envestreet financial logo

4 Economic concepts that tend to justify how & why we make Purchase Decisions for the things we use every day.

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.

 

1. Supply and demand.

If there is only one thing to learn in economics as a household consumer is supply and demand.

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 behaviours. 

When the prices go up people buy less, when the prices go down people buy more. This is called the law of demand.

Related Post:   How Economy’s Inflation rate can affect your efforts to Save and Invest

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;

    1. Supply can decrease
    2. Supply can increase
    3. Demand can decrease
    4. Demand can increase

Supply and demand have a very big impact on the prices of products and services.

 

2. Incentives.

Incentives are rewards and punishment that motivate behaviours. They are a fundamental economics concept that helps us predict human behaviours.

Incentives are usually extrinsic motivators which rewards 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.

All of a sudden, the government announces that Mints have added health benefits, this increases demand for Mints.

Related Post:   How Economy’s Inflation rate can affect your efforts to Save and Invest

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 in order 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 also 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 signalling and incentives functions of price that reallocates resources when prices change as a result of change in demand conditions.

 

3. Costs and benefits.

Economics is the study of analysing choices and making decisions.

Most decisions we make are significantly depending 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.

Related Post:   How Economy’s Inflation rate can affect your efforts to Save and Invest

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 to 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.

 

4. Scarcity.

Anytime individuals in the society demand for goods yet those goods are limited in supply, it is known as a scarce resource.

Something is scarce when it is limited in supply.

The problem of scarcity and choice give 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 amount 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.

Share This Post

Like This Post

0

Related Posts

0 0 votes
Article Rating
Subscribe
Notify of
guest

0 Comments
Inline Feedbacks
View all comments
0
Would love your thoughts, please comment.x
()
x