The Five Basic Principles of Economics

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The field and discipline of economics is the study of the production and distribution of goods and services. It is split into two main areas, scaled to individuals and society as a whole. The study of individuals, the economic decisions they make, and how those decisions interact is called microeconomics. Macroeconomics is concerned more with the up-and-down trends in the larger economy. Both of these disciplines are based on some key fundamental principles.

Opportunity Cost

  • In economics, the principle of opportunity cost is that the real cost of something is what you have to give up to get it. All costs are opportunity costs, not just financial ones. For example, the opportunity cost of taking a certain course in college is another class you could have potentially taken.

The Equi-Marginal Principle

  • The equi-marginal principle states that it is best to conduct economic activity at the level where marginal cost equals, or is lower than, the marginal benefit. In economics, the word marginal means incremental. In marginal analysis, costs and benefits are weighed on a marginal basis. This could be per unit, or per 100 units, or whatever quantity deemed necessary for the analysis.

Diminishing Returns

  • With the principle of marginal diminishing returns, if one input of production is increased while keeping the others fixed, overall production output will increase, but the rate of this increase will incrementally decrease. A farmer with a set number of acres in production will find that a certain number of workers will yield the highest production rate, and thus the highest returns. If more workers are hired then the proportion of income from overall production will be less than the increased cost of the new workers.

The Spillover Principle

  • This principle states that at times, decision makers will not get all of the benefits or bear all the costs of their decisions. An example of this is that runoff from a manufacturing plant can negatively affect those living downstream. On the flip side, the existence of a product can have unforeseen and unintended benefits in society beyond the financial benefit to the manufacturer.

The Reality Principle

  • The idea behind the reality principle is that purchasing power and income is what really matters to people, rather than face value of money and goods. This principle is about the real versus the nominal value of something. Nominal value is the monetary value of something. For example, a car is $10,000. Real value is the value of that product relative to other goods. That same $10,000 could also pay rent for the year.

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