Fascinating economy

Short-Term Expenses

Fixed expenses cannot be avoided. They are part of life. The financial planning that takes care of these expenses is known as short-term planning. Short-term planning involves keeping track of and covering all fixed expenses such as food and rent.

Most consumers do not limit their budget to just the necessities. They also try to plan for flexible expenses like entertainment, gifts, trips, and unforeseen circumstances that are a regular part of nearly every consumer’s spending habits. Short-term planning allows consumers to have enough money to do some of this discretionary spending.

Securing Your Future

Short-term planning takes care of expenses for necessities and some luxuries. But most people have financial goals that go beyond just meeting their day-to-day expenses.

To prepare for spending in the years to come, many people employ long-term planning. This kind of planning involves looking into the future to make wise decisions.

Long-term planning can seem a bit overwhelming. It can be hard to plan for spending that you will not do until 20 years have passed. But long-term planning has many important benefits. Wise consumers try to think about the long-term plan even though it can be difficult to predict the future.

What is Your Plan?

How about you? Have you considered your long-term expenses? Have you started saving money for college, or maybe for a down payment on a car? These are two common reasons for long-term planning.

Assets and Income

When consumers plan for the future, they pay attention to assets and income. An asset is anything a person owns that has monetary value. Personal assets can include cars, computers, jewelry, or a savings account. Income is the money a person gets, whether as a gift, a salary, or earnings from an investment.

Knowing your assets and income is necessary in helping you plan your budget. This, in turn, will affect the way you spend your money. For example, you could decide to invest in stocks this year. Five years from now, you may show a profit on this investment. That extra money can help pay for tuition. This is an example of how long-term planning can be effective. You can plan now for how your assets and income might grow in the future.

View Assets and Income. Sort each example into the appropriate column to show whether it is an asset or a form of income.

Financial Planning and Decision Making

Consumers engage in both short-term and long-term planning. Without short-term planning, you might have fixed expenses that go unmet. Without long-term planning, you cannot move toward your bigger goals such as going to college, owning a home, and eventually retiring.

Both short-term and long-term planning affect how consumers make decisions. What consumers spend now often depends on their plans for the next month, the next year, and the distant future.

View Financial Planning and Decision Making. Sort the following financial goals into the correct column below to make sure you understand the difference between short- and long-term planning.

Consumers in the economy are a bit like runners in a race. The runners each have a different reason for competing. Some may be happy just to be in the race at all. Others may be intent on achieving a personal best, while for others only winning the race will do. All the runners take part in the race to achieve some sort of satisfaction. They run to find fulfillment. Consumers buy goods and services for just the same reason. They want to find satisfaction when they participate in the economy.

What makes someone satisfied? Of course, the answer is different for everyone. Some people are content with little, while others can never seem to get enough. As one of the richest men in the world, Henry Ford was once asked, «How much is enough?» He answered, «Just a little bit more.»

Some want to win, while others are happy to participate.

Utility

Satisfaction cannot be easily measured. But because nearly all economic decisions involve consumers in search of satisfaction, economists try to understand it. They call a person’s economic satisfaction utility. Utility is the amount of personal satisfaction consumers get from the goods and services they purchase.

For instance, if you buy a new CD and find that you really like the music on it, then you are satisfied. Your utility is high. If you do not like the music, however, you are not so satisfied. Your utility is low. The concept of utility applies to every decision you make when buying goods and services. It is an important factor to consider when looking at how consumers make decisions.

Remember that your measure of utility is quite different from that of others. Your utility depends on your personal tastes and preferences, your goals, and your individual situation. Someone else might love a CD that you did not like very much. Utility levels differ from person to person.

Some things can be weighed easily, but satisfaction is not one of them.

Utility and the Cost-Benefit Analysis

You already know that consumers use the cost-benefit analysis to make economic decisions. Costs and benefits can be measured in monetary or nonmonetary terms. Ultimately, costs are measured in satisfaction, or utility. Since each person’s utility is different, different people make different decisions in the same situation.

Consider this example. Mike and Emily are in the same physics class. They are both having a hard time understanding the material, so the teacher offers to help them catch up after school. The cost to each of them is a few hours at the end of the school day. While the time commitment is the same for both, their utility may be quite different. Emily has other after-school activities that she does not want to miss. Mike has no other plans after school. The cost of this time is different to each of them. Their utility is different.

Different decisions result from different tastes and preferences.

The Road Not Traveled

When you make decisions as a consumer, you do not consider just one possibility. For instance, if you are thinking about going to a movie, you are weighing two different options: going and not going. Not going leaves you other options: reading a book, taking a walk, or playing a game with a friend. Every decision involves following one path and not following all the other possible paths.

So, a decision is not just about selecting something that has more benefits than costs. It is about selecting the option that gives the greatest amount of utility from among all the available opportunities. Consumers have to consider the benefits lost as a result of their decisions.

Think of a farmer who decides to grow corn on his land. His opportunity cost is the alternative crop that might have been grown. What if he decided to grow wheat instead of corn? Would he have made more profit? Since he decided to grow corn, he gave up the alternative to grow wheat. He considered both options before making his decision, and in the end, he thought that it would be more profitable to grow corn.

Utility and Incentive

To maximize utility, consumers and producers look at incentives. These are the factors that motivate or influence human behavior.

Incentives can be monetary or nonmonetary. If you work very hard at your job, you might get rewarded with a bonus or a pay raise. Your employer is giving you a monetary incentive to work hard. If your hard work earns an extra week of vacation instead, that is a nonmonetary incentive. Because utility is a person’s satisfaction, an incentive can raise utility whether it is monetary or nonmonetary.

Incentives increase the possible benefits of a decision. As such, they affect the cost-benefit analysis a consumer might make.

Most people would agree that a bonus is a better incentive than a pat on the back.

What Drives You?

When you look at opportunity costs, you consider monetary and nonmonetary incentives.

If you reduce your part-time work hours to do volunteer work in your field of study, you will decrease your monetary benefits but probably increase your nonmonetary benefits. The volunteer work helps others and makes you feel good. This decision could also have a monetary effect; the experience you get from volunteering might help you get a better paying job in the future.

Untangling and calculating the monetary and nonmonetary incentives can be tricky. As a consumer, you do it all the time when you make decisions.

Marginal Analysis

Consumers try to boost their utility by making decisions that maximize satisfaction, or benefits, while minimizing costs. You have seen that cost-benefit analysis and paying attention to opportunity costs help consumers figure out what decision will be best.

Consumers also use marginal analysis when they make decisions. Marginal analysis helps answer an important question: What happens if the situation changes by one unit of something? Economic players ask themselves this question in one way or another all the time.

Consider this situation: The latest summer blockbuster has gotten some pretty bad reviews but seeing it will give you a chance to do something with your friends. Besides, tickets for a matinee are only $5. The utility you will receive from that purchase seems high.

But what if you get to the theater and discover that the ticket prices have been raised by $1? It might still seem worth it to go. But it is also possible that the extra dollar pushes the cost higher than the benefit. If that is true, then your utility has decreased, and you likely will choose not to go.

Will you see the movie for $6? How about $7? What about $8? At a certain point, the price will rise high enough that the cost outweighs the benefit, and your decision would change. That is marginal analysis.

Producers Thinking Like Consumers

Even though they may be unaware of it, consumers use marginal analysis when they make economic decisions. For every good or service, there is a point at which consumers change their minds about making a purchase if the price gets too high. Consumers are not necessarily aware of the fact that it was marginal analysis that led to that decision.