The Ten Principles of Economics
Definition of Economics
Economic conditions are constantly changing, and each generation views its own economic problems in its own way. Economics is regarded as a social science due to the fact that it uses scientific methods to generate theories aiding to explain the behavior of individuals, groups, and organizations. Similar to all other sciences, economic processes continuously evolve far from traditional approaches leading to a dynamic behavior inspired by both individuals and society as a whole. Therefore, economists believe that with the current adoption of modern practices and technological changes, the field of economy will never tend towards an equilibrium state.
Economics can be defined in few different ways. In high level terms, economics is defined as the study of scarcity as to how individuals use resources and respond to incentives. By that means, economic approaches are put into action to find ways of reconciling unlimited wants with limited resources. Hence it is essential to assess the gap between supply and demand through the comprehension of production, distribution, and consumption of goods and services.
Economics vs Finance vs Accounting
Many people struggle to explicitly differentiate economics from the fields of accounting and finance. In a nutshell, finance is a term used to illustrate the arrangement, investment, and management of funds. Accounting is the method of recording financial activities to generate decision making data. Economics has a way much broader scope than both fields. It oversees and identify trends, triggers, and status of economy in general. The outlook of economics takes into account government policies, national income, inflation and unemployment. In a narrower scale, economics is focused on the demand and supply aspects of all parties in a society.
The Ten Principles of Economics
Despite the dynamic nature of economics, the field is unified by ten principles that remain constant in the evolutionary economics. These principles make up an economic theory and act as a guide for economists.
1. People face trade-offs
Making decisions always require trading off one thing against another. Consider a project manager who must decide how to allocate their most valuable resource “time” on two different projects. No matter what decision they make, for every hour they are working on one project means that they are giving up an hour on the other project.
The most common example of a society trade-off is between equity and efficiency. The design of government policies is always in a conflict between the objectives of equity and efficiency. Efficiency refers to maximizing the benefits of scarce resources. Equity refers to benefits being distributed fairly among society members. If the government policy is designed to sacrifice efficiency for equity, this leads to reducing the reward of working hard, hence people work less and produce less goods and services. Put in simple words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.
2. The cost of something
The cost of something is simply the “opportunity cost”. As people face trade-offs and come to a decision, they only consider the cost of the action they decided to take. However, the cost of alternative courses of action is usually overshadowed. Therefore, the opportunity cost of an item is what you give up to get that item. For example, if you decide to cook dinner at home because it is cheaper than ordering from a restaurant, then you gave up the opportunity to spend your time doing other things for the sake of saving money.
3. People are rational
Economists like to assume that people are rational thinkers. This theory proposes that people tend to find the optimal balance between cost and benefit. This principle is described using the term marginal changes which means small incremental changes to an existing plan. Therefore, it is assumed that people make decisions and adjust their plans by comparing marginal benefit with marginal cost. For example, if a student has plan of studying five hours a day, and one day they decide to put in an extra hour to review their notes instead of watching tv, then this student did a small adjustment to the plan to benefit from their notes on the cost of watching tv.
4. People respond to incentives
This is the simplest and most sensible economic principle. Economists proposed a theory that incentives inspire people to change their behavior by offering them an extra reward. Incentives could be both positive and negative. A positive incentive would be offering employees a bonus if they work extra hours. A negative incentive would be charging more taxes on fuel to motivate people to use it less.
5. Trading is better
Trading is not a competition. In many cases, trading can have a positive influence on all parties involved. Trading makes everyone better off as they focus on what they can do best and trade it for something else they are struggling to achieve.
6. Markets are usually good
Markets are usually a good way to organize economic activity. For example, buyers always consider the price of a good when deciding how much to demand, and sellers do the same when deciding how much to supply. The outcome of both decisions is that the market price will reflect the value of a certain product to the society and the cost of this product on the society. Therefore, this economic activity is organized and the society welfare is maximized.
7. Governments can help
The interference of government policies and guidelines can sometimes improve market outcomes. Markets can fail when resources are not allocated efficiently, and that is where the government’s invisible hand comes to the play. Policies and guidelines enforced by governments on the market activity will namely promote both efficiency and equity.
8. A country’s productivity
Theories in the field of economics justify that the standard of living depends on the country’s production. The growth in the standard of living can be accelerated by producing more goods and services. Therefore, public policies should promote the access to better education and technology in order to maximize the productivity level.
9. Printing too much money
Price rises when the government prints too much money. This is a fairly simple concept as prices follow inflation, and high rate if inflation results in increasing costs. Therefore, policymakers always aim to maintain low levels if inflation to keep markets going. The root cause of inflation is when having too much money in circulation, that is when more money is available, the more the value decreases.
10. Inflation and unemployment
This could be surprising, but high levels of inflation lead to lower levels of unemployment. Although many economists still question this inverse relation between inflation and unemployment, the historical data justifies it. When more money is circulating in the economy, this stimulates the demand on goods and services hence increasing production. Although higher demand means higher prices, firms will hire more people to cope with high demand levels. More hiring means lower unemployment rates.