Key economic principles we wish we learned about in school

Economics was a snooze fest in school, but it doesn’t have to be! We are here to teach you the basic of economics without all the boring lectures so you can manage your finances with confidence.

Economics is an incredibly broad term that will make your head spin if you think about it too long. Thankfully, four key economic concepts can help explain a lot about economics and why people make the financial decisions that they do.

Understanding these concepts can help you in many ways, like figuring out your budget or developing a savings plan. These four concepts include supply and demand, scarcity, costs and benefits, and incentives.

Understanding these concepts will help you navigate the often intimidating world of economic policy. Politicians and big corporations love to take advantage of a “complex” economic system that may not be easy for the average person to understand - let’s change that!

How Supply and Demand Works in Economics

Arguably the most important principle, supply and demand determines the price of goods and services depending on the availability of said goods and services, and how much people want them.

When demand is greater than supply, the price of the supply will usually rise. For example, avocados take three to four years to mature and bear fruit. Avocados are incredibly popular — I mean have you tried avocado toast? The stuff is unreal. Avocados are expensive because demand far outpaces supply.  

On the other hand, if there is more supply than demand, the price of these supplies will fall. Imagine an unlikely scenario where there are more avocados than demand for avocados.

If a grocery store tries to sell 500 avocados at $3.00 a pop, but people only buy 250, the store is left with 250 avocados nobody wants (at least not at that price). To sell the remaining 250 avocados, the store might lower the price to attract people. Supply and demand go hand in hand, with one always affecting the other.

Understanding Scarcity

We are all affected by scarcity whether it is immediately felt or over the long-term. Scarcity is based on the basic fact that our planet has limited resources, while we seem to have unlimited wants. This means that decisions have to be made about how resources are distributed so that higher priority wants are met as much as possible.

A limited resource forces us to prioritize certain wants over others and make decisions about how to allocate that resource, on both a personal and societal level. For example, when you buy groceries, you are sometimes limited by how much money you have in your wallet or bank account.

If you go to the supermarket with fifty dollars, you are not able to buy everything available to you. You will need to make choices that allow you to spend no more than fifty dollars while also satisfying your wants. In this example, money is a scarce resource, but it isn’t the only scarce resource.

Time is Money

On a personal level, our scarce resource is often time - you are not always able to satisfy your wants and needs with the time available to you in a day. On any given day you may need to sleep for eight hours and work for eight hours, which leaves you with a resource of 8 hours of ‘free’ time.

This free time may be spent eating, commuting, cleaning your house, etc. The time you have to satisfy your ‘wants’ may be reduced to just three or four hours. In those few hours, you would need to choose how to divide up your time between exercising, socializing, watching television, playing with your dog, or fulfilling your other wants.

Unfortunately, we often can’t divide our time equally, forcing us to prioritize and make trade-offs between our wants. In addition to everyday life, time is also a valuable resource in investing and savings. The sooner you invest or put money away, the more money you will make over time.

If you start contributing to an RRSP at age 25 and put away $1,000 every year, you would have put away $46,000 by the time your account matures when you turn 71. Meanwhile, if you only started putting $1,000 away annually at age 41, you would have only put away $30,000 when your account matures. The sooner, the better.

This balancing act of resources occurs on a larger scale too, especially with national or global resources such as electricity, water, fuel, and other important resources. It is up to our governments, policymakers, international organizations, private corporations, NGOs, and the general public through their purchasing power to decide how these resources are spent.

Economic principles like supply and demand also influence how resources are divided. If a resource becomes scarce, the price may go up, which can reduce demand or inspire the creation of alternatives.

For example, the cost of lithium skyrocketed in 2023 due to a worldwide shortage. In the same way, if avocado harvests were particularly bad and cut production in half, the cost of avocados would increase substantially.

What to Know About Costs and Benefits

The concept of costs and benefits is based on the idea that people behave rationally...most of the time. Rational people naturally want to maximize the benefits-to-cost ratio of every decision they make, be it financial or otherwise.

For example, a gym membership may cost you $50 per month. That is the monetary cost, but there may be other costs to consider, such as the time it would take to get there, the time spent working out that could be used elsewhere, or the emotional cost of repelling the creep that keeps asking for your number.

Cost-Benefit Analysis

To assess the benefits, you could include the improvement to your fitness, weight loss, mental and physical health, increased energy, release of endorphins, potential to make new friends, and so on. When you are thinking about purchasing a gym membership, you will decide whether or not the benefits outweigh the costs.

If they do, these costs are worth it; if not, you might not bother. This process of weighing the costs against the benefits is important to how we make everyday decisions, as well as economically. Successful economics assumes people are generally rational, but that’s not always the case.

We actually make a lot of decisions based on emotions rather than maximizing the benefit. Whether it’s a large pizza or a cute purse, we all make impulse purchases from time to time, some more than others. It may not be rational or well thought out. It might just be that in the heat of the moment, we want to eat a pizza.

Corporate tactics such as advertising encourage us to act irrationally and can attempt to trick us into overestimating the benefits of a given product or service. Limited-time offers are a great example. You could have perfectly good food at home, but Wendy’s limited-time Krabby Patty burger is a must-buy!

I mean, it’s a real-life Krabby Patty and won’t be around forever! It would be a crime not to buy one, right? This thought process falsely rationalizes an irrational decision. But let’s be real. We have all been there.

The Incentive Behind Incentives

Remember Pavlov’s dog? Incentives are similar in the sense that they use rewards to increase the likelihood of a desired outcome, just without the cruelty and mental anguish. Pavlov was a bit of a dick. There are many different kinds of incentives and they all play a very important role in each decision we make.

Your incentive for reading this blog might be to learn more about economics so you can translate whatever your self-employed “stock analyst” cousin spews at the next family gathering. Economic incentives demonstrate how supply and demand encourage producers to supply the products or services that the consumers want.

When demand for a product increases, the market price for the product also rises, giving producers a good reason to make more of said product. More products sold means more money for the producers. It’s no surprise that a fatter paycheck is always a good incentive. Similarly, if the scarcity of a resource drives up the price of a good or service, consumers have an incentive to reduce their consumption to save money.

Fast food prices have skyrocketed in recent years, causing industry titan McDonalds to post its first quarterly sales miss in nearly four years back in February 2024. The people did not Mc’Love the price hikes.

Incentives can also be used to ensure individuals’ behaviour align with wider objectives, such as those of businesses or governments. For example, if you want to increase avocado sales at your farmer’s market stall, commission-based pay might incentivize your employees to focus on selling as many avocados as possible.

In this example, you are aligning your desire to make more money for your business, with your employees’ desire to take home more money, essentially killing two birds with one stone. To provide a more literal example, the Bank of Canada uses interest rates to keep inflation in check.

By adjusting interest rates, the Bank of Canada can influence the demand for goods and services. For example, if the Bank of Canada were to reduce interest rates, it would incentivize people to spend their money instead of hoarding it.

However, if interest rates are too low, it can cause inflation to get our of hand. To understand how inflation can impact you, we recommend learning about what inflation is first!

Summary

Supply and demand, scarcity, costs and benefits, and incentives are your gateway to understanding the open ocean of economics. Even a basic understanding of these economic concepts will go a long way toward helping you save money, make better purchasing decisions, and protect you from greedy corporations looking to take advantage of you. Your money is yours to spend, not theirs!