Definition Of Economics:
Economics is a social science which studies the rational choices made by people in the areas of production, consumption and wealth creation in the face of the conflict between unlimited wants and scarce resources.
3 Areas Of Study
The study of economics can be divided into microeconomics, macroeconomics and international economics.
Microeconomics
Microeconomics is the study of economics from the individual level on up to the industry level. Its major concepts are:
1. Supply - The total quantity of a good or service that is available for purchase at a given price.
2. Factors of Production - These are the requirements for production, usually represented as capital, labor, and land.
3. Economic Efficiency - This refers to the use of resources so as to maximize the production of goods and services.
4. Demand - The want or desire to possess a good or service through legal means.
5. Demand elasticity - This is the relationship between changes in the demand quantity of a good and the changes in its price.
6. Scarcity - This refers to limitations such as insufficient resources, goods, or abilities to achieve the desired ends.
| 7. Shortage - This is the situation which exists when the quantity demanded is greater than the quantity supplied. |
9. Opportunity cost - This is the cost of any activity measured in terms of the value of the next best alternative that is foregone.
10. Price - The money value of a unit of a good or service.
| 11. Price ceiling | - This is the maximum legal price that can be charged for a product. |
| 12. Profit- | This is the difference between revenue received and the cost of production. |
14. Market structure - The number of firms producing identical products or the degree of monopoly.
15. Competition - The effort of two or more parties acting independently to secure the business of a third party by offering the most favorable terms.
16. Income distribution - The manner in which a nation’s total GDP is distributed amongst its population.
17. The roles of Government - Its roles are to (1) produce services which private firms are either unwilling or not allowed to produce, (2) alter the structure of private production in order to improve the allocation of resources, (3) intervene in the private market in order to make the distribution of income more equitable, (4) stabilize the economy by attempting to reduce fluctuations in income, employment and the general price level.
Macroeconomics
Macroeconomics is the study of the economy of entire countries. It analyses the distribution or allocation of scarce goods in society. Its major concepts are:
1. Gross Domestic Product - The dollar value of all final goods and services produced in a year.
2. Aggregate Demand - The total demand for final goods and services in the economy at a given time and price level.
3. Aggregate Supply - The total amount of goods and services that firms are willing to sell at a given price level in an economy.
4. Fiscal Policy - The government program of spending and taxation to promote desired economic goals for the nation.
5. Monetary Policy - A plan of the government to regulate the money supply in the nation.
6. Tax - This is a pecuniary burden laid upon individuals or property owners by legislative authority to support the government.
7. Productivity - This is the amount of output per unit of input and is one of the basic yardsticks of an economy's health. Living standards tend to rise when productivity rises.
8. Fiscal Deficit - When a government's total expenditures exceed the revenue that it generates.
9. National Debt - This is the total amount of money a nation owes its creditors.
| 10. Unemployment - The situation in which people are willing and able to work at current wage rates, but do not have jobs. |
| 12. Inflation - A sustained and continuous increase in the general price level. |
14. Depression - A prolonged period with large numbers of unemployed, declining incomes, and general economic hardship.
15. Recession - This is a decline in a country's GDP for two or more successive quarters. It
is usually characterized by a significant decline in economic activity.
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International Economics
International economics concerns itself with the interaction of economic agents, such as
individuals and firms across borders. Its major concerns are:1. Absolute Advantage - This is the ability to produce something with fewer resources than other producers.
2. Comparative advantage - This refers to the advantage a country enjoys when it specializes in the production of goods in which it has a lower opportunity cost than other countries.
3. Economic growth - An increase in the total output of a nation over time.
4. Balance of payments (BOP) - This is the method countries use to monitor all international monetary transactions at a specific period of time. If a country has received money, this is known as a credit; and, if a country has paid or given money, the transaction is counted as a debit.
5. Exchange rate - This is the rate, or price, at which one country's currency is exchanged for the currency of another country.
6. Trade barriers -These are the imposition of some sort of cost on trade that raises the price of the traded products. These barriers can take the form of tariffs or non-tariff measures such as the need for licenses, quotas, restraints, subsidies or local content requirements.
7. Economic stability - This refers to a scenario of absence of excessive fluctuations in output growth coupled with low and stable inflation.
The Natural Laws of Economics
The fastest short-cut to learning economic principles is to be aware of the following natural economic laws:
1. The law of demand. When the price of a good falls, the quantity demanded usually rises with a substitution of cheaper goods for more expensive goods due to a relative change in price.
2. The law of supply. When the price of a good rises, the quantity produced usually rises.
3. Law of supply and demand. In a free market, the equilibrium price of a good is that at which the quantity supplied equals the quantity demanded.
4. Walras' law. If there is an excess quantity supplied in one market, there must be a matching excess quantity demanded in another market.
5. The law of one price. In an efficient market, all identical goods must have only one equilibrium price.
6. The law of diminishing returns. Given a fixed amount of some input, when ever more amounts of the variable input are added, eventually, the last unit's contribution to output declines.
7. The law of diminishing marginal utility. As one obtains more and more of a particular good, eventually the value from one more unit declines.
8. The law of unintended consequences. Human actions, and especially governmental acts, have consequences which were not intended and not anticipated by the actors.
9. The law of iterated expectations. One cannot use the limited information at some previous time in order to predict the forecast error one would make if one had better information later.
10. Engel's law. The proportion of income spent on food in an economy is inversely proportional to the general welfare of the society in that economy.
11. Wagner's law. As an economy grows, government spending will increase by a greater proportion.
12. Say's law of markets. Production is the source of demand. According to Say's Law, when an individual produces a product or service, he or she gets paid for that work, and is then able to use that pay to demand other goods and services.
13. Law of time preference. People tend to prefer to obtain goods sooner rather than later, and will pay a premium (i.e. interest) to shift buying from the future to the present.
14. Law of the market. Statements made by market participants are assumed to be truthful, and products are presumed to be safe and effective unless otherwise stated.
15. Pareto's law of distribution. There is a general tendency for 80 percent of the consequences to result from 20 percent of the causes.
16. Law of cost. All costs are opportunity costs, the true cost being what is given up to get something.
17. Law of comparative advantage. Trade takes place because parties specialize in the products which have a lower opportunity cost, rather than merely a lower physical cost.
18. The law of wages. The wage level of an economy, where labor is mobile and competitive, is determined by the marginal productivity of labor at the margin of production, i.e. the least productive land in use.
19. The law of economizing. People tend to economize, maximizing gains for a given cost, and minimizing costs for a given gain.
20. The law of economic rationality. Human action is economically rational if one's preferences are consistent and if one economizes.
The 3 Giants of Economics
1. Adam Smith (1723-1790)
Magnum opus: The Wealth of Nations
2. John Maynard Keynes (1883-1946)
Magnum opus: The General Theory of Employment, Interest and Money
His major departure from Smith is his advocacy for Government intervention in the economy. The government’s central bank can stabilize and balance the economy by controlling the money supply.
When something happens to shake consumer confidence in the economy, people begin to hoard money resulting in reduced economic activity and increased unemployment. So, to fight unemployment, the money supply should be expanded either (1) by the central bank in buying government bonds (debts) from commercial banks thus increasing the amount the latter can lend; (2) by decreasing bank reserve requirements thus increasing the banking sector's excess reserves; or (3) by reducing the discount rate (the interest rate the central bank charges commercial banks for borrowings to meet bank reserve requirements) thus allowing banks to hold fewer excess reserves. Expanding the money supply will create more spending in the economy, which in turn will create more jobs.
On the other hand, to fight inflation, the Central Bank should contract the money supply by doing the opposite to the above.
Keynes also believed that depressions are recessions that had fallen into a "liquidity trap" when people hoard money and refuse to spend no matter how much the government tries to expand the money supply. In such a situation, Keynes believed that the government should reestablish the circular flow of money by increasing government deficit spending, for example, by investing in public works and hiring the unemployed to maintain full employment. Only when full employment had been achieved can the market mechanism be allowed to operate freely again.
3. Karl Marx (1818-1883)
Magnum opus: The Communist Manifesto
Conclusion
In theory, recessions are actually self-correcting provided people respond to them rationally. Also, government intervention during an economic crisis may often be ineffective or even harmful.
Yet, in practice, Keynesian economics still predominate current economic thinking. That's because of the moral demand for government action during the rather long time lag between the recognition of a recession and people's eventual rational response to it.
As Richard Nixon once declared, "We are all Keynesians now"! Few will disagree with that statement, even today.
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