Economic Concepts

Article byRishabh Chaddha
Reviewed byDheeraj Vaidya, CFA, FRM

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:

Economic Concept

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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 society.read 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.

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#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 vice-versa.read 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 x-axis.read 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 market.read 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 i.e. as the price increases, demand decreases keeping all other things equal.read 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 year.read 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 also.read 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 economy.read 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 society.read 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 afloat.read 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 resources.read 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 period.read 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.

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 –