Identifying Needs and Wants

Economics focuses on the way the market uses demand and supply to create a price as well as influence the producer strategy and consumer behavior. One of the basic tenets of economics is want vs. need. But, what exactly are they?

A Need…

A need is something you should have, something that you cannot do without. An excellent example is food. When you don’t eat, you will not survive for long. Many individuals have gone for days without eating, but they eventually ate lots of food. Although you might not eat a lot, you need to eat to live.

A Want…

A want is something you would like to have. Although it is not a necessity, it still is a good thing to own or have. Music is one example of a want. While some people are likely to argue that that music is an absolute need since they cannot do without it, but you do not need music to live. You do have to eat, however.

These are just general categories, and some categories have both wants and needs. Food is one instance that has both. You need to consume minerals, vitamins and protein. Ice cream is a want that you really do not have to have to survive. To many people ice cream tastes good and they like to eat it, they want it, but they do not need it. This is unlike nutrients you get from sources like meat, nuts or soy products.

Numbers for Business

This time I will tell you about numbers which are the very foundation of Economics.When I make my Businessmen friends understand the importance of knowing numbers before making business decisions, their immediate reaction would be – Patty do you think I can really understand numbers? Do you think I can read a financial statement? I was not good at math when I was in school. I did not study any subject related to accounting, when I was in my college. Well friends let me tell you something. Even I do not have commerce or accounting background. I am a Civil Engineer. I did my masters in Entrepreneurship but finance was not my main elective. What I am trying to say is you do not have to be a mathematics genius. You do not need to have any kind of finance or accounting background to understand reading financial statements.

It was an article that got me excited about finance, and then I started my journey to learn more about it. I spent more than 200 hours with senior chartered accountants to understand numbers, to demystify numbers for a layman. Throughout this blog I will be using my philosophy which is KISS – Keeping Information Simple and Specific. Albert Einstein very beautifully said – “If you can’t explain it simply, you don’t understand it well enough”.

It is very simple if you can read numbers as scores in cricket match, or a tennis match you can understand numbers. So do not get misled by people who say numbers are difficult. Reading Financial statements is as easy as reading a magazine or a newspaper. Just need to know how.

Some Basic Economics for Consumers

As a consumer you should know some basic economic concepts. It will help you in spending and ultimately you will be wiser and richer.

• Scarcity – the most basic concept of economics. In simple words it means that there are fewer resources or things in the world and wants are unlimited. For example the wheat production is increasing every year but the demand is increasing more. Hence wheat is a scarce resource.
• Supply and Demand – This is basic concept that drives the prices. The more the demand supply gap the more fluctuation in price. You can read more about this here.
• Cost and Benefits – The cost and benefit concept is another basic concept. We unknowingly use this concept in all our purchases. We will always want more for less cost. Hence we look for fuel-efficient cars and appliances which will save electricity. The rational concept is to maximize the benefits for a particular cost.
• Opportunity Cost – When we buy something we forgo another option available at the same price. This is the opportunity cost of buying anything.
• Premium price – We always see that when a new product is launched it will be having more price on it. As the time goes by the price will go down. With time the premium price of the article comes down and you can buy the same for less. So wait watch and save money.

Income Elasticity of Demand

 

What exactly is Income Elasticity of Demand? Today we will try to understand this term.

Income Elasticity is a measure of change in demand as compared to the subsequent change in Income. It is a measure of proportionate change in the quantity demanded of a commodity in response to a proportionate change in income. While calculating income elasticity no other factors are considered. It can be represented in formula form.

Elasticity of demand may be of the following types:

Unitary Elastic Demand (Elasticity is equal to 1): In unitary elastic demand proportionate change in Income and the proportionate change in demand are equal.

The percentage change in demand and percentage change in income are equal in this case. Therefore the Elasticity is unitary.

Relatively Elastic Demand (Income Elasticity is greater than 1): In relatively elastic demand percentage in demand is more than a relative percentage change in Income.The percentage change in demand is more than percentage change in Income.

Relatively Inelastic Demand (Price Elasticity is less than 1): In relatively inelastic demand percentage in demand is less than a relative percentage change in Income.

Overall the demand of a commodity will increase with increase in Income. So, Income is directly proportional to the demand for a commodity.

 

 

Understanding “utility” in Economics

In Economics, utility is an abstract concept that explains how consumers (both individuals and markets) hope to get the maximum satisfaction when dealing with scarcity of goods and services. In other words, utility is the amount of satisfaction a person gets when they consume a certain amount of goods. The more a person consumes, the more their utility will be.

There are two types of utilities- total utility and marginal utility. Total utility increases when a product or a service is consumed more, so it is a permanently upward sloping curve. On the other hand, marginal utility describes how much satisfaction is derived from each additional unit of a product or service consumed. Marginal utility decreases along with the units, so this is a slope that steeps up at first, but starts falling after (as described in the law of diminishing marginal utility).

For instance, let us say you love ice cream. So, when you have one ice cream, the satisfaction you have achieved is high (let us say 70%). This means both marginal and total utility will be 70%. Now, if you eat another cup, you would be satisfied, but since your craving has been fulfilled, you would not enjoy it that much (let’s say you only enjoy it 10%). This means that the marginal utility of the second cup is only 10%, whereas the total utility will be 80.

The theory of utility helps determine demand, and indirectly, the pricing of commodities, as well.

Meaning of Perfect Competition

Perfect Competition is a market situation in which large number of buyers and sellers are gathered, and they deal in similar products. The buyers and sellers have full knowledge of the market, and firms are free to enter or exit.

According to Marshall ” The more nearly perfect a market is, the stronger is the tendency for the same price to be paid for the same thing at the same time in all parts of the market.”

Perfect Competition

 

Perfect competition has the following characteristics:

• Large number of buyers and sellers – There are a large number of buyers and sellers and hence no single buyer or seller can influence the price. The price is determined by the collective effect of the market.
• Homogeneous Product – All the products are having product which are similar. So no firm can charge more. Ferratum has some homogeneous loan products for you.
• Free Entry and Exit – All the firms are free to join and leave the market. There is no entry or exit restrictions.
• Perfect knowledge of market – All the concerned players (Buyers and Sellers) have all the information about the market. Hence advertising will have no effect.
• Perfectly mobile factors of production – The factors of production are perfectly mobile, and are free to move to any industry.
• Independence in decision-making – All the buyers and sellers are independent to make their own decisions. The price remains equal and the buyers and sellers have to make the choice when to buy.
• No Selling or Transportation cost – One of the main assumptions is the absence of selling or transportation cost. Even if there are costs involved it plays no role in price determination.

Perfect competition is an ideal situation and very rarely exists practically. However understanding the concept is central to understanding other kinds of market structures.

 

Price Elasticity of Demand

Price Elasticity is a measure of change in demand as compared to the subsequent change in price. It is a measure of proportionate change in the quantity demanded of a commodity in response to a proportionate change in price. While calculating price elasticity no other factors are considered. It can be represented in formula form.

Elasticity of demand may be of the following types:

Unitary Elastic Demand (Elasticity is equal to 1): In unitary elastic demand proportionate change in price of a commodity and the proportionate change in demand are equal.

Unitary Elastic Demand

The percentage change in demand and percentage change in price are equal in this case.

Relatively Elastic Demand (Price Elasticity is greater than 1): In relatively elastic demand percentage in demand is more than a relative percentage change in price.

The percentage change in demand is more than percentage change in price in this case.

Relatively Inelastic Demand (Price Elasticity is less than 1): In relatively inelastic demand percentage in demand is less than a relative percentage change in price.

The percentage change in demand is less than percentage change in price in this case.

Perfectly Elastic Demand ( Price Elasticity is equal to infinity) : In Perfectly Elastic demand there is increase or decrease in demand of a commodity with no change in price.

In unitary elastic demand proportionate change in price of a commodity and the proportionate change in demand are equal.

There is change in demand with no change in price in this case.

Perfectly Inelastic Demand ( Price Elasticity is equal to zero) : In Perfectly inelastic demand there is no change in demand of a commodity with increase or decrease in price of a commodity.

Perfectly Inelastic Demand

There is no change in demand with change in price in this case.

What is the Law Of Demand?

This is the first economic question most students have to tackle- what is the law of demand? But before we address that question, we need to understand what demand is.

In economics, demand is not just the want for a particular item or a service, it is want for a particular item combined with a means to pay for it. For instance, if you want to buy a car, it will not be considered demand, if you don’t have the money for it. However, if you want to buy a car, and you have the money for it, or you can apply for a loan, it will be considered demand.

Now that we know what demand is, we can study the law of demand. Simply put, the law of demand states that ceteris paribus (all other things constant), the price and quantity of a demanded product or service is inversely related to each other. This means that when all other factors are kept constant, the price of a product will decrease as the demand rises, and increase as the demand falls.

So, essentially, things that are more expensive have less demand by virtue of them being that expensive. We would want to buy 6 or 7 beers because they are rather cheap- so the demand is high. But since diamonds are expensive, we would either not want to buy a diamond, or we would just buy one- which is why the demand is low.

Macroeconomics vs Microeconomics

If you have just started exploring your options in economics, you might have come across the terms Macroeconomics and Microeconomics. What exactly is the difference between the two?

Let’s start with Microeconomics. Microeconomics studies the individual person, firm or industry. It deals with decisions made by these actors and the theories associated with them. It primarily deals with topics such as demand and supply, income and expenditure, consumption, etc. So, microeconomics will study things like incomes of people, what people do with this income, how they get loans, how companies want to run on profits, etc.

Macroeconomics on the other hand, studies the economy as a whole. It studies economic decisions and problems of whole countries, and entire industries. It deals with problems like Gross Domestic Product, national income, economic development and growth, trade, import-export, taxation policies, international economics, etc.

So, if you end up studying microeconomics, you will learn a lot of about people and how they make individual economic and financial decisions. You will learn about how they take out loans, or why people consume more salt than caviar, or why your local car salesman is always trying to push you into buying the bigger car.

On the other hand, if you study macroeconomics, you will study about why Australia wants to do trade with China, or why we are in so much debt, and exactly where all that money you are paying as tax goes!