Financial decisions form a basis of the quality of life that we live. Every single day we face a conflict of interest where financial needs are concerned. As such, we are required to create priorities that suit our immediate and crucial needs. In situations where our needs clash, an in-depth financial analysis becomes invaluable. Financial analysis
helps us to determine the overall financial costs and benefits that come with our choices. When the benefits of a financial decision outweigh the financial costs, we deem the decision “economically sound.”
Economic reasoning is a framework that guides an individual in making rational choices that yield maximum benefits and provide maximum satisfaction. Economic reasoning is a concept that is moulded by opportunity costs, market forces, government regulations and supply of goods and services. Human beings analyze the costs that come with certain choices, future repercussions of the choices, available incentives and the regulations governing trade. The principles of economics shape the market outcomes in a given country. They form the backbone of economic reasoning.
The principles of economics
- Trade-offs exist in any given market. An individual has to choose one goal over another based on the circumstances at a given time. Whereas both goals may be important, a person has to select the goal that if pursued, will reap the most benefits at that specific point in time.
- Opportunity cost
- plays a crucial role in the decision making process. Opportunity cost provides a comparison between material or financial costs and the benefits that arise from pursuing alternative actions.
- Margin analysis stimulates rational choices. A rational individual pursues objectives in a systematic way to derive the maximum benefits and the highest satisfaction levels. Individuals make rational choices after analyzing marginal costs against marginal benefits.
- Human beings respond to economic incentives. Economic incentives may be in the form of rewards or restrictions. Rewards promote the adoption of preferred choices to reap maximum benefits. Restrictions such as over-taxation and trade block restrictions are negative incentives that limit free exchange of goods and services.
- Trade allows even distribution of wealth. Through trade, individuals from different countries are able to engage in their areas of specialization. The exchange of goods and services promotes fair distribution of goods and services. In so doing, money circulates to a large number of people in different regions.
- Economic markets structure economic activities. A market economy operates on a decentralized system. The decentralized system comprises of stakeholders who understand the business dynamics in a given niche. The entities running business in a given niche ensure that there is a smooth flow of goods and services in the market. Market economies dictate the value of products and services, oversee resource allocation and cushion the welfare of a society.
- A ruling government has the authority to adjust market outcomes to improve equal distribution of resources and trade efficiency. When a market economy fails to implement effective resource allocation procedures, the government chips in to ensure there is equal distribution of resources to facilitate trade.
- A country’s living standards relies on its level of productivity. Productivity is a measure of product output per hour for one employee. The higher the quantity of products per hour, the better the country’s living standards. This is due to the high income generation per day.
- Excessive printing of a country’s legal tender by the government triggers inflation. The prices of goods and services shoot up when excess government legal tender is in circulation. The excess bills reduce the value of the legal tender.
- A society experiences temporary trade-off between unemployment of citizens and market inflation. In the event of this situation, the government injects liquid cash into the economy for circulation. In so doing, people continue trading their goods and services. The government reduces the number of unemployed citizens by ensuring uninterrupted flow of trade activities. The government opts to cut down unemployment rate over trading costs.
6 factors that influence economic reasoning
- In every situation, an individual has to make a decision out of various options. The selected option has to be the one offering the most benefits.
- Choices attract costs that may be material or monetary in nature.
- All choices attract consequences that manifest themselves in the future.
- Human beings are influenced by economic incentives that may be either positive or negative. Incentives streamline human behavior to support or reject a given financial decision.
- The availability of an economic system and legal framework dictate human behavior. Economic systems play a huge role in the supply and demand curve. Legal frameworks restrict traders to honoring approved trade regulations in trading blocks.
- Voluntary trade yields significant benefits for people to engage in economic activities in which they have a wealth of experience.
Pros and cons of economic reasoning
Businesses undergo dynamic changes in the market. The market forces may be influenced by politics, culture and external economies. Economic reasoning creates a rational space for making decisions for the greater good. It stimulates affirmative action to save the interests of a larger population. A large number of individuals can accumulate wealth through fair trade practices. By individuals engaging in their fields of expertise, a country is able to generate a lot of revenue. A peaceful political environment emerges when countries depend on each other for goods and services. Since economic reasoning considers future consequences of an action, it makes decision makers mindful of market trends.
Economic reasoning requires sacrifice. An entity has to forego one interest over another. This may subject a person to a conflict of interest. Unregulated printing of legal tender may cause inflation to stick for a longer period than anticipated. The decentralization of power to certain entities to dictate market prices often faces challenges from cartels. The monopolization of certain sectors of the economy infringe on the rights of traders.
A comprehensive market analysis is a necessity in the decision making process. Market analysis shows operational costs, operational risks, the supply and demand curves and cost margins. This analysis facilitates sound economic reasoning. A government that practices sound economic reasoning survives the evolutionary business cycle at any point in time.