Basics of Economy
Normative and Positive Economy, Opportunity Cost, Demand, Supply, and Equilibrium…
Normative and Positive Theories
Economics has two main purposes: “Positive and Normative Analysis.”
Positive analysis is based on understanding the scarce resources of the economy (the goods and the services) allocation mechanism or predicting the effects of change in rules without any value judgments.
“Positive economics is a stream of economics that focuses on the description, quantification, and explanation of economic developments, expectations, and associated phenomena.”
On the other hand, the normative analysis makes judgments about the value of scarce resources.
For example, a gasoline tax to build highways harms gasoline buyers (who pay higher prices) but helps drivers (by improving the transportation system). Since drivers and gasoline buyers are typically the same people, a normative analysis suggests that everyone will benefit. Policies that benefit everyone are relatively uncontroversial.
Two types of normative analysis are:
- Cost-benefit analysis weighs the gains and losses to different individuals to determine changes that provide greater benefits than harm.
- Welfare analysis trades off gains and losses to different individuals.
Opportunity Cost
The opportunity cost is the value of the best-forgone alternative.
This definition emphasizes that the cost of action includes the monetary cost as well as the value forgone by taking the action.
In other words, it is the loss of value in order to get a higher return.
The process of selecting between payment and action may be employed to monetize opportunity costs in other contexts. For example, a gamble has a certainty equivalent, which is the amount of money that makes one indifferent to choosing the gamble versus the certain payment. Indeed, companies buy and sell risk, and the field of risk management is devoted to studying the buying or selling of assets and options to reduce overall risk. In the process, the risk is valued, and the riskier stocks and assets must sell for a lower price (or, equivalently, earn a higher average return). This differential, known as a risk premium, is the monetization of the risk portion of a gamble.
Demand, Supply, and Equilibrium
Supply and demand are the main terms of the economy.
Economists use the term demand to refer to the amount of some good or service consumers are willing and able to purchase at each price. The total amount of quantity purchased at a price is called quantity demanded. A rise in price will always decrease the quantity demanded of a good or service. This inverse relationship is called the law of demand.
When economists talk about supply, they mean the amount of some good or service a producer is willing to supply at each price. A rise in price always increases the quantity supplied which is the rule in the law of supply.
The equilibrium, on the other hand, is the intersection of these two terms, supply and demand. This point is where the consumer and the producer agree about the price.
In some cases where the price is below equilibrium, there is excess demand or as is called “shortage” which is a decrease in supply and an increase in demand. When the price is above equilibrium, there is excess supply or as is called “surplus” which is a decrease in demand and an increase in supply.
