People tend to choose either by reasonable or logical means while making decisions. This implies that people respond to things that motivates or encourages them to do or buy. Everyone makes decisions by comparing the marginal cost and marginal benefits of every choice. These incentives trigger them to make decisions at the margin.
People who choose rationally change decisions when circumstances change, they respond to change as an incentive. What comes to your mind when you hear the word economics?
One of the greatest economists, Marshall; Defined Economics as the study of human activities in the ordinary course of business. Marshall believed that economics is the study of how man attains his income and how he makes practical and effective use of it. If goods and resources are scarce then nothing is free. Everything you get requires giving up something.
Since we are unable to have everything, we desire, we must make choices on how we use our resources. The following are some of the economic concepts that influence how we make choices and even buy the things we use every day.
Supply and demand.
If there is only one thing to learn in economics as a household consumer is supply and demand. Supply and demand have a very big impact on the prices of products and services
Demand is the desire consumers have for goods or services. The more people who want goods or services the higher the demand for them. Supply is the total amount of goods or services available for consumption. The higher the amount of goods or services produced and available to consumers the larger the supply.
Understanding supply and demand is key to understanding our purchasing behaviors. When the prices go up people buy less, when the prices go down people buy more. This is called the law of demand. On the seller side, if the prices go up the producer will make more profit. So, they will have an incentive to produce more.
If the prices go down the producers are not going to produce more. This is called the law of supply. When we put demand and supply together.
If the prices are high, the producers would like to produce more but consumers are not willing to buy them. This mismatch is called a surplus. If the price goes down, the buyers will want to buy a whole lot, but producers won’t have incentives, and they will produce little. This mismatch is called shortage.
There is only one price where the quantity that the buyers want to buy is exactly equal to the quantity that the seller wants to sell. This is called equilibrium.
Where supply equals’ demand. The price is called the equilibrium price, and the quantity is called the equilibrium quantity.
There are only 4 scenarios that can happen in the market.
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- Supply can decrease
- Supply can increase
- Demand can decrease
- Demand can increase
Incentives.
Incentives are rewards and punishment that motivate behaviors. They are a fundamental economics concept that helps us predict human behaviors. Incentives are usually extrinsic motivators which reward actions to yield the desired outcomes. This can be monetary or other types of rewards.
Ultimately incentives aim to provide value for money.
A price is a signal wrapped in an incentive. For example, let’s say we have a market for Mints with normal price, suddenly, the government announces that Mints have added health benefits, this increases demand for Mints.
Consumers are willing to pay a higher price for Mints. Because consumers’ preferences for Mints have increased. However, producers are still only willing to produce Mints at the original price and there arises a situation in which quantity demanded exceeds quantity supplied.
This is called excess demand. which creates an upward pressure on price from higher prices that consumers are willing to pay for Mints. Therefore, the price acts as an incentive for producers to produce more Mint to sell them at a higher price to increase profitability.
This increase in prices also acts as a signal to tell consumers that Mints have gotten more expensive and therefore it acts as an incentive for them to buy less at the higher prices. With prices acting as a signal and incentives, the two forces work together to reallocate the resources in the market and to determine a new equilibrium quantity price.
This market mechanism is known as the invisible hand of the market, introduced by Adam Smith. This illustrates the signaling and incentives functions of price that reallocates resources when prices change because of change in demand conditions.
Costs and benefits.
Economics is the study of analyzing choices and making decisions.
Most decisions we make are significantly dependent on the different alternatives. Whenever you are about to make a decision commonly, you will weigh your choices against each other. Also, you will be likely to weigh the cost against the benefits over the returns that you get from such a decision. This is known as cost benefit analysis.
We use cost benefit analysis every day. For example, if you went to school today. Before going to school, you weighed the benefits, and the cost associated with going to school. You looked at different alternatives and you chose school.
The benefits of going to school are pretty obvious. On average, the higher your education, the less likely you are to be unemployed and the more income you earn. These are explicit benefits, the monetary benefits that can easily be quantified.
The economist calls the total benefits that you receive when you do something “Total Utility”, and the measure that the economist uses this term called “Util”. To maximize your utility, you need to weigh in the right benefits and the right cost. Cost is easy to quantify. That’s money (value) but benefits are often more ambiguous.
Scarcity.
Whenever individuals in society desire goods that are in limited supply, those goods are referred to as scarce resources. Scarcity occurs when the availability of something is insufficient to meet demand. The problem of scarcity and choice gives rise to the need for a system of how individuals and society choose to allocate scarce resources between competing needs and wants.
Some resources are abundant while others are infrequent. From supply and demand basics, we know that the price of a rare commodity will be more expensive than that of a common commodity. If commodities were not scarce there would be no price attached to them.
Scarcity necessitates choices.
When there are competing wants and needs yet a limited number of resources, choices must be made about how to allot scarce resources efficiently. As a consumer you are faced with this problem every now and then. With this scarcity, you must choose how to assign your resources appropriately.
Key Takeaway
Our everyday purchase decisions are often influenced by a few fundamental economic concepts. Understanding these principles helps to explain why we choose one product over another or decide when and how to spend our money.
Economic concepts such as opportunity cost highlight the trade-offs we face when choosing between alternatives, while supply and demand influence product availability and pricing, shaping our buying habits.
Additionally, the idea of marginal utility explains how the satisfaction we get from each additional unit of a product diminishes over time, impacting our decision to continue purchasing.
Finally, behavioral economics delves into psychological factors, such as emotions and biases, that affect our seemingly rational decisions. These four economic principles provide insight into the complexities behind our daily consumer behavior.
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