The basic/fundamental economic concepts are:
i. Incremental concept
ii. Discounting concept
iii. Time perspective
iv. Opportunity cost
v. Equimarginal concept
Incremental analysis refers to changes in cost and revenue due to a policy change. For example – adding a new business, buying new inputs, processing products, etc. Change in output due to change in process, product or investment is considered as incremental change. Incremental principle states that a decision is profitable if revenue increases more than costs; and if costs reduce more than revenues.
Application: This concept is used while making a policy decision like adding a new business, buying new inputs, processing products etc.
According to Discounting concept, if a decision affects costs and revenues in long-run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today. Money actually has time value. Discounting can be defined as a process used to transform/reduce future money into an equivalent number of present money. For instance, Rs.100 invested today at 10% interest is equivalent to Rs.110 next year.
FV = PV*(1+r) t
Where, FV is the future value (time at some future time), PV is the present value, r is the discount (interest) rate, and t is the time between the future value and present value.
Application: This concept is used in investment decisions, loan transactions, selection of projects etc.
According Time perspective, a manger/decision maker should give due emphasis, both to
Short-term and Long-term impact of his decisions, giving apt significance to the different time periods before reaching any decision.
Application: Pricing decisions.
According to Opportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than its opportunity cost. It is also defined as the cost of sacrificed alternatives. For instance, a person chooses to forgo his present lucrative job which offers him Rs.50000 per month, and organizes his own business. The opportunity cost is Rs. 50,000.
Application: Choice between alternative projects, Investment decisions.
Equimarginal concept refers to the marginal utility of a product. Marginal Utility is the utility derived from the additional unit of a commodity consumed. The laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal. Also in resource allocation to various activities, the marginal product of each resource added is considered. An optimum resource allocation is said to be achieved when the value of marginal product of each activity is the same.
Application: Resource allocation.