By Puja Shah. Edited by Arjun Chandrasekar.
When doing things, people normally have a reason for doing so. This greatly affects the economy so economists have come up with theories to attempt to explain why people make the decisions they do. According to Investopedia, “economics is the study of how people, businesses, and countries make decisions on how to distribute and why they make those decisions.” There are 4 main theories in economics — scarcity, supply and demand, costs and benefits, and incentives — which help explain many decisions that people make.
Scarcity is the idea that there are infinite wants and finite amounts of resources so people must learn to put the resources into things in the best way possible so that the most important of people’s needs are met. But how do people decide how much of the resources to put into each thing? One way is through supply and demand.
Supply and Demand
This theory talks about how market systems rely on many people wanting a thing meaning the demand is high and charging more for that. This can lead to a situation where a lot of people start to make that thing and then there is too much of that product and the demand goes down causing the price to go down too.
Costs and Benefits
Another theory is the theory of costs and benefits. This says that when making decisions, people want to make the most of the ratio of benefits to costs. This is often seen when people buy the version of the product that they can afford which isn’t necessarily the best version of it. An example of this is cars. Many cars are very expensive and not everyone can afford them, so a lot of times, people have to buy the best car that they can buy with the money they have. It also applies when businesses make things and have to decide if it is financially worth adding something on or not and if they will get a good return from that or not. However, this theory is not only related to money, but it can be for any decision, like if putting time into something like studying will have a good reward or not. Keep in mind, though, that this theory doesn’t really take into account that people often make choices based on their emotions and sometimes make irrational decisions, not just the most beneficial choice.
The fourth theory is the incentive theory. This is the idea that supply and demand can make a producer want to or not want to supply the things that consumers want, and also for consumers to use or use less of certain resources due to their availability. When the demand goes up then the amount of money that is spent on the product goes up and so producers are incentivized to produce the product since they may get more money. And, when the supply of a product and the resources needed to make it go down then the price to make it go up and so those who make it have to make less and to maintain the amount of money they make they must charge more for producing it since they now make less and consumers then have an incentive for using less and only when it’s most needed since it is too much to spend on something used regularly.
These four theories help to explain why people make choices that they do and can be used to understand a lot about the world and businesses. By understanding these theories, you now know much more about things when buying or doing them.