Advanced Economic Principles
While classical economists such as Adam Smith and David Ricardo have set the groundwork for much of economics as a field of study, neoclassical economics has built on and improved upon their theories. Today, the field of economics has become well ingrained in many aspects of other fields of study, not limited to psychology, sociology, and business. Here are some advanced economic principles which are used today in economic analysis.
Behavioral Economics
Behavioral economics is a branch of microeconomics which attempts to account for human nature when providing economic analysis. As mentioned earlier, classical economics has many assumptions which are unrealistic given human nature. Behavioral economics attempts to use psychology in addition to economics in order to account for this.
One early example of the usage of behavioral economics is the idea of moral hazard. Moral hazard is the phenomenon that people will act differently if they know that they have a safety net offered at little or no cost. For example, a person who has extensive health insurance may treat their bodies in dangerous or unhealthy ways, knowing that they are essentially already paying for treatment.
In order to help alleviate this problem, governments have tried several ways to change how people act. For example, many countries around the world help subsidize health insurance costs. By doing so, it allows all citizens, even the ones which do not cause harm to their own bodies, to help pay for universal coverage, essentially bringing down costs for everyone.
Network Theory
Network theory became prominent with the invention of internet. Economic institutions have experienced “diminishing returns to scale,” which simply means that when there are more users of a certain good or service, the next user must incur a higher cost when using the product than the first user.
Network theory clearly contradicts classical economics because with the advent of the internet, by increasing the number of users and webpages, the incremental value of each user and webpage actually increases, due to the low costs relative to benefits. As all users are able to access all new content, the internet is able to create value with increasing returns to scale.
Business Economics
Given the close ties that business has with economics, there are many economic principles that businesses use in order to maximize their profits. For example, an investment bank may use the Black-Scholes formula in order to price financial securities when determining where to invest their capital.
Furthermore, a highly renowned clothing store may choose to set its prices much higher than their costs of production, as it realizes that economic theory allows them to increase their profit margins by setting prices higher.