Fascinating economy. Larissa Zaplatinskaia
are needed to be clean, but is that all? If advertising can convince consumers that they also need deodorant and conditioner to feel clean, then more people will buy deodorant and conditioner.
Advertisers can also succeed at increasing demand by getting people to see luxuries as necessities. This is usually just a perception – you think you cannot live without something when, in fact, you probably can.
The Brand-Name Game
In our fast-paced world, producers know that consumers like to find what they need quickly and conveniently. Today, you can order a product online from anywhere in the world and have it delivered to your house in a matter of days.
This leads to a lot of competition among producers who want consumers to buy their stuff. This is another purpose of advertising – to get people to choose a specific product or service instead of the same thing provided by a competitor.
One method used by companies to get people to buy their products instead of someone else’s is branding. Branding gets people to recognize a particular company’s product and associate it with quality and popularity. Some brands can even succeed in becoming common names for the products they sell, such as Kleenex or Band-Aids.
Branding is not the only method that advertisers use. Advertisers know that consumers are more likely to buy products that they identify with, so they make ads that appeal to people by telling a story or connecting the consumer to the product.
Some brands are so familiar that we use their names generically.
Adverse Advertising
People get their news mostly from TV, newspapers, the Internet, and the radio. When it comes to informing the public on goods and services, the news media can be an effective and powerful tool of communication. When a new product comes out, like the latest car, gadget, or toy, the news media will likely discuss it, providing another form of free advertising.
News stories also alert the public to defects, dangers, and recalls. This kind of negative exposure also influences consumers by getting them to avoid certain goods and services and to beware of dangers in general.
Producers Influencing Consumers
Consumers make the final choice in all purchases, but producers do not want to leave all of the deciding up to consumers. They want consumers to demand more goods and services, and they want consumers to choose their products over those offered by someone else. Producers try to influence what consumers think and do to increase demand for their products so they can beat out the competition.
Consumers are the driving force of the economy, but they cannot do it alone. Without producers, there would not be anything to consume. To have consumption, there needs to be production. That is why businesses are important.
Businesses come in all shapes and sizes, from small home businesses run by one person to large international corporations that employ thousands of people in dozens of countries.
In many ways, businesses are like consumers. But there are important differences too. You will study some of these key differences and learn more about the role of businesses in the economic system.
Producers make all kinds of economic decisions. Just like consumers, they use rational choice when they do. In fact, producers are often more likely than consumers to pay close attention to the rationality of their decisions.
Usually, there is a lot more risk for producers when it comes to decisions. As a result, producers have significant incentive to use cost-benefit analysis and other tools of financial management. If they do not make good decisions, they will not make money. If they do not make money, they will go out of business.
Producers try to be as rational as possible, so they can keep playing their role in the economy.
Producers and Rational Choice
Remember that rational choice is a decision-making process that compares the benefits and costs of an action. Rational choice is a way of looking at several potential choices and deciding which choice is the best.
You have seen how consumers do this. Producers do the same thing, though there are some important differences. For one thing, businesses consider benefits and costs just as a consumer does, but only the monetary costs and benefits are relevant to their calculations. Consumers often take into account non-monetary things when doing cost-benefit analysis.
For instance, a farmer decides which crops to grow just like a consumer decides what to eat for dinner. But while the consumer might consider nonmonetary factors, the farmer is going to focus on monetary considerations.
Consumers might think about what is cost-effective when planning dinner, but they probably also prioritize nonmonetary considerations, such as what they like to eat or how healthy the food is.
Farmers do not think about what they like to eat when deciding which crops to grow. A farmer’s food preference does not affect production decisions. What farmers do pay attention to is how much money it will cost to plant various crops and how much they can expect to earn by selling those crops. Whichever crop will have the highest expected return is the crop the farmer will plant. It is the rational choice in monetary terms.
Profit
Monetary calculations are central to any producer’s decision-making process because making money is the reason businesses exist in the first place. In a market economy, businesses are free to make as much money as they can.
To make a profit, a business must have more revenue than costs. This means a business must earn more from the sale of its goods and services than it spends producing those goods and services. Here’s a simple formula that shows how to calculate profit:
Revenue – Costs = Profit
Profit is often called «the bottom line» because it is at the bottom of the calculation. The calculation of profit can be a bit more involved than simply subtracting costs from revenue. There are different types of expenses – production costs, administrative costs, taxes, and so on – that are calculated and subtracted in different ways.
For example, imagine a lemonade stand that rings up $30 in sales on a particularly hot day. Making and distributing the lemonade cost $7. You can calculate profits with a simple equation:
$30 (revenue) – $7 (costs) = $23 (profit)
The lemonade stand made $23 profit.
The Profit Motive
Making profit is not just something businesses like to do. It is something they have to do.
Every producer must make a profit in order to remain in business. Without profits, businesses disappear. This gives producers the profit motive, which tells them that they have to minimize costs and maximize monetary benefits. This is not exactly a law of economics, but it is so universally followed that it might as well be.
The profit motive is a necessity. Producers who choose to ignore profit end up going out of business. Only those businesses that have the profit motive will remain in business. You can easily say that all businesses are driven by the profit motive because they do not have any other choice.
Profits and Losses
A free-market economy is driven by businesses’ desire to make a profit. Businesses make production, pricing, and hiring decisions based on that goal. A business that keeps costs low and brings in more money than it spends makes a profit.
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