Investopoly Economics 101: 7 key principles you should know
An understanding of basic economic principles will set you in good stead to understand financial commentary, political rhetoric and make your own assessment of economic risks and opportunities. That is not to suggest you need to become an economic expert but understanding some basic principles will go a long way.
The foundation of economics: the law of supply and demand
The law of supply and demand is the cornerstone of economic theory.
The law of demand states that as the price of a product or service rises (holding all other factors constant), the level (quantity) of demand for that product or service falls. Basic logic supports this principle because fewer people will be able to afford the product as the price increases and/or an increasing proportion of people will consider it uneconomical to buy it at that (higher) price. The demand curve is downward sloping, as depicted in the diagram below.
The law of supply is the opposite to demand. That is, the higher the price of a product or service, the higher the quantity of the product or service supplied by the economy (i.e., business). Again, this is common sense because as the price of a product or service rises, so does its profitability, so businesses therefore want to produce more.
The intersection of the supply and demand curves is the equilibrium price. This is the is the price at which the producer can sell all the units they want to produce, and the buyer can buy all the units they want.
A current example
A current example of the law of supply and demand at work is reflected in the price of lettuce – a topic being discussed in the media lately. As we know, supply has contracted due to supply chain issues and floods. Consequently, the supply curve has shifted left, and the price has risen to find a new equilibrium (i.e., equilibrium moves from A to B in the chart below). When supply returns to normal, so will prices.
Economic output and growth
The economic health of a country is primarily measured using Gross Domestic Product (or GDP). This measures the market value of all the goods and services that a country produces. The formula to calculate GDP is:
GDP = Consumer spending + Government spending + Investment + N
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