In simple terms, people's decisions eminently contribute to an economy.
Examples of people making decisions are how much they choose to work, what they choose to buy, how much they choose to save, how much they choose to invest. The list is ongoing.
However, in all of the examples mentioned, do you notice a similarity? That's right, they all contain the word "choose." Anything that humans choose to do falls under this category.
The principles in this category relate to what happens when people make decisions and what factors influence them to make the decisions they do.
Principle 1: Economics seeks to understand human behavior
Choices are the basis of human behavior, and therefore the foundation of economics.
2. Cost is what is given up when making a choice.
Most people act rationally by seeking to maximize their benefit while minimizing their costs. In other words, when people trade, they try to get the most out of the least. However, regardless of how profitable the choice may be, every choice has a cost.
In the modern world, the cost of something is usually determined by the amount of money spent on a product or service.
In the modern world, the cost of something is usually determined by the amount of money spent on a product or service.
3. Opportunity costs are the value of the best alternative.
The opportunity cost of a choice is the foregone alternative, or the benefits of the alternative that was given up.
Click below to read our article where opportunity cost is thoroughly explained.
Click below to read our article where opportunity cost is thoroughly explained.
4. Incentives are rewards or punishments that influence people’s behavior and decisions.
Incentives impact everyone; consequently, when incentives change, people’s behavior also changes. People’s behavior changes in predictable ways, which is why economists can deduce what the economy would look like if a certain event took place. For instance, when the price of a product goes up, people tend to buy less of it.
Although different incentives engender different responses, all incentives motivate people to act, make choices, and be productive. Businesses motivate their employees by offering incentives such as healthcare benefits, paid vacation time, sick time, and a lucrative salary.
An incentive is the reason behind any choice made; thus, it is one of the biggest driving factors of economic decision-making. For example, a business owner decided to take the risk and open a business because he or she was incentivized by something.
Some possibilities of that incentive are money, making the environment better (the business owner can live in a better world), or fabricating technological devices (the business owner's life is easier).
Many different incentives may influence one’s decision, but money is by far the biggest incentive.
Incentives are shaped by a society’s institutions.
Although different incentives engender different responses, all incentives motivate people to act, make choices, and be productive. Businesses motivate their employees by offering incentives such as healthcare benefits, paid vacation time, sick time, and a lucrative salary.
An incentive is the reason behind any choice made; thus, it is one of the biggest driving factors of economic decision-making. For example, a business owner decided to take the risk and open a business because he or she was incentivized by something.
Some possibilities of that incentive are money, making the environment better (the business owner can live in a better world), or fabricating technological devices (the business owner's life is easier).
Many different incentives may influence one’s decision, but money is by far the biggest incentive.
Incentives are shaped by a society’s institutions.
5. Marginal thinking evaluates the cost of “one more” unit.
Marginal thinking is when people evaluate whether the benefit of “one more” unit is greater than the cost. When running a business, marginal thinking is especially advantageous because it allows one to decide whether something is worth investing in or not.
For example, if a business wants to produce 1 more t-shirt but it requires a new factory to be purchased, the business must evaluate whether the benefit of the 1 t-shirt is greater than the expense of the factory.
Besides businesses, marginal thinking is used by everyone because it allows people to deduce if a decision is the most profitable possible.
For example, if a business wants to produce 1 more t-shirt but it requires a new factory to be purchased, the business must evaluate whether the benefit of the 1 t-shirt is greater than the expense of the factory.
Besides businesses, marginal thinking is used by everyone because it allows people to deduce if a decision is the most profitable possible.
6. Markets are the best way to allocate resources between producers and consumers. Markets efficiently organize the economy.
Markets are vital because that is where buyers (consumers) and sellers (producers) interact. Without markets, there would be no purchases; hence, there would be no economy. No one is obligated to do anything in markets; consumers are free to buy whatever they want and producers are free to sell anything they want.
7. Government intervention in markets alters the way markets naturally operate.
Government intervention is based on certain circumstances and is crucial to an efficient economy. The government can set rules about how workers and businesses operate, or it can regulate what types of products can be bought or sold, or by whom, or for what prices. For instance, if the price of a good is unreasonably high, the government can enforce a price ceiling to lower the price.
When considering government action, the question is “Do the benefits outweigh the costs?”
An in-depth article on government intervention, price floors, and price ceilings can be found by clicking below.
When considering government action, the question is “Do the benefits outweigh the costs?”
An in-depth article on government intervention, price floors, and price ceilings can be found by clicking below.
8. Scarcity
Almost everything is scarce, which means that people undergo trade-offs every day. Scarcity causes us to make choices because there is a limited amount of resources to fulfill our insatiable wants.
Click below to read our article where scarcity is thoroughly explained.
Click below to read our article where scarcity is thoroughly explained.
9. Trade
Trade benefits all parties involved when it is voluntary. Voluntary trades contribute to a better economy and create wealth because parties will only participate in trade when they expect to benefit from it. Although it may seem like only individuals benefit from trade, the invisible hand concept shows that the economy benefits as a whole.
10. Specialization
Producers and nations specializing is propitious because it drives production efficiency, which generates more wealth.
If producers wish to operate at full capacity, they must ensure that their employees are specialized in the area they work in. This will allow more work to be done in less time.
Individuals must also recognize the importance of specialization and focus working on what they are best at. When everyone works at what they are best at, production is maximized, which allows the businesses to be more wealthy; hence, the employees also get higher wages.
Specialization is often known as division of labor because when labor is split and assigned to those who are best at it, productivity reaches its peak.
If producers wish to operate at full capacity, they must ensure that their employees are specialized in the area they work in. This will allow more work to be done in less time.
Individuals must also recognize the importance of specialization and focus working on what they are best at. When everyone works at what they are best at, production is maximized, which allows the businesses to be more wealthy; hence, the employees also get higher wages.
Specialization is often known as division of labor because when labor is split and assigned to those who are best at it, productivity reaches its peak.
Summary
Economic principles introduce and present economics in a way that makes it easier to understand. One should become exceedingly familiar with these economic principles to be able to better understand future complex economic topics.