The Economic Principle: Definition & Example

The Economic Principle: Definition & Example
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Lesson Transcript
Instructor: Ronald Price

Ron has held a variety of positions in higher ed and business, including 25+ years as an instructor and 20+ years as a corporate senior manager, and consultant.

This lesson identifies key economic principles and their interactions in certain economic conditions, including examples of the cause and effect that may result from a change in economic factors.

What Is the Economic Principle?

Economics is not an exact science. In fact, when the question in the title of this section is asked, it typically results in a variety of answers. Essentially, economics and the economic principle are about satisfying unlimited consumer wants with limited resources. Generally speaking, it encompasses a wide variety of economic laws and theories that define or explain how an economy attempts to satisfy the unlimited demand in the marketplace with a finite supply of resources available. Thusly, some choices and trade-offs must be made.

Another version of the definition of the economic principle is the study of the choices consumers make and the factors and behaviors affecting those choices. A consumer is any person, company, organization, or governmental body that consumes goods (finished, unfinished, or raw) or services (medical, legal, accounting, entertainment, etc.). When you buy or download anything, regardless of whether it is something you can hold in your hand, wear on your body, listen to or watch, or a service that treats an illness or improves your health, you are a consumer or a buyer. This holds true for companies and governments as well. Anyone or anything that acquires goods and services from the marketplace (the whole of things for sale) is a buyer.

Economic Decision-Making Principles

When buyers make choices, four economic decision-making principles apply:

  1. Buyers make trade-offs
  2. Buyers must give something up to get something
  3. Buyers consider the margin
  4. Buyers respond to incentives

Let's first take a look at trade-offs. As we discussed earlier, supply (what the marketplace offers) typically falls short of demand (what buyers want), so the economy must decide what's to be offered. In most cases, this results in a good or service included in the marketplace supply at the expense of another good or service being left out of the marketplace.

The trade-off between bombers and butter is a common illustration of this principle. If a country wants to have a strong national defense, it will put more of its resources into making bombers. However, if the same country isn't really into war, it may choose to increase the production of butter. This example is somewhat extreme, but it shows how goods, services, goals, and objectives of an economy are subject to trade-offs.

Now let's look at the principle of giving up to get. When you want to buy something from the economic marketplace, you must give up something of equal value. One resource that is typically in short supply is income. To buy something, you give up money (currency) in the same value as the item being purchased. If an item costs $1, then you trade the supplier (merchant) a one-dollar bill for the item.

However, not all marketplace transactions involve currency. The value of a good or service is set through mutual agreement between the seller and buyer in a transaction. A good or service is exchanged for anything of a mutually agreed equal value. The exchange medium could be money, labor, another good or service, or some future consideration. For example, in a barter system, a house painter could trade painting services for a used car offered by a homeowner, providing the two parties agree that the two items are of equal value.

Another principle of trade-off applies here: when you give up something, you lose its benefits. Therefore, when a resource is given up in a transaction, such as a used car, you lose any future value or benefit from that resource. The lost value of whatever you give up or spend in a transaction is its opportunity cost.

Now let's look at the relationship of marginal benefit versus cost. Another economic principle involved in a buyer's decision-making process is rationality. This principle says that a buyer is rational if she/he makes logical decisions that are based on gaining the highest benefits at the lowest costs and the results of those decisions are in his/her best self-interest.

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