The term opportunity cost
The term opportunity cost, also referred to as the alternative cost, involves the choice of foregoing the next best alternative among a set of two choices. This is a fundamental concept in microeconomics that provides the consumer with the ability to budget between scarcity and choice. For instance, in a market situation where there is scarcity, a consumer is left with the option of choosing the best option and foregoing the next alternative. This concept can be illustrated in a production possibility frontier where for instance, a government has 870 billion dollars to spend between war and education programs. If the government spends the whole budget allocation on war, then the opportunity cost is that it will fore-gore education. This concept reveals the idea of scarcity in the market and the best options a consumer can take to be better off.
The role of Adam Smith's concept of the invisible hand in a Market Economy
The concept of the invisible hand is an economic term that illustrates the automated market operations, which sets the forces of supply and demand to be in equilibrium. This term could also be termed as the free market economy where the market operates without any external intervention (Jones 34). The concept of the invisible hand as introduced by Adam Smith is an important concept that explains how the invisible operations of the buyers and sellers help to maintain a state of equilibrium in the free market. For instance, in a free market with no regulation, an increase in demand for a certain good will lead to scarcity, thus causing the suppliers to increase the price of the commodity. The price changes will ultimately reduce the demand to equilibrium. Therefore, this invisible force engaged by the buyers and sellers is what Smith referred to as the invisible hand.
Market failure
Market failure is a situation where there is an inefficient allocation of goods and services in the market. That is to say, the quantity of good produced by the suppliers does not equate to the quantity demanded by the consumers. The importance of this concept is to validate the need to understand what can cause a free market to fail, and this may be due to monopoly, public goods, or externalities. Furthermore, from the study of market failure, we tend to understand that in case the invisible hand fails to operate; government intervention may be required to retain equilibrium through elements of taxation, subsidy, policy changes, or buffer stocks.
The business cycle
The business cycle involves a period in which an organization, industry, or the whole economy enters in a phase of expansion (growth) and contraction (losses). In many cases, business cycles are irregular periods that occur in different time-frame and intensity. The four major phases occur as follows; boom, recession, trough (burst), and expansion. The boom phase is the highest level of growth the economy can attain in a certain time period. During this phase, there are higher employment rates since more production is needed to satisfy the growing demand for goods and services. The recession phase is a period marked by a decline in economic growth. The third phase, trough, is the lowest point in the business cycle. The expansion phase occurs immediately after trough, and during this period the economy begins to expand. For instance, taking American’s economy as a case study, data indicate that the economy was at its peak in the year 2005 with a real GDP of 550. However, a year later, the nation entered into a recession and reached its trough in 2006 with a GDP of 534. However, the economy began to expand again in 2007 with a GDP of 537.
Works Cited
Jones, Lucas. "Basic Concepts, Definitions and Classifications." Understanding Economic: An OECD Perspective, 2008, pp. 23-64.
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