Undeniably, having a grasp of economics isn't thought to be as crucial as managing your own finances or mastering driving. However, the principles of economics are intertwined with our lives, helping to formulate the purchasing choices we make.
The principles of scarcity, supply and demand, costs and benefits, and incentives have a major role to play in the choices we make. Scarcity, a principle we inherently know, even if we are unaware of it, is tied to the basic economic dilemma of limited resources for endless needs. This constrains us to optimize the allocation of resources to cater to our priority-based needs.
For instance, take the world's annual wheat production. It's finite. But the desire for products like bread and beer, which depend on wheat, are limitless. So, how can a fair distribution be decided? The market system influenced by supply and demand answers this question.
Adopting the beer case, if beer is high in popularity and demand, it can be sold for more, making higher profits by utilizing wheat for beer over flour. However, following this, more people may be attracted to beer production, which could soon flood the market and reduce the value of beer. While this is a simplified analogy, it provides a fundamental understanding of how supply and demand dictate the price plunge of trending products over time.
Costs and benefits, another principle is tied with the economic theories of rational choice and decisions. It suggests that individuals strive to amplify the benefit-cost ratio in their decisions. For instance, a brewery may decide to hire more workers to increase beer production, only if the sales turnover and price justify the additional wages and brewing costs.
Likewise, the customer will buy the best beer within their budget, not necessarily the most flavorful one. This principle is applied to decisions outside the financial realms too. For instance, students perform cost-benefit analyses every day to invest their time in courses they deem most beneficial.
Although economics assumes rational behavior, many decisions lean towards emotions and don't necessarily benefit us. For instance, advertising exploits our emotional responses, persuading us to overestimate the worth of a product.
Finally, incentives: the reward technique to promote a certain outcome. Economic incentives influence producers to supply the goods desired by the buyers and encourages consumers to conserve scarce resources. For instance, in a brewery, the owner may offer a bonus to the shift producing the most bottles in a day to increase production. However, if the incentive motivates the teams to produce more smaller-sized bottles, ignoring the larger ones, it leads to misalignment with the original goal.
Incentives, when aligned with organizational objectives can produce extraordinary results, including profit sharing, performance bonuses, and employee stock ownership. On the flip side, misaligned incentives, like poorly structured performance bonuses can result in behaviors that enhance short-term financial performance at the expense of long-term company health.
At the heart of economics lies scarcity. It influences our decisions based on their costs and benefits. On an individual scale, scarcity means we have to choose the best options based on the incentives offered. On a market scale, the collective impact of millions of these choices leads to the phenomena of supply and demand.