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Key Economic Concepts to Understand when Running a Business

Decision making

Decision makingThere are many new challenges that one faces when starting up a business. An entrepreneur needs to have a wide variety of knowledge in many different subjects, or at least employees who have that knowledge and can utilize it for them. However, one absolutely necessary weapon that every business owner needs is a keen understanding of certain economic principles. Understanding economics can help you organize your finances and assess certain business situations in an educated way. This gives you a much needed edge in the business world, and is certainly not something that you want to give up, early on. Here’s a few key economic concepts to understand when running a business…

Macro vs. Microeconomics

The first thing that must be understood about economics is what specific types of concepts and theories you will be dealing with. There are two different categories of economic thought that it is important to be able to differentiate: microeconomics and macroeconomics. Each of these concepts refers to a different way of dealing with different economic issues, depending on the scale that they must be addressed. Macroeconomics is a study that focuses on economic trends on a wide scale, such as entire countries, or gigantic corporations. This makes macroeconomic concepts highly applicable to things like unemployment, inflation, or import/export balance. The theories of macroeconomics are meant to measure how changes at the head of a system will ripple downwards and affect the rest of the economy. This makes it more of a “top down” sort of system.

On the other hand, microeconomics refers to a system of economics that is meant to study the economic decisions made by an individual, business, or any other singular unit of an economy, and how their decisions affect the rest of the economy around them. Microeconomics is used to study things like the supply/demand pattern of certain products or the determination of price of certain products. Microeconomics is what you will be dealing with as a business owner. Anytime you are going out of your way to learn about economics that can improve your business dealings, learn about microeconomics. While macroeconomics is important, your business will be unable to affect anything on that sort of economic level. For more information about macro and microeconomics, check out this blog post here.

Progressive tax rates

When running a business, you will have to handle an unpleasant thing called taxes. Improper management of taxes can cause you to pay a lot more than you have to, or suffer fines for doing it wrong. Because of this, it is highly important to understand how taxes work, which brings us to the progressive tax rate. We, and most other industrialized countries in the world, have a progressive tax rate. This means that higher income brackets are taxed at a higher rate than lower ones. Keep in mind, that doesn’t mean that individuals with a higher income are flat out taxed at a higher rate, but rather, that each bracket in that individual’s income are taxed at different rates.

For an example of progressive tax rates, consider this: A person who makes $20,000 a year will pay two different tax rates for different sections of their income. $0-$10,000 may have a 10% tax rate, while $10,000-$20,000 will be taxed at a 15% tax rate (these rates are theoretical, and not representations of the tax code). This means that the final (marginal) tax rate for an individual will end up being 12.5%. In the end, this does lead to those with higher incomes paying a higher portion of it, but it also makes it impossible for an individual to have a lower net income than someone in a lower tax bracket due to taxes.

Product life cycles

When entering an industry (or if you are already there) it is important to understand the appeal of the product and where it is at in its life cycle. The product life cycle consists of four different stages: the introduction stage, the growth stage, the mature stage, and the decline stage. Each product experiences a different life cycle, and it may even revert to a previous stage (declining products have hit spurts of new growth before)…

The introduction stage is spent largely on marketing and bringing this new product to consumers. During this time, all customers are first-time buyers. A company probably won’t see many returns during this time. Rather, the growth stage is where the real money is made. As you hit the growth stage, the product is beginning to pick up. Competition is incredibly low, and expenses drop as the company gets more experienced. This means that the profit margins are incredibly high here. After the growth stage, the product will reach the mature stage, which is when the competition catches up with the demand, and the product is reaching its peak audience. This means that the market is saturating and leveling out. Profits are still up, but no longer growing at their previous rates. After this, a product will eventually reach the decline stage, when the audience levels out and profits begin to fall, due to oversaturation.

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