Now we arrive at one of the basic building blocks of economics, demand. So what is demand?

“Demand: the various quantities of a good or service that consumers are willing and able to purchase over a range of prices during a specified period of time,” you say.

Fantastic. Looks like someone has been reading ahead.

Since that was a bit of a mouthful (that’s what she said), let’s break down the definition to figure out what it means. There are four important parts that I want to highlight.
Consumers, Purchase
This part is a bit obvious. Demands refers to people like you, me, and the guy down the street who are buying things. We, the consumers, are on the receiving end of the transaction.
Willing and Able
Like I mentioned in the Five Fundamental Questions of Economics, the ones who get the output are the ones who are both willing and able to purchase that product or service. Just because you want something really badly doesn’t mean you can have it; you need to have the means to pay for it. So when talking about demand, we’re only referring only to those who are willing and able to buy whatever it is that we’re looking at.
Various Quantities, Range of Prices
Demand refers to not just one price, but an entire series of prices and how much would be purchased at each of those corresponding prices. Note that demand by itself does not tell you what the market price for the good or service is; it only tells you what consumers are intending to buy at each price point.
Specified Period of Time
Demand without a time constraint is meaningless. Are we looking at how much consumers are willing to buy per week? Hour? Year? Without the time frame, there’s no way to tell if the demand is large or small.
The easiest way to be able to wrap your mind around all of this is to take a look at an example. Let’s look at Greg’s demand for pounds of bacon per week. I can illustrate his demand in three different forms: as an equation, a table, or a chart. (Remember that we’re talking about quantities and prices, so those are our two variables.)

Demand for Bacon Example

Note: Demand curves aren’t always necessarily straight lines. This one just happens to be in this case to make our lives easier.

The equation, table, and graph all tell the same story. Let’s start with the table. This table shows how much bacon Greg will buy at any given price. When the price per pound of bacon is $10, Greg won’t buy any bacon at all, when it’s at $8, he’ll buy 10 pounds, and when it’s at $2, he’ll buy 20 pounds of bacon a week, so on and so forth. (Greg really loves his bacon.) Like I mentioned earlier, demand by itself does not show you what the prevailing market price is. Just by looking at the table or graph, we can’t tell how much bacon actually costs at the moment; all we can see is how much bacon Greg is willing and able to buy at any particular price.

“Hey, the numbers on the table look like they’re moving in opposite directions,” you notice.

That’s absolutely correct. As the price of bacon goes up, the amount that Greg is willing to buy goes down. As the price goes down, the amount of bacon Greg is willing to buy goes up. In other words, there is an inverse (or negative) relationship between price and quantity demanded and we economists call this relationship the law of demand.

The law of demand states that all else equal, as price increases, quantity demanded decreases and as price decreases, quantity demanded increases. You can easily see this relationship in the graph because the line is downward sloping and in the equation because the slope is negative.

Why would this be the case? Let’s think about it.
Diminishing Marginal Utility
One thing to consider is the satisfaction that we get when consuming something. In general, the more of something we have, the less satisfaction we get each successive time we consume it during a given time period. For example, the second taco that you eat right after the first one isn’t quite as good as the first. The third taco isn’t going to be quite as good as the second, so on and so forth. We call this concept diminishing marginal utility. At some point, the cost of tacos will be greater than the satisfaction or benefit you derive from consuming them and so you’ll stop buying them. The higher the price, the faster you reach this threshold, the less you consume and vice versa.
Income Effect
If our income rises, we are able to purchase more of a good or service. Similarly, when the price for a good or service falls, we’re able to purchase more of that good or service. Thus, a fall in price for a good or service creates the perception of an increase in income. We call that perception change the income effect. It’s an effect because income itself hasn’t actually changed. When the price increases, the income effect causes us to purchase less of that good and service (because we feel poorer) and when the price increases, the income effect causes us to purchase more of that good or service (because we feel richer).
Substitution Effect
Changing the price of a particular good also changes the relative prices of its substitutable goods. For example, if the price of beef goes up, the relative price of chicken goes down (even though the actual price of chicken hasn’t changed). Because of that, we become inclined to buy more chicken and less beef. The opposite is also true: a decrease in the price of beef makes beef relatively less expensive, resulting in the purchase of more beef and less chicken. This is called the substitution effect because deals with goods/services you could use to substitute for your original good or service.

It’s a combination of these effects that cause the demand curve to slope downwards.
Market Demand
Thus far, we’ve taken a look at the demand schedule for a single person. But when economists analyze the demand for a product, they don’t look at the demand for just one individual; they look at the entire market. To go from an individual’s demand to the market’s all we have to do is total the quantity the consumers are willing to purchase at every price point and create a new schedule from that. Graphically all you’re doing is horizontal summation; for every Y value, you’re adding up all the corresponding X values to come up with a new X value.

And with that you now understand the basics of the demand curve. Our journey is far from over though. In my next post, I’ll go over what happens when we break the all else equal assumption and allow things other than price to change.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
Next economics post: Determinants (Shifters) of Demand
Previous economics post: Characteristics of the Market System

How much life insurance coverage should you have? Here are some things that a typical person should take into consideration.
Income Replacement
Financially speaking, one of the biggest impacts that your death will have is the loss of income. If you’re married or have dependents, you should figure out how much of your income you need to replace so your family can maintain its standard of living. The first step is determining how long you would like your income to be replaced for. Do you want it to last ten years, twenty years, or for the rest of your beneficiary’s life? If you have a spouse, one thing to consider is whether he or she will continue working if you pass away or if he or she will be taking care of the children full time. If the spouse decides to continue working, the total amount needed here gets reduced significantly. Keep in mind that the money received here wouldn’t just be sitting under the mattress; it would be earning interest somewhere. To figure out the exact numbers here, you’ll likely need a financial calculator.
Something that would be good to know here is whether any debt you have will be passed on to somebody else in the event of your death. If that’s the case, you should have enough life insurance coverage to make sure that someone you love doesn’t end up paying off the money that you borrowed. Credit card debts, school loans and car payments all fall under this.

Something special to think about is the mortgage. Would you like the house to be fully paid for if you pass away? If you aren’t a homeowner and are renting instead, calculate how many years worth of rent you would like to leave behind for your beneficiary, if at all.
Children’s’ College Education
Do you want your kids’ college education paid for if something happens to you? Do you want to pay for all of their tuition or just part of it? Right now, the average cost of attending a four year university is somewhere around the range of $50,000 and is on the rise. Of course, having access to financial aid and/or going to a community college first would change this number dramatically and is something you should take into account.
Other Expenses
Do you need to have extra insurance to cover child care? Is one of your beneficiaries disabled and has special needs? Figure out how much you need to cover these other expenses and for how long.
Final Expenses
As I mentioned before, dying can be expensive. Final expenses include a number of different areas such as funeral expenses, medical costs, and attorney fees. If you’re leaving behind a large inheritance, you have to take into account estate and probate taxes as well (that’s something that deserves a whole post by itself). Unfortunately it’s impossible to predict how much all of those other expenses will cost. I typically recommend having a minimum of $50,000 for this area, if not more. It’s better to overestimate than underestimate for this area. [break]
Let’s say that Jack and Jill just read this post and Jack is trying to figure out how much life insurance coverage he should get. They’re both 35 years old, they both make $50,000 a year, and they have a child, Jane, who is 8 years old. [break]
Income Replacement
If Jack passes away, he would want Jill and Jane to maintain the same standard of living that they have now for the rest of their lives. With Jack out of the picture, he figures that Jill and Jane would only need 70% of the current total household income before tax ($80,000) to continue living the way they do. Jane said she would continue working if Jack passed away, so Jack only needs to replace $20,000 of his $50,000 current income. He assumes that if the income replacement money gets invested conservatively, it could earn an average of 5% a year. So to figure out how much money Jack needs for income replacement, we take $20,000 divided by 5% which gives us $400,000. In other words, if Jill takes $400,000 and invests it so that it earns on average 5% a year, then she will be able to withdraw $20,000 a year for the rest of her life. [break]
Jack doesn’t have any debt to his name other than a mortgage. Right now Jack and Jill still have twenty years left on their mortgage and they still owe $300,000. He wants the house to be fully paid off in the event that something happens to him.[break]
Children’s College Education
Jack is willing to help Jane pay for her college education, but not all of it. He believes that Jane should work during her college career to pay for part of her education. That way, not only will she gain valuable job experience, she’ll place more value in her degree because she paid for part of it herself. He’s willing to set aside $20,000 for Jane’s education. [break]
Other Expenses
Jack can’t think of any other expenses that might come up. He believes that the extra $20,000 a year from the income replacement should be enough to take care of things. [break]
Final Expenses
Jack thinks that $50,000 in coverage will suffice for final expenses. [break]
Total coverage needed: $400,000 for income replacement, plus $300,000 to pay off the mortgage, plus $20,000 for Jane’s education, plus $50,000 for final expenses puts Jack’s total life insurance needs at $770,000. So if Jack passed away today, his family would need $770,000 so that they could live out the life he envisioned them living.[break]
Now that we’ve figured out Jack’s total life insurance needs, all he has to do is get $770,000 in coverage, right? Not so fast. There are a couple things to take into consideration still.

Ten years from now, Jane is going to turn eighteen and will probably be able to provide for herself, at least in part. Four or five years after that, she’s going to be done with college so Jack won’t have to worry about having that expense covered any longer. Twenty years from now the mortgage will be paid off so Jane won’t need the $300,000 in coverage to pay off the house. The point that I’m trying to get at is that life insurance needs change over time and so Jack is going to have to reevaluate his polices to determine if he’s underinsured and leaving his family unprotected or over insured and paying for something he doesn’t need.

Additionally, he needs to think about what combination of policies he’s going to use to cover his insurance needs. How much of the coverage is going to be term insurance and how much is going to be permanent? Is he going to use whole life, universal life, variable life insurance or some mixture of three?

There are many different kinds of policies out there and you want to use the ones that fit your needs the best. Every person’s situation is different so there’s no catch all policy that can be recommended to everyone.
Previous life insurance post: Why Life Insurance is an Important Part of Your Financial Plan

Whenever I see anything related to personal finance, I often hear about what should be done with savings or how investments should be directed. Something I noticed a lot of people have left out is life insurance. They view it as an entity that’s completely separate of their financial plan when they’re one in the same. Life insurance plays just as important of a role as savings or investment; savings and investments represent the offensive side of a financial strategy whereas life insurance represents the defensive side. In my opinion, life insurance is one of the most underrated and misunderstood financial tools out there. You can start an investment at any time. It doesn’t get more expensive as you get older and it isn’t something you will ever have to qualify for. Life insurance is exactly the opposite. Let’s also look at it from a protection point of view. Suppose today you put $100 in a mutual fund. Tomorrow on your way to work you get into an accident and are instantly killed. What’s that $100 in investments going to do for your family compared to what it could have done in life insurance? That same $100 could have provided thousands of dollars in death benefits. Which would you rather have, thousands of dollars, or just $100?

Life insurance, like any other kind of insurance, is there you protect you and your family from any unforeseen circumstances that might come up. In this case we’re talking about death; it’s there to protect your family in the event that you pass away. Unlike every other kind of insurance out there like home insurance, auto insurance, or liability insurance, life insurance is the only “when” insurance. All the other types are “what if” insurance. What if something happens to your home, what if something happens to your car, what if someone decides to sue you, etc. It’s possible all these things can happen, but none of them are guaranteed to happen. Life insurance is the only one where we know the end result; nobody lives forever. The question isn’t whether or not if you will die, it’s when you will die and it’s up to you to make sure that your loved ones, whether it’s your parents, spouse, or children, are going to be financially able to cope with your death.

I’m not sure if you’ve ever had to deal with the death of a loved one before, but dying can cause both an emotional strain and a financial strain. There are final expenses to consider which include a number of different areas like funeral expenses, medical bills, various attorney fees, and estate and probate taxes. All of these costs add up. I’ve seen final expenses run as little as $20,000 all the way up to $500,000. Not having life insurance means that your family will have one more thing to worry about when you pass away.

A common misconception is that the only people who need life insurance are older people, typically married with children. This could not be further from the truth. In my opinion, everyone could use life insurance. It is the tool that you use to make sure that even though you’re not there, your family will still be able to carry on.

Let’s say you’re young, single, and have no dependents. If something happens to you then it’s likely that your parents are going to be the ones who have to pick up the final expense bill. How many people do you know that were in their twenties or thirties that passed away peacefully in their sleep? That doesn’t happen very often; when a young person dies it’s usually due to a tragic accident. And typically with tragic accidents come hospital bills. How would you feel if you passed away and you left your parents with a $50,000 final expense bill? How do you think they would feel? What do you think that’ll do to their retirement and any other things they might have been saving up for?

If you’re married with kids, then this becomes even more important. Think about your spouse. If you were suddenly taken out of the picture, would he or she still be financially able to continue to live the lifestyle you two had before? Would he or she be able to pay the rent or the mortgage? Pay off any debts you might have accumulated? Raise your children and send them off to college?

If you’re older and have a lot of assets, then the picture becomes more complicated. If your spouse has already passed away, then your kids are probably going to be the ones who pay for the funeral expenses and any hospital bills. On top of that, they’re going to have to deal with estate and probate taxes on the inheritance you left behind for them. These taxes are paid for in cash so if you don’t leave behind enough liquid assets, then your kids will have to scramble to come up with that money.

Hopefully you’re starting to see the importance of this financial tool. However, just having any policy isn’t enough. You want to make sure that you’re adequately covered so that you’re not underinsured, leaving your family unprotected or that you aren’t over insured and paying for something you don’t need. You also want to make sure you have the right type that fits your specific needs as there are many different kinds of policies out there. Lastly, you want to make sure that the insurance will be there for your family when they need it the most.

So how do you figure out how much life insurance do you need? That’s something I’ll cover in my next life insurance post.
Next life insurance post: How to Determine Your Life Insurance Needs
Previous life insurance post: Understanding the Difference between Term Life Insurance and Permanent Life Insurance

We’ve gone over the basic outline of what defines a market system. Let’s take a closer look at how it functions. Any given economic system must be able to answer the following five questions:

-What goods and services will be produced?
-How will the goods and services be produced?
-Who will get the goods and services?
-How will the system accommodate change?
-How will the system promote progress?

Let’s see how the frame work of the market system answers these questions.
What Goods and Services Will Be Produced?
There are two parts to this answer. First, there needs to be a demand for this product; in other words, consumers need to want this good or service. Second, businesses need to be able to provide this good or service at a profit. Remember that self interest is the main motivating factor in the market economy; we do what we believe will benefit us the most. So entrepreneurs and businesses are going to produce the things that satisfy their own self interest, i.e. produce what makes a profit for them. As long as an industry continues to provide a profit for the resources that are put in, then that industry will expand. New firms will enter that market and current firms will grow. When that industry ceases to provide a profit, then it will begin to contract. Fewer and fewer resources will be devoted to it. Some firms will shrink while others will exit that market altogether. That will continue to happen until that market picks back up and businesses realize profits again or until that market collapses and disappears all together.
How Will the Goods and Services Be Produced?
Firms are going to produce their products in the manner that costs them as little as possible. They have the self interest motivator to be efficient in production because they want to minimize cost in order to maximize benefit. If that isn’t enough, remember that the market system is a competitive one; there are rival firms who are constantly innovating, trying to take away your sales. So firms will use some combination of land, labor, capital, and entrepreneurial ability that costs the least amount of money. As technology and resource prices change over time, the least costly combination will change with it. As that happens, firms will adjust their production process. For example, if the price of labor falls, then a firm might decrease the amount of machinery (capital) it employs and hire more workers instead. It isn’t necessarily about using the fewest resources as it is using the cheapest combination of resources.
Who Will Get the Output?
Now that the goods have been made, who’s going to buy them? In short, those who are willing and able to. It may sound a bit harsh, but just because you want something doesn’t mean that you can have it. In order to acquire something in the market system, you need to have the means to be able to pay for it. Similarly, just because you can afford something doesn’t mean that you’re going to buy it; you need to want it as well. The higher your income, the more of society’s output you’ll be able to afford.
How Will the System Accommodate Change?
There are a lot of moving parts in an economy; trends change, new discoveries are made, and the amount of resources available fluctuate. A good economic system needs to be able to smoothly adjust to all these changing components without generating too much waste. As you may have guessed, the market system is very efficient at this.

The main regulating force in the market system is price and it is through prices that all these changes will take place. As consumer taste changes, the amount of money a firm makes will change, which will cause them to alter the price and how much that product they produce. As technology improves, different production processes become more efficient, leading to different resource prices, altering the least costly combination of resources for production. Running out of one resource and finding more of another will once again affect resource prices, changing the least costly combination of resources for production. Like I said earlier, firms will try to produce at the lowest cost possible in order to make the most profit. If there is a change to the system that leads to a lower production cost, they will move to it. Resources will be reallocated form higher cost production to lower cost production. Similarly, if there is a change that will lead to a higher profit, they will move to it. Resources will be reallocated from lower profit production to higher profit production. Firms have an incentive to keep up with change and stay ahead of their rivals because of the competition factor.
How Will the System Promote Progress?
Remember the original problem that economics is trying to tackle: there aren’t enough resources in the world to meet all of our wants so we have to find the best way possible to utilize them. Eventually, we’re going to run out of resources so we want to be as efficient as possible with what’s available to us. A good economic system will always be innovating, finding more efficient ways to work, and driving waste and costs down while increasing production. That will allow the economy to have a greater output and therefore have a higher standard of living.

The market system works in two ways to accomplish this goal. It promotes technological advance through competition. Better technology means increased production and lower costs Because of competition, firms have a huge incentive to discover this technology before their competitors. The technological advances that are made will also spread quickly throughout the system because competitors either have to adopt the new means of production or find one of their own that matches the increased efficiency. If they don’t, they’ll be left behind in profits and will eventually be driven out of business. The market system also promotes capital accumulation as technological advances often require more capital to take advantage of them. As entrepreneurs make a profit, they’re encouraged to take some of that money and reinvest it back into their own businesses in the form of capital goods (goods that help you produce other goods). This increases the firm’s productive capability (and therefore the economy’s productive capability) over the long haul. Making an investment in capital goods is making an investment in the future.
Recap (tl;dr)
What goods and services will be produced?
-The ones that consumers want that will be able to provide a continuing profit to businesses.

How will the goods and services be produced?
-In the manner that costs the least amount of money.

Who will get the goods and services?
-Those who are willing and able to purchase them.

How will the system accommodate change?
-Through the changing of prices.

How will the system promote progress?
-Through competition, firms have an incentive to find technological advances and accumulate capital.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
Next economics post: What is Demand?
Previous economics post: Characteristics of the Market System

Several different types of economic systems exist. All the models and theories that I will be covering will assume that we are in a market system, otherwise known as capitalism. There are also several different forms of capitalism, but I’ll go over that another time. For now, let’s cover six basic defining characteristics of a market system.
Private Property
In the market system, the majority of things are owned by individuals and firms, not the public or the government. Rights to private property is something that’s ingrained into western social norms and so we tend to take it for granted, but if we lose this element, much of our economy would fall apart. Having the rights to property helps drive economic growth because it encourages people to maintain and invest in their assets, allows them to trade their belongings with others, and it spurs innovation. You have an incentive to take care of your assets, make good use of them, and also improve them because you are the direct benefactor of the gains that come from your property.

For example, pretend you’re a giant pharmaceutical company like Johnson & Johnson or Pfizer. These companies take many years and spend billions of dollars researching various ailments and diseases to find a cure that they can sell. Suppose after spending $10 billion and doing research for twenty years, you finally develop a drug that cures boredom. (A legal drug anyway; I know there a bunch of things that “cure” boredom, but all of them are illegal.) Right before you announce your cure and put your drug on the market, I break into your lab and steal your recipe, releasing the drug before you do. So I end up stealing all of the credit and the money you would have made by releasing the drug first. If there were no rights to private property and there wasn’t any consequence for theft, you probably wouldn’t have spent all that time and money trying to develop this drug. There wouldn’t be very much incentive for you to own belongings, develop your ideas, and create things. That’s why we have things like trademarks, copyrights, and patents. Rights to private property also frees up your time and allows you to pursue productive activities because you don’t have to sit at home with a shotgun all day guarding your belongings.
Self Interest
Another characteristic of the market economy is self interest. Self interest is the motivating factor behind all of our actions; all of us try to do the things that we believe will benefit us the most. Businesses try to maximize the amount of profit they bring in, employees try to maximize the amount of money they make for their time, and consumers try to get the most satisfaction out of every dollar spent.

Keep in mind the economizing problem that we have: scarcity. There are an unlimited amount of wants, but only a limited amount of resources. Acting out of self interest, each person will attempt to maximize his or her benefit while minimizing their cost which leads to resources being used as efficiently as possible because we are trying to waste as little as possible.

Note: self interest doesn’t necessarily mean being selfish. Often times when you are meeting your own interests, you are fulfilling someone else’s as well. For instance, if you are extended a job offer at a company you want to work for, the employer wants to hire you and you want to work for that employer; both of you are acting out of self interest. If you help pay for your children’s college education because you want to see them succeed, you are acting out of self interest, but not being selfish. If you donate to a charity or a cause that you support because that brings you a certain sense of satisfaction, you are again acting out of self interest, but not being selfish.
Freedom of Choice and Freedom of Enterprise
Freedom of choice is exactly as it sounds; you do what you want (within legal limits of course). You can choose what kind of job you want to take, who you work for, and how you spend your money. No one is going to force you to do things you don’t want to do.

Freedom of enterprise means that entrepreneurs have the ability to acquire resources (land, labor, and capital) and use them as they see fit. They can choose what to produce; how much of it they want to produce; and when, where, and how much to sell it for.
Markets and Prices
So now we’ve got all these entrepreneurs coming up with revolutionary ideas and products that they think will change the world (intellectual private property). They’re renting buildings, hiring workers, and getting factories and warehouses ready to produce their great idea (freedom of choice and enterprise) and they’re doing it in such a manner to maximize profits (self interest). What next? Do they just sit on all the things they made? Of course not; they’re going to sell it on the market.

In economics, a market is any place that brings together people who want to buy things and puts them with people who want to sell things. In the olden days, a market used to mean meeting a in a physical location, but with the advent of technology, buyers and sellers can interact with one another by mail, phone, or internet.

Entrepreneurs don’t just produce things willy-nilly, put them on the market, and hope for the best; they’re going to produce the goods and services that consumers want to buy. We convey what we’re interested in with our “dollar votes” or our money. In other words, we use prices to signal to businesses what we want to see more of and what we want to see less of. Prices are the regulating force of the market; the ones that react to a change in prices in the correct way are the ones who will benefit the most.
Another important characteristic of the market system is competition. In the broadest sense of the definition, competition is defined as a market where there are two or more buyers and two or more sellers, all acting independently of each other buying/selling the same thing. There are no barriers to entry or exit, so anyone can come and go out of this market whenever they please.

So why is competition important? Let’s take a look at an example. Suppose you and I are rival corn farmers and right now we’re the same in every way. We produce the same kind of corn, at the same cost, and we sell them for the same price so we make the same amount of profit. If I manage to get my production costs lower than yours, then there are two things that I can do: I can sell my corn for the same price that you sell it at and have increased profits or I can sell my corn at a price lower than yours and take customers away from you, increasing my sales. I have a huge incentive to be more efficient so I can lower my total cost and up my total benefit. At the same time, you also have an incentive to be more efficient because you want to be able to experience increased profits yourself or be able to keep up with any price cuts that I make.

So competition is a driver of innovation and efficiency because in order to keep up with your rivals, you have to keep on finding better means of production otherwise you risk earning less profits or being taken out of business all together. It also helps limit the power that suppliers have on prices; they can’t arbitrarily raise their prices because they’ll lose sales to other producers who are selling the same thing at a lower price.
Active, but Limited Government
The final piece of the puzzle is an active, but limited government. In a pure market economy, the only reason government would exist is to enforce private property rights; the other characteristics of the market outlined above would take care of everything else. On the other extreme, you have a command economy, where the government has full control of everything. In many of the countries that exist today, the government has a role that lies in between the two. Because of that, they’re considered to be mixed economies, rather than pure market economies. Although the market system is an efficient system, it isn’t a perfect one. There are goods and services that would provide huge social benefits to the public that private individuals acting out of self interest have no incentive to supply. That’s where many of the modern governments step in, fixing the market failures and providing these public goods and services, making the economy more efficient.
And there you have it, the basic characteristics that define capitalism. Of course, it goes into much more detail than that, but that’s for another time.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
Next economics post: The Five Fundamental Questions that Every Economy Must Answer
Previous economics post: Understanding Opportunity Cost

Figuring out what kind of life insurance policies fit your needs best can be overwhelming at times, especially with the number of different kinds of policies that exist. Talking to a life insurance agent, who’s paid by commission, probably isn’t going to help either. To help you with this, I’m going to be writing a series on understanding the different kinds of life insurance products that exist and how they work.

Let’s start out with the basics. There are two main types of life insurance: temporary (or term) and permanent.
Term Life Insurance
The most common type of term life insurance is group term, which is often provided by employers. If you have life insurance through work and you’re not sure what kind you have, it’s more than likely going to be group term. Group term is an inexpensive type of policy, provides decent coverage, and is available to everyone in the work place. The catch is that you must remain with that employer in order to be covered by that plan. This means that changing jobs, getting laid off, or retiring will all cause your coverage to cease.

Term insurance is also something that you can purchase on your own outside of work. The coverage lasts for a predetermined amount of time, so it could be for ten years, twenty years, until you’re age sixty-five, etc. Term is typically used for things like protecting college expenses, ensuring that a mortgage is covered, and making sure that short term debt is paid off. In the short run, this kind of policy is very cheap to buy because it’s only going to be there for a limited amount of time. In the long run, it can become very expensive. If you’re twenty-five years old and are in good health, you would be able to get a large amount of term insurance for a pretty low price. Let’s say for example that you got a thirty year contract for $500,000 in coverage for $50 a month. The policy payments are based on the age at issue, so for the next thirty years, you’ll be paying the same $50 a month like you did when you were twenty-five, all the way until you hit fifty-five. When insurance contract expires at fifty-five years old, it’s going to be a lot more expensive to renew it because it’s going to be based on your new age. The same $500,000 in coverage could run you upwards of $500 a month. And that’s also assuming that you can renew it, as you may not be insurable anymore. Having a heart attack, a stroke, or cancer can cause your insurance rates to hike up significantly or it might make you ineligible all together. In addition to that once the contract expires, the coverage is gone. You could die the day after your insurance ends and the life insurance company won’t have to pay your beneficiaries a dime. If nothing happens to you during your period of coverage, all the money that was paid into the insurance won’t be returned to you.
Permanent Life Insurance
The other type of life insurance is permanent insurance. These policies are referred to as permanent insurance because they will stay with you forever, until you die, provided that you keep them in force. There are three main types of permanent life insurance: whole, universal, and variable life. There are also combinations of those three, but we’ll get into that another time. Permanent insurance is commonly used for income replacement, in case the primary income earner passes away, and for final expenses. Examples of final expenses are funeral expenses, medical bills, attorney fees, estate and probate taxes, etc. In the short run, permanent insurance is a lot more expensive than term insurance. In the long run however, permanent is a much cheaper alternative than term. Generally with permanent insurance, the rate that you pay when you get the policy is going to be the rate that you pay for the rest of your life. If you got permanent policy when you’re twenty-five, you’re going to be paying that same premium over the entire policy, even if you live to be 100. Permanent policies also build up cash value, which is your equity in the policy that you can redeem should you no longer want the policy. Additionally, you lock in your insurability because with permanent insurance, you’ll never have to renew it, so you don’t have to worry about health problems affecting your insurability.
Getting term insurance is similar to renting an apartment. Every month that you live in an apartment, you pay rent. From time to time, the landlord is going to increase the rent. Suppose you live in that apartment for thirty years. After thirty years of paying rent if you decide to move out, you won’t have anything to show for the past thirty years of payments. However, you at least had some place to live during that time.

Purchasing permanent insurance is like buying a home. The cost upfront is a lot higher than renting an apartment: you have to make a down payment, pay the real estate agent, and maybe even pay home owner association fees. On top of that you still have to make your monthly mortgage payments which tend to be more expensive than rental payments. But as you make your monthly payments, you build up equity and after thirty years of payments, you now own your home.

The differences in these two kinds of insurance are huge and it would be beneficial to know what kind you have. If you’re thinking about getting life insurance, make sure you get all the details first so you know what you’re buying. There are pros and cons to each type of insurance; most people use a combination of temporary and permanent life insurance to meet their needs. Each person’s situation is different so how much of each kind of coverage that you need depends on you.
Next life insurance post: Why Life Insurance is an Important Part of Your Financial Plan

Growing up, I didn’t have the benefit of having a rich family. My parents were divorced and I was raised by my mom who made around $30k a year. When I was older, I also didn’t have the benefit of a high paying job. Yet somehow I managed to provide for myself, pay my way through school, and graduate with a bachelor’s degree without any debt. I also seemed to have more money than my friends that higher paying jobs than I did; my income was lower than theirs, but my bank account was fuller than theirs. How could that be?

No, I didn’t do anything illegal. I just developed very good personal financial habits. I had these habits ingrained into me from a very young age, but I didn’t receive any allowance as a kid, so I didn’t have my own money when I was young. My mom and my friends never really spoke to me about how to save my money either. And I also wasn’t reading any personal finance books or blogs back then.

I learned a lot of what I know from playing Neopets.

For those of you who don’t know or don’t remember what Neopets is, it’s a website that allows you to have a virtual life with virtual pets, virtual money, and virtual items. Think The Sims, but browser based and free. I’ve been playing Neopets on and off since the early 2000’s when I was a child and I still play it today as a fully fledged adult. Lots of people would say that I’m wasting my time, but I disagree. Here are five things that I learned as a child from playing Neopets that translated into real world results.
1) Money doesn’t come from thin air
Like many other games, Neopets has its own economy with virtual currency, neopoints. If you wanted more money in the game, you have to work for it. Can’t have your parents buy things for you here like they could in real life (unless they played the game too). To someone like you and I, this is less than profound, but to someone who was ten years old, this helped me understand why my mom wouldn’t buy me all the toys that I wanted.
2) You can either work hard for your income or you could work smart for your income
You could either work for your money or have your money work for you. In Neopets, one of the easiest ways to make money was by playing games, however it’s pretty time consuming and you’re not rewarded very handsomely. You could risk some of your hard earned money and become an aspiring entrepreneur/store manager at the benefit of a much greater return. You could invest in the Neopian stock market and look to earn money there (way less risk and a lot less complex than in real life, but the basic concept still remains). You could look to generate passive income, which would earn you money around the clock with minimal effort. The more passive income you had, the more time you can devote yourself to doing other things while not having to worry about money. Just like in real life, how efficient you are at generating income was up to you.
3) Income disparity is a real thing
In Neopets, there are those who are super rich, those who are super poor, and everyone in between, just like the real world. Here’s the thing though, everyone starts out with the same empty bank account, but it’s up to you whether you want to be rich or poor. Some figure out what they need to do to earn money and rocket their way up to becoming millionaires. Others have played this game for years on end and still struggle to hang on to a few thousand neopoints. Since everyone starts on equal ground, the income disparity arises not from one’s circumstances (e.g. being born in a rich family), but from how well money is managed. Which side of the coin you fall on depends on you, which brings me to my next point.
4) The secret to growing your net worth: spend less than what you make
If at the end of the day you added more money to your bank account than you took away from it, you’ll eventually be a millionaire. The way it works in the game works the same way in real life. The biggest obstacle to building your net worth isn’t how are you going to make more money, it’s how you’re going to keep all of it. The number one reason people can’t hang on to their neopoints is because they keep seeing things that they want and they decide to keep spending every penny that they have, leaving them broke. Many first generation millionaires didn’t all of a sudden stumble upon their fortunes when walking down the street one day; they saved for it. (The other lucky bastards got to inherit their money, but my point still stands.)
5) Always shop around
The first deal you see isn’t always the best one. Just like in the real world, consumers in Neopets have imperfect information about the market (we don’t know all the available prices we could purchase at), but that doesn’t mean that we’re doomed to the first price we see. There’s always the option of going to other shops first and seeing what others list their prices at. If you want your net worth to grow at a significant rate, then don’t needlessly throw your money away by not taking a few moments of your life to see if a better deal doesn’t exist. With the advent of smartphones these days, all it takes is an internet connection and three seconds to scan a barcode to find out what everyone else is selling something for. Those small savings add up to a significant amount of money over time.
And there you have it, the five basic fundamentals of personal finance that I had ingrained into me as a child from a video game. Playing Neopets allowed me to learn how to manage my money and control my spending (and make mistakes) with virtual currency before I got my hands on any real money, putting me ahead on the personal finance experience curve.

One of the fundamental ideas derived from the concept of scarcity is that every decision that we make has a cost associated with it. Economists call this cost the opportunity cost and it’s defined as the alternatives that we forgo when making a choice. Each action that we take drains away from the available resources we have, depriving us of the benefits of the other things those resources could have been used for.

If you have $100 in your pocket and you decide to use that money to buy shoes, you give up all the other things you could have used that $100 on. Instead of shoes, you could have bought $100 worth of food, movies, games, etc. You also could have saved the $100 and gotten interest from the savings. All the alternatives that you gave up for buying shoes are referred to as the opportunity cost.

The concept of opportunity cost isn’t limited to just money either. Every day we have to make a decision as to what to do with our time. Every morning (or evening for you night owls) when you wake up, you are presented with a choice: get up or stay in bed. If you get up and start your day, you give up any extra sleep/rest you might have gained by staying in bed. If you stay in bed, you give up the extra time you could have spent preparing for work, watching a morning cartoon, or running naked around the house singing the latest Katy Perry song (I don’t know what it is that you do in the morning). These choices and costs are everywhere we go and it’s something that we deal with on a daily basis.

Pop quiz: Suppose you’re presented with the following problem: You’re in the final months of your high school career, just about to graduate. You’ve been accepted into your dream college, the University of (website name) as an undergraduate economics major. You expect to complete your degree requirements in four years and the total cost of your educations going to run you $45,000. At the same time, you have an uncle who owns his own business and since he knows you’re a hard worker, is willing to hire you to work for him as a receptionist for $40,000 a year.

What’s the opportunity cost of going to college?

What’s the opportunity cost of going to work for your uncle?

Going to college: If you decide to get your undergrad degree in economics, your opportunity cost is the $45,000 in tuition plus the $160,000 in income you could have earned by working for your uncle in the four years you spent studying.

Working: If you decide to work for your uncle instead, the opportunity cost is all the potential higher income that you could have earned from other jobs with a bachelor’s degree. The higher income isn’t guaranteed, but people with college degrees tend to earn more money over their lifetimes than those who don’t.

Most of the time when I present this problem to people, they think the opportunity cost of going to college is just the $45,000 they have to pay in tuition. What most people forget about is the extra $160,000 they could have been earning instead of going to school, which is a decent chunk of change in my opinion. The point I wanted to illustrate with this problem is that opportunity cost includes all of the alternatives that are forgone, not just the money that comes out of your pocket.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
Next economics post: Characteristics of the Market System
Previous economics post: Types of Resources in Economics

-In economics, all of the worlds’ resources fall under four main categories. Resources, also known as factors of production or inputs, are things that are used in the production process of a good or service.
Land refers to the earth itself and all of the natural resources that we derive from it.
-The ground we stand on is considered land, but so is the air we breathe, the water that we drink, and the oil that we mine. To economists, all of that is lumped together under the category of land.
Labor refers to the work that is done by people, whether it physical work (constructing a house) or mental work (accounting).
-As long as that work is used in the production of a good or service, it’s considered to be labor.
Capital refers to anything that assists in the production of another good or service.
-A factory that manufactures cars is capital. The computer that I typed this post on is capital. The tables in restaurants are capital.
-There’s also another special type of capital called “human capital” which refers to your brain and your education. Your mind has the power to make things that no machine could ever replicate.
-The key defining difference between capital and consumer goods is the purpose that the good serves. If the product directly satisfies a want, then it is a consumer good. If it’s used in the production of something else that will satisfy a want, then it is a capital good. The same item (like a computer) could be classified as either a consumer good or a capital good, depending on who’s using it.
-In economics, the word capital does not refer to money as money itself can’t produce anything. We simply use money as a means of acquiring capital. To distinguish between the two, we often refer to money as financial capital.
Entrepreneurial Ability
-The final resource is entrepreneurial ability. Entrepreneurial ability is different from labor in that an entrepreneur combines the three other resources (land, labor, and capital) to produce something new.
-An entrepreneur is also a risk bearer; he or she has no guarantee of making any money. In fact, all the time and effort spent trying to combine these resources in a meaningful way may even result in a loss. This is one of the key differences between an entrepreneur and a laborer.
Next economics post: Understanding Opportunity Cost
Previous economics post: Ceteris Paribus (All Else Equal)

Suppose two people, Mike and Sharon, are standing ten feet away from each other. Mike walks five feet towards Sharon.

Question: Is Mike now five feet away from Sharon?

Answer: Maybe. It depends.

In the time that Mike spent walking, Sharon could have done an infinite number of things. She could have walked five feet towards Mike, in which case they would be right in front of each other. Sharon could have ran away screaming because Mike looks like an ax murderer and she has no idea who he is, so now she’s more than five feet away. Sharon could have been transported into an alternate dimension in which case she no longer exists anywhere close to Mike. The only way we could know with absolute certainty if Mike is five feet away from Sharon after he walks forward is if we assume that the only variable that changes is Mike. In other words, we restrict everything else to be fixed and assume that all else is equal.

If it’s so difficult to figure out the end result of this simple example, imagine just how much more difficult it is to predict everything else with all the random variables of life. It would be impossible to study economics. To make things easier, economist employ a simplifying assumption, ceteris paribus which is Latin for all else equal into all their models. This allows us to see the results of changing one variable at a time, giving us more definite answers. The more we keep constant, the more certain we are about the outcome.

It’s a minute, but important detail that you’ll be seeing pop up everywhere. Also, professors love to use this to trick students during exams, so watch out for it. But hey, at least now you’ll have something new to talk about at your next party. Although, if this is the most interesting thing that you have to say, you might want to start looking for different parties to go to.
Next economics post: Types of Resources in Economics
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