Starting a company or one’s own enterprise is hard for lots of reasons. But you don’t have to go it alone. One of the best ways to minimize the risk is to gather information. Usually, that’s stuff about market size and fit, potential customer receptivity, and the regulatory environment you’ll be operating in. But you also need to know your basic economics.
While very few people can claim to have mastered economics, one only really needs a good grasp of the basics. To help, we’ve compiled the following five (by no means exhaustive) basic concepts to provide you with an introduction.
So here they are – five basic concepts in economics:
1. Cost-benefit analysis (CBA)
CBA is a good way of developing a reliable approach to making decisions. A CBA approach can help entrepreneurs understand the clear cost associated with a set of choices. Basically, the question becomes, “if I take this course of action, how much will it cost me versus how much will I make?”
For example, the manager of a popular restaurant has to a choice to make about whether to upgrade the restaurant’s interior décor. Is it worth it? Lots of things may contribute to the decision, like whether most customers sit down to eat or whether they order out. A systematic cost-benefit analysis can help the manager make a clear choice.
2. Opportunity cost
Opportunity cost is related to CBA, but not quite the same thing. Basically, there are economic costs associated with the choices one makes, and some of those costs are best described as the cost associated with not making another choice. Every choice you makes means you’re making a choice about something else too. If you choose red, you’re not choosing blue. And not choosing blue is part of the cost that one has to consider when choosing red.
For example, a restaurant may receive an order for 10 pizzas. But the customer who made the order lives half an hour away. And the manager knows that three other customers are going to make an order in the next half hour and they each live only a few minutes away. Does the restaurant take the order? The opportunity cost of delivering ten pizzas in half an hour equals the loss of the benefit associated with delivering the pizzas to the three other customers. It may or may not justify the first choice, but it should be considered.
This is a pretty big one. Technological change in an economy is one of the drivers of economic growth. Put simply, better technology improves productivity, which increases yield, or output. And more technology helps produce more growth across economies.
The computer, obviously, was a big technological breakthrough for lots of industries. It helped improve output for lots of people. Critically, it also helped create new industries.
4. Gross Domestic Product (GDP)
An economy – or country’s – GDP is the total market value of all the goods and services produced by that country in a year. Usually, the number is expressed in USD. However, it’s also expressed on a per capita basis, which means that it’s divided by the number of people in the country. What you get is the dollar value of all that a country produces per person.
In particular, per capita GDP is a useful metric when deciding whether to enter a market or how to price a product or service in a new market. If you’re selling games online, the best way to price a game sold in Egypt or the UAE requires understanding how much the average person in either of those markets can spend on video games. Per capita GDP provides some of that insight.
5. Aggregate Demand
One hears a lot about supply and demand. And for good reason – they’re some of the most basic economic concepts there are. Aggregate Demand is usually used in a slightly different way however.
Aggregate demand is the total demand for goods and services in an economy – at a certain price level and time. It’s what people in an economy will consume at all price levels, which is why it’s usually expressed as a curve. It is also the demand for an economy’s Gross Domestic Product.
Aggregate demand becomes useful in conjunction with other economic characteristics or indicators. It’s just one more pixel in the overall picture of how large and healthy an economy is.