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.
This concept goes hand in hand with supply and demand. Scarcity is defined by investopedia.com 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 [email protected]