Economic Theories You Should Know About

Below, we’ll run through some basic concepts of economics to give you a stronger foundation when it comes to the money matters that surround our everyday lives.

What is an economic theory?

Things are going to get technical pretty quickly here, but it’s all in the name of knowledge, of course.

Basically, an economic theory is a set of ideas and principles that detail how different economies function. Certain theories might aim to describe specific economic developments such as supply and demand, whereas others can allow economists to analyze, interpret, and predict the ways in which financial markets, industries, and governments might behave.

What are the main economic theories?

Supply and demand

Supply and demand refers to the relationship between the price of a product and how willing people are to buy or sell it. This unit price will vary until it settles at a point of economic equilibrium – or when the quantity at which consumers demand a product equals the quantity at which a consumer supplies it.

In other words, as the supply of a product decreases but there’s still a demand for it, the price of it might soar. In this example, the demand is greater than the supply.

Scarcity

A key economic concept, scarcity refers to when the demand for a product or service is greater than its availability. This is paramount for understanding how products and services are valued. Take diamonds, gold, or even certain kinds of knowledge, for instance. These things are scarce – and are more valuable for being scarce – since those who sell such things can set higher prices.

They’re aware that because more people want these products or services, and availability is low, they can find buyers at a higher cost.

Opportunity cost

Opportunity cost is the amount of potential gain an investor misses out on when they commit to one investment choice over another. In laymen’s terms, it’s the loss you take to make a gain or the loss of one gain for another gain.

Let’s say an investor has the choice of selling stock shares now or holding onto them to sell later. Selling them now would provide immediate gains, but they’d be losing out on any gains the investment might make them in the future.

Opportunity cost doesn’t necessarily have to be applied to investments or money either; you can just as easily apply it to life decisions, no matter how small.

Incentives

In the economic world, incentives are what encourage or motivate us to act in certain ways financially. They’re what make consumers and businesses respond to market changes like prices and financial benefits.

This can be something as simple as offering buy-one-get-one-free discounts or government subsidies that allow businesses to financially benefit from carrying out certain actions.

Willingness to pay

Willingness to pay (WTP) is the maximum price that a customer is willing to pay for a product or service. This amount varies from person to person and is usually informed by extrinsic and intrinsic differences.

Extrinsic differences are demographic factors such as age, gender, race, income, and level of education. Intrinsic differences, meanwhile, go a little deeper.

These are factors that you’d unearth by asking specific questions rather than something you can identify through observing people. These differences might include someone’s risk tolerance, their desire to fit in with others, and their interest levels in different subjects.

Purchasing power

This concept refers to the number of goods or services that a certain amount of money can buy at any one time. As such, it’s an indicator of the current market condition, since it allows businesses (or individuals) to work out how far their money will go.

Classical economics

Established way back in the 18^th and 19^th centuries by the likes of economists and political thinkers such as Adam Smith, John Stuart Mill, and others, classical economics posits that market economies are, by definition, self-regulating systems ruled by the laws of production and exchange.

It’s also where we get the invisible hand concept. Smith noted that by following their self-interest, consumers and firms can create an efficient allocation of resources for the whole of society.

Confused? OK, here’s a clearer explanation: a company charges a very high price for a certain item at $6. This incentivizes another company to charge $4 for their version of the item.

Consumers then switch from the high-price item to the lower-price item. This puts pressure on the first company to lower the price until the equilibrium between supply and demand has been reached.

Malthusian economics

Malthusian economics takes the view that while population growth rapidly increases, the supply of food and other resources is linear. This means that when a population grows over time and overtakes a society’s ability to produce resources, their standard of living may reduce and result in depopulation.

Monetarism

Monetarism puts forward the idea that governments can achieve economic stability by controlling monetary supply. Its central principle believes that the total amount of money circulating in an economy is the main factor that determines its growth.

New growth theory

The New Growth Theory (NGT) focuses on how the individual’s desires and needs act as the main reason for economic growth. People purchase, sell and invest depending on their wants and needs, all of which results in GDP growth.

A large part of NGT is the assumption that competition flattens profit, causing people to look for better, more efficient methods of doing things to maximize their profit-earning potential.

Moral hazard theory

An economic phenomenon that involves parties entering contracts in bad faith, moral hazards arise when an entity, such as a corporation, increases its exposure to risk during a transaction so they can maximize profit. Typically, this is to potentially avoid the consequences associated with taking on that risk.

In these scenarios, it’s the other party that has to bear the cost of such risks.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto, and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

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