I am of the opinion that for many years a lot of retail investors have, on countless occasions, made investment decisions without first assessing the economic factors driving what they are investing in. As a result, when their investments make them money or lose them money, they are unable to explain and reflect properly about what went wrong or what went right. This is a risky approach to investing because, without the ability to reflect on your investments and the ability to do an educated analysis of your investment returns, your investment strategy resembles that of gambling, which is not what investing should be.
The answer to make investing less of gambling and more of a controlled process lies in the study of economics; an academic study which, for many years and decades, developed knowledge that can help us make better money decisions as well as better investments decisions. It helps us reflect on the performance of our investments in an informed manner, and as a result, allow us to learn from past experiences in order to make wiser future investment choices and better secure our money in the stock market.
An Introduction to your first economic concepts
For many of my younger days whilst I was growing up, it was not uncommon to find myself or any of the other friends faced with the situation of having to make tough decisions with the 50c we received from our parents as pocket money, or seeing our parents having to decide which brand of porridge to purchase for the household since there was little to no money available for any other luxuries. Although the upbringing was a difficult one filled with only spending on necessity, little did I realise at the time that I, along with my parents, were engaging with the economic concepts of scarcity and choice as we were engaging in making rational economic decisions on what to consume based on the limited amount of income available at our disposal. Although in economic terms income is not defined as a form of resource, for the purpose of this article income will be referred to as a resource of a household for acquiring goods and services.
A formal definition of scarcity
In its basic form, economics can be defined as the study of CHOICE, with SCARCITY being the foundation of economics. Scarcity reflects the relationship between limited resources and the unlimited human needs and wants. Since we have unlimited needs and wants with fixed amount of resources, we are thus forced to make a choice between goods and services that we need and those that we want. As indicated earlier that income will be referred to as a household’s resource, based on the amount of income a household receives at a given time they would then make rational decision on which goods and services they will purchase based on their needs and wants. This concept also forms the basis of our everyday decision-making as individuals when it comes to money or other non-monetary decisions. The relevance of this concept of scarcity in our everyday consumption as individuals is that it does not only affects our present pattern of consumption, but also affects our future consumption as well.
Example: Government and Scarcity
The principle of scarcity is quiet broad but let us look at a scenario involving our government in economic decision making taken for a particular year.
Suppose the government had a R1 trillion to spend annually, without borrowing any additional funding. What this would mean for us as a country is that we would have a limited budget of R1 trillion that would have to be spread through the different sectors of the economy (e.g. education, infrastructure spending, etc.) This limited budget would not only have to boost the economy but it would also need to improve the lives of citizens, who are formally referred to as economic agents. These economic agents are the ones who are required to initiate and stimulate the drivers of economic growth. Assuming that the Government had R200 million to spend on salaries and wages given to the rational agents (citizens of the country) for their work, all of these economic agents will only have the R200 million to fulfill their needs and wants. The remainder of the R800 million will be spent on other aspects of the economy that do not form part of salaries and wages.
With a limited budget, government had to allocate enough money for public workers for them to be able to fulfill their economic needs and wants. Meaning, government had to decide on the type of economic segment to spend their money on (public sector, salaries and wages) as well as how much to spend. These actions mirror the definition of what we described scarcity to be.
Scarcity is an economic concept that affects us in our daily lives, hence it is crucial at the end of every month or week when you receive a form of income to effectively allocate it amongst your needs and wants. Even though scarcity does not necessarily have a direct effect on your investment decisions, it helps serve as an introductory concept to economic concepts as well as to help familiarize you with the type of logic and thinking that underlies the study of economics.
- Retail investor: an ordinary person, just like you and me, who invests in the stock market.
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