Economic Concepts

Economic Concepts Basics

Economic concepts refer to the collection of basic ideas that explain various occurrences in the economy, like the actions and choices of economic agents. Therefore, a basic understanding of the concepts is important in studying and analyzing the decisions and behavior of economic agents. For example, it includes the producers’ and consumers’ decisions on producing and buying.

Key Takeaways Economic concepts interpret the decisions and behavior of economic agents like producers, government, and consumers in an economy.

Real-world economic concepts have applications in various fields, notably market structure and welfare economics.

Wants or needs vary with people, and they make uncountable economic decisions. Concepts explain how different entities allocate scarce resources for investment, production, distribution, and consumption.

Some of the concepts are scarcity, supply & demand, incentives, trade-off and opportunity cost, economic systems, factors of production, production possibilities, marginal analysis, circular flow, and international trade.

Let us look at the top 10 basic economic concepts:

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#1 – Scarcity

Scarcity is one of the key economic concepts. In economicsEconomicsEconomics is an area of social science that studies the production, distribution, and consumption of limited resources within a more, it refers to the limited availability of resources for human consumption. The world population needs are unlimited, whereas the resources to meet the needs are limited. The limited feature of resources makes it more valuable and expensive. Effective resource allocation techniques and integration of alternatives confront the scarcity issues. Examples of scarce resources are oil and gold. Its scarcity will limit the human want for it.

#2 – Supply Demand

Another important economic concept is supply-demand. Supply refers to the number of goods and services available for consumers. The law of supplyLaw Of SupplyThe law of supply in economics suggests that with other factors remaining constant, if the price of a commodity increases, its market supply also goes up and more states that as price increases, also supply increases and vice versa. Hence the supply curveSupply CurveSupply curve represents the relationship between quantity and price of a product which the supplier is willing to supply at a given point of time. It is an upward sloping curve where the price of the product is represented along the y-axis and quantity on the more is upward sloping.

Demand indicates the number of goods and services consumers are willing and able to purchase. According to the law of demandLaw Of DemandThe Law of Demand is an economic concept that states that the prices of goods or services and the quantity demanded are inversely related when all other factors remain constant. In other words, when the price of a product rises, its demand falls, and when its price falls, its demand rises in the more, as price increases, demand decreases and vice versa. Therefore it points to a downward sloping demand curveDemand CurveDemand Curve is a graphical representation of the relationship between the prices of goods and demand quantity and is usually inversely proportionate. That means higher the price, lower the demand. It determines the law of demand as the price increases, demand decreases keeping all other things more. If demand is greater than supply, the price of goods and services tends to increase in a market, but the price decreases if supply is greater than demand. The equilibrium price happens when the supply meets with demand.

If the price of a chocolate brand increases, its demand decreases and vice versa. When the price of cocoa rises in the global market, chocolate price increases, and producers increase the supply to obtain the advantage.

#3 – Incentives

Incentive refers to the factor that influences the consumer in the decision-making process. Two types of incentives are intrinsic and extrinsic incentives. Intrinsic incentives originated in the consumer without any outside pressure, whereas extrinsic incentives developed due to external rewards. For example, the decrease in the price of a discretionary item is an incentive to purchase that item.

#4 – Trade-off and Opportunity Cost

A trade-off occurs when a decision leads to choosing one thing over another. The loss incurred by not selecting the other option is called opportunity costOpportunity CostOpportunity Cost is the benefit that an individual is losing out by choosing one option instead of another option. Let us suppose that a person has $50000 in his hand and he has the option to keep it with himself at home or deposit in the bank which will generate interest of 4% annually so now the opportunity cost of keeping money at home is $2000 per more when one option is selected. For example, a trade-off occurs when Mr. A takes a day off at university to go to a cinema. The opportunity cost is what Mr. A loses by not attending university for a day like participation point.

#5 – Economic Systems

An economic system comprises various entities forming a social structure that enables a production system, allocation of resources, and exchange of products and services within a community. CapitalismCapitalismCapitalism is an economic system consisting of businesses, resources, capital goods, and labour. Private entities own it, and the income is derived by the level of production of these factors. Because of the private hands, these entities can be operated efficiently and maximize their production activity more, communism, socialism, and market economyMarket EconomyA market economy (ME) refers to a form of economic system where businesses and consumers drive the economy with minimal government intervention. In other words, the laws of demand and supply determine the price and quantity of goods produced in an more are types of economic systemsTypes Of Economic SystemsThere are four prominent types of economic systems in the world based on their characteristics. It includes traditional economy, command economy, market economy and mixed economy. read more.

#6 – Factors of production

Another important economic concept is factors of production. It refers to inputs applied to the production process to create output: the goods and services produced in an economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a more. The essential factors of productionFactors Of ProductionFactors of production define resources used to produce or create finished goods and services, the sale and purchase of which keeps the market economy more forming the building blocks of an economy include land, labor, capital, and entrepreneurship. For example, consider a manufacturing entity, where factors of products are land representing the natural resources used, labor represents the work done by workers, capital represents the building, machinery, equipment, and tools involved in the production, and finally, the entrepreneur aligns other factors of production to create the output.

#7 – Production Possibilities

In economics, production possibility frontierProduction Possibility FrontierThe Production Possibility Frontier (PPF) is a visual representation used to illustrate the maximum possible output combinations of two separate products produced using the same amount of limited more is a curve in which each point represents the combination of two goods that can be produced using the given finite resources. For example, a farmer can produce 20,000 apples and 30,000 apricots in his fixed land so that the trees are placed to have adequate space to develop a healthy root system and receive enough sunlight. However, if he intends to produce 50,000 apricots, he will make only 10,000 apples on his farm.

#8 – Marginal Analysis

The marginal analysis compares the additional cost incurredCost IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more and the corresponding additional benefit obtained from an activity. Usually, companies planning to expand their business by adding another production line or increasing volumes perform this analysis. For example, if a company has enough capacity to increase production but improves the warehouse facility, a marginal analysis indicates that expanding the warehouse capacity will not affect the marginal benefit. In other words, the ability to produce more products outweighs the increase in cost.

#9 – Circular Flow

The circular flow model in economics primarily portrays how money flows through different units in an economy. It connects the sources and sinks of factors of production, consumer & producer expenditures, and goods & services. For example, resources move from household to firm, and goods and services flow from firms to households.

#10 – International Trade

International tradeInternational TradeInternational Trade refers to the trading or exchange of goods and or services across international borders. read more occurs when a trade happens between countries. Goods and services are traded across countries contributing significantly to GDPGDPGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a more. The two main types of international trade are import and export. Import is the purchase of goods or services from another country. In this form, payment has to be made to the other country. Thus, it involves the outflow of money. The sale of goods and services to another country is called exports. In this form, payment is received from another country. Thus, it involves an inflow of money. Examples of international trade include trade between companies in China and USA, and goods exported from China to the USA include electrical and electronic equipment.

Frequently Asked Questions (FAQs)

What are the 3 basic economic concepts? The three basic concepts are supply & demand, scarcity, and opportunity cost. When supply and demand meet, the quantity demanded is equal to the quantity supplied, and we can say that the market is in equilibrium. Scarcity indicates a shortage of resources. Finally, opportunity cost is the benefit missed due to not selecting a particular alternative. What is the economic development concept? Economic development concepts serve as the foundation for many programs or activities to improve society’s financial well-being. Economic development tactics include increasing job creation, enhancing the quality of life, and marketing the community’s assets. What is the economic growth concept? The concept of economic growth explains the significance of increasing goods and service output in an economy. Economic growth is a function of different elements like capital stock, labor input, and technological advancement. A stable economic growth increases a nation’s wealth and improves the quality of life.

Recommended Articles

This article has been a guide to Economic Concepts. Here we explain the list of 10 basic economic concepts: scarcity, supply-demand, incentives, trade-off, opportunity cost, etc. You may learn more about financing from the following articles –

Five economic concepts that everybody should know

It’s a sad fact that despite being affected by economic and financial issues on a daily basis, the average person is woefully uninformed about basic financial issues.

While many economic topics can be confusing, there are some basic facts and terms that are important to know. This knowledge can help you manage your money, make smart purchasing decisions, explore investment options and understand our local and national economic model.

Here are five economic concepts that everybody should know:

1. Supply and demand

Many of us have seen the infamous curves and talked about equilibrium in our micro- and macroeconomic classes, but how many of us apply that information to our daily lives?

Supply and demand is more than just two intersecting lines; it affects us in every aspect of our lives. From the groceries that we buy to cook our daily meals to the gas that we put in our car, there are countless forces at work that mold the supply and demand of a particular good or service.

The basic theory behind supply and demand states that there is a price point where consumers and producers both match up; in essence, every good or service has a unique point at which buyers and sellers agree to make an exchange.

Supply and demand can be affected by factors like speculation of future developments, advances in technology and shortages and surpluses in the domestic and international markets.

For example, this past summer, the U.S. experienced one of the worst droughts in recent memory. As a consumer, your economic knowledge should lead you to the conclusion that food prices will rise in the future; so go do your grocery shopping before you pay an arm and a leg for your dinner.

2. Scarcity

This concept goes hand in hand with supply and demand. Scarcity is defined by as “the basic economic problem that arises because people have unlimited wants but resources are limited.”

Examples of scarce resources include time, money and natural resources; essentially anything that is finite falls under this category.

The reason that this is an important concept to understand is because it helps us place a value on a good or service. The scarcer a resource and the higher the demand for it, the more expensive it is going to be.

When allocating your resources for any project, you must learn how to prioritize your resources. The scarcest resource is your most valuable, so plan accordingly.

3. Opportunity cost

Many of us have heard the phrase, “Nothing in life is free.” While trying to understand this concept, we should also be familiar with the term “tradeoff.” Tradeoff means that in order to gain something, you have to give up something else.

The trick is being able to identify when you are giving up something, and remember: inaction is also a cost. For example, every time that you skip class to sleep in, your upfront, sunk costs are what you directly paid in tuition for that class.

You also, however, could have used that time that you spent in bed to go to work, go to the gym, or be productive and get your homework done. Your inaction itself is a cost, whether it is missing out on making some money at work, the calories you could have burned from lifting or the improved grades that you could have made from studying.

Before making any decision, be sure that what you are choosing to do is more valuable to you than the things that you are missing out on.

4. Time value of money

This concept is a fundamental truth for any student that wants to effectively manage their money. The theory behind the time value of money states that, in purely economic terms, a dollar today is worth more than a dollar tomorrow.

This is illustrated by the fact that, generally speaking, investing a dollar today will generate some sort of interest return that will give you more than a dollar tomorrow.

The time value of money guides us to do several things. In addition to encouraging us to invest our money to beat market interest rates, it also tells us to factor in the concepts of inflation.

Inflation, which is the general increase in prices of goods and services over time, can affect consumers drastically. Over the years, as our economy and gross domestic product continue to grow, goods and services will continue to become more expensive.

As a consumer, your ultimate goal is to increase your income rate at a higher rate than inflation; only then will you be able to sustain your lifestyle.

5. Purchasing power

I remember when I was in first grade, I received a $25 gift card for winning a bookmark design contest. Back then, I thought I was rich; I had never held so much money in my life. I was able to buy several things that I wanted and was a happy camper.

Today, however, that same $25 can only buy me about half of the goods I bought back then. As inflation continues to grow, our purchasing power goes down. Purchasing power is the amount that money can buy us.

We have to remember that wealth is relative to how much we can buy with it. If prices continue to increase and all else stays the same, our purchasing power decreases.

The way to counter this is to make your money grow. Invest in funds that take calculated risks and look for investment arrangements that give you a higher return than the inflation rate.

Andy Rao is a junior in accounting and finance. Please send comments to

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Key concepts

Key concepts are the big ideas and understandings that we hope will remain with our students long after they have left school.

Key concepts or big ideas in economics

The following are key concepts/big ideas in economics:

Scarcity results in choices with opportunity costs

Resources are scarce when unlimited wants exceed the capability of the available resources to satisfy them, so that economic choices must be made.

Resources are used when an economic decision is made, meaning that a cost is incurred.

The “opportunity cost” is the next best alternative use of those resources.

Opportunity cost can be used to evaluate decisions. If the net benefits from a choice are greater than the next best alternative, then a sensible economic choice has been made.

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Economic growth reduces scarcity

Economic growth occurs when the real value of the goods and services produced by an economy enables more wants to be satisfied.

Accordingly, societies strive for economic growth as a way of reducing scarcity.

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Full employment reduces scarcity

Full employment occurs when all resources are fully utilised.

If resources are fully employed, then more can be produced. Societies therefore strive for full employment as a way of reducing scarcity.

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International trade reduces scarcity

Countries trading products and services they are comparatively better at producing will be able to sell them overseas for a higher price than they sell them locally. They will be able to buy other imports for a lower price than they can be produced locally. This enables more wants to be satisfied and reduces scarcity.

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Values influence economic choices

Values are the core beliefs that people hold. The different values or perspectives held by individuals and groups influence the economic choices they make.

Values affect the importance (or weighting) people give to the different factors they consider in making a choice. Groups and individuals with the same information, but different values, may make different choices.

For example, Māori may believe that their traditions and values best suit them to conserve natural resources and that they should be given the responsibility to manage the stretches of the New Zealand foreshore they own.

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Markets provide incentives and ration scarce resources

Markets are places or situations where producers and consumers exchange goods and services.

In free market economies, the prices set by the interaction of supply and demand allocates scarce resources.

Whenever resources are particularly scarce, demand exceeds supply, and prices are driven up. The effect of higher prices is to discourage demand and conserve resources.

The greater the scarcity, the higher the price, and the more the resource will be conserved. For example, as oil slowly runs out and its price rises, demand will be discouraged, leading to more oil being conserved than at lower prices.

An incentive is something that motivates a producer or consumer to follow a particular course of action or to change it.

Higher prices resulting from increased consumer demand are an incentive for producers to supply more of a good or service because they may earn more profit.

For example, as world demand for dairy products rises, New Zealand farmers are switching to dairying. Similarly, students are likelier to work hard to develop skills they recognise as required for the high paying job they aspire to.

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Perfectly competitive markets are efficient

Efficiency is an economic concept related to how well an economy allocates scarce resources to meets the needs and wants of consumers.

Efficient markets allocate scarce resources so that the price consumers are prepare to pay for a good equals the marginal cost of the resources used to produce that good.

Adam Smith (widely cited as the father of modern economics) argued that if consumers are allowed to freely choose what to buy and if producers choose freely what to sell and how to produce it, a free market will, as if led by an invisible hand, settle on products and prices that make both consumers and producers both better off.

For example, market equilibrium occurs at the price where the quantities demanded by consumers equals the quantity supplied by producers, meaning that just the right amount of resources are used, since there are neither shortages nor surpluses.

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Market failure may require government intervention

Market failure occurs when free markets fail to allocate resources efficiently.

For example, in the cigarette market, consumers’ decisions can impact negatively on other people in a variety of ways.

One such negative impact is the health problems caused by inhaling second hand smoke in domestic settings or public areas.

When the smoker pays only the price at which the producer sells the cigarettes, they are not paying for the cost of these negative impacts.

The government intervenes by applying an excise tax on tobacco products to deliver a more efficient and equitable outcome.

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The benefits of market activities may not be equitable

Equity is an economic objective relating to fairness or evenness.

A market may be efficient, but society may be concerned that the benefits from market activity are unfairly shared out.

For example, free markets inevitably distribute incomes unevenly because the income earned depends on supply and demand for labour resources, which are different in different markets.

If a government believes the gap between rich and poor is too great, it will redistribute wealth by giving benefits to the poor, for example, unemployment benefits, and taxing the rich at higher rates.

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Government intervention may involve an equity–efficiency trade-off

Government interventions to improve equity may sometimes diminish efficiency.

For example, higher marginal tax rates may discourage high-income earners from working harder or longer if they feel that more of their income goes to the government. As a result, productivity falls.

Some governments seek to help low-income families by adopting policies to stimulate economic growth. They believe that the benefits of higher growth will trickle down to the low-income families.

Other governments recognise that reducing poverty will improve economic efficiency.

For example, reducing poverty tends to reduce levels of illness, which are linked to poor housing and nutrition. Improved public health reduces demand for more hospital services and the need for more hospitals to be built.

Improved economic efficiency also gives a government the opportunity to can spend more on developing infrastructure to improve productivity.

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Interdependence results in flow-on effects

The different sectors of an economy (households, producers, financial, government, overseas) rely on each other (are interdependent).

Events impacting on one sector will flow on to affect other sectors.

For example, when overseas countries that trade with New Zealand go into recession and reduce their spending, the flow-on effect for New Zealand is fewer export receipts and lower levels of economic growth.

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Marginal analysis will maximise results

Marginal analysis compares the additional benefit of an activity with its additional cost.

An economist would recommend the use of scarce resources to satisfy wants only when the extra benefit gained from using the scarce resources exceeds the extra cost associated with using them.

For example, a student with an after-school job could use marginal analysis to optimise the number of hours worked. How much the student values their time not working (the opportunity cost) represents the marginal cost. The amount they are paid is the marginal benefit.

Although the marginal cost of the first or second hour worked may be low (the student still has plenty of times to do other things), the cost of further hours begins increase.

If the student is paid $15 an hour, but values the marginal cost of a third hour spent working at more than $15 – they really want to use it for study or to be with friends – then the most hours they should work are two.

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Economic indicators aid economic analysis

Economic indicators are usually economic statistics, such as the unemployment rate, real GDP, or the inflation rate.

These statistics are important for economists. They use indicators to estimate how well the economy is doing and to highlight trends in contemporary macro-economic issues, such as economic growth, employment, international trade, inflation, and equity.

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Inflation can distort economic indicators

Nominal indicators have not accounted for the effects of inflation.

Real indicators account for the effects of inflation.

For example, nominal national income is the dollar value of an economy’s income in a particular year. Real national income is the income with the effects of inflation removed, thereby indicating the actual purchasing power of the income.

Economists use increases in real income to identify economic growth – increasing real income shows that a country, with its resources, is now able to satisfy more wants and needs.

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Economic models aid economic analysis

Economic models are simplifications of the real world. They are developed to aid analysis and support predictions about economic behaviour and performance.

Economists have developed a variety of models to aid analysis of both macroeconomic and microeconomic issues.

A supply and demand model

Microeconomics uses a supply and demand model. This model combines producer supply and consumer demand to support analysis of the effects of choices on price and the flow-on effects of decisions on others.

More sophisticated applications allow users to make predictions about economic efficiency.

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An aggregate supply and aggregate demand (AS AD) model

The macroeconomic AS AD model aids analysis of changes in the internal and external influences affecting an economy, in particular, their impact on inflation, economic growth, and employment.

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Micro and macro-economics

Economics is traditionally divided up into two branches – microeconomics and macroeconomics. ‘Micro’ means small and ‘macro’ means big.

Micro-economics is the branch of economics that examines individual decision-making by firms and households and the way they interact in specific industries and markets. Among economists, the most commonly accepted set of ideas about how the economy works is called neoclassical economics. Key concepts outlined above, including, opportunity cost, thinking at the margin, incentives in consumer/producer decision-making, markets efficiency, and why markets fail are all based on neoclassical ideas and form the basis of micro-economic theory.

Macro-economics is the branch of economics that examines the workings and problems of the economy as a whole. It is concerned with aggregate supply (total national output of goods and services) and aggregate demand (the total spending of the whole economy ) and issues such as economic growth, inflation, unemployment, and economic fluctuations. Macroeconomic policy suggestions therefore tend to focus on the balance of aggregate demand and aggregate supply. Demand side policies seek to influence the level of spending in the economy. This in turn indirectly affects the level of production, prices, and employment. Supply side policies are designed to influence production directly.

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