The Economics Of Personal Finance

Economics can be an intimidating topic sometimes with all the concepts, numbers and calculations. As complex as the principles of economics may seem though, we can apply them in our day to day financial decisions to derive full potential for our personal finances. We will look at a few concepts and how you can use them to improve your personal finance skills.

  1. Needs, Wants and Opportunity Cost

Our needs are actually limited. Traditionally they were food, shelter, and clothing but more recently you could add education. Just about everything else is a “want,” and our wants are endless yet our resources are limited. This is the basis of economics, allocating scarce resources against competing needs. It is therefore important to make choices about which wants to fulfill, based on which ones matter the most to you.

When we fulfill our needs and wants, we have to make a choice. When we make a choice, we forfeit an alternative want due to the limited resources. If you have Ksh.1,000 for example, you could buy shoes or a book. If you choose to buy the shoes, you will miss out on the information in the book, this is the concept of opportunity cost.

Understanding these three concepts will help you make better decisions when you have multiple options before you, but limited resources, which is often the case with our finances every month.

  1. Scarcity of resources

It would be wonderful if we lived in a world of endless abundance. The reality, however, is that at any given point in time, our resources have limits. Whether it is minerals on the ground or the cash in our pockets, there is only so much available to be spent. And the more we get, the more our wants increase. Ignoring this reality will see your expenses outweigh your income and if this is left unchecked, you will eventually get into debt.

Overlooking the importance of making the often hard choices needed to responsibly manage money means that you will eventually have even fewer desirable choices in the future.

  1. Time Value of Money & Inflation

This comes down to a relatively simple proposition: that the shilling you earn today is worth more than a shilling you will get some time in the future. Think about the shopping you could have with Ksh.1,000 in 2008 and what you can actually buy with the same amount today.

Why is this so? The answer is inflation. You have probably heard of it, inflation decreases the value of money over time.

You cannot wish inflation away and neither can governments stop it, they just manage it. However, a little inflation is actually good for economic activity.

You too can ‘manage’ inflation and ensure your money does not lose value over time. The secret is to keep your surplus money in an interest-earning savings product and ensure that the interest you earn is higher than the rate of inflation after deducting all fees and charges.

Conclusion: Based on these principles, it is easy to see how the broad concepts of economics can be adopted to create a better personal financial plan. What it all boils down to is the main principles of personal finance: Always remember to save before you spend, spend wisely, and borrow only when necessary.

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