Questions & Answers: Economics - Basics of Economics

Define economics and review what is important to an economy that drives an individual society.
Economics is the study of the ways specific societies allocate resources to individuals and groups within that society. Also important are the choices society makes regarding what efforts or initiatives are funded and which are not. Since resources in any society are finite, allocation becomes a vivid reflection of that society’s values.
 

In general, the economic system that drives an individual society is based on:
· What goods are produced
· How those goods are produced
· Who acquires the goods or benefits from them
Economics consists of two main categories, macroeconomics, which studies larger systems, and microeconomics, which studies smaller systems.

Review the types of money.
There are three basic types of money: commodity, representative and fiat. Commodity money includes gems or precious metals. Representative money can be exchanged for items such as gold or silver which have inherent value. Fiat money, or legal tender, has no inherent value but has been declared to function as money by the government. It is often backed by gold or silver, but not necessarily on a one-to-one ratio.
Money in the US is not just currency. When economists calculate the amount of money available, they must take into account other factors such as deposits that have been placed in checking accounts, debit cards and “near moneys” such as savings accounts, that can be quickly converted into cash. Currency, checkable deposits and traveler’s checks, referred to as M1, are added up, and then M2 is calculated by adding savings deposits, CDs and various other monetary deposits. The final result is the total quantity of available money.

Review the use of money.
Money is used in three major ways:

1. As an accounting unit

2. As a store of value

3. As an exchange medium
In general, money must be acceptable throughout a society in exchange for debts or to purchase goods and services. Money should be relatively scarce, its value should remain stable, and it should be easily carried, durable, and easy to divide up.

Review the need for banks to loan money.
Banks earn their income by loaning out money and charging interest on those loans. If less money is available, fewer loans can be made, which affects the amount of spending in the overall economy. While banks function by making loans, they are not allowed to loan out all the money they hold in deposit. The amount of money they must maintain in reserve is known as the reserve ratio. If the reserve ratio is raised, less money is available for loans and spending decreases. A lower reserve ratio increases available funds and increases spending. This ratio is determined by the Federal Reserve System.

Explain the Federal Reserve System.
The Federal Reserve System, also known as the Fed, implements all monetary policy in the US. Monetary policy regulates the amount of money available in the American banking system. The Fed can decrease or increase the amount of available money for loans, thus helping regulate the national economy.
Monetary policies implemented by the Fed are part of expansionary or contractionary monetary policies that help counteract inflation or unemployment. The Discount Rate is an interest rate charged by the Fed when banks borrow money from them. A lower discount rate leads banks to borrow more money, leading to increased spending. A higher discount rate has the opposite effect.

Explain a planned economy.
In a planned economy, a public entity or planning authority makes the decisions about what resources will be produced, how they will be produced, and who will be able to benefit from them. The means of production, such as factories, are also owned by a public entity rather than by private interests.
In market socialism, the economic structure falls somewhere between the market economy and the planned economy. Planning authorities determine allocation of resources at higher economic levels, while consumer goods are driven by a market economy.

Explain a market economy.
A market economy is based on supply and demand. Demand has to do with what customers want and need, as well as how quantity those consumers are able to purchase based on other economic factors. Supply refers to how much can be produced to meet demand, or how much suppliers are willing and able to sell. Where the needs of consumers meet the needs of suppliers is referred to as a market equilibrium price. This price varies depending on many factors, including the overall health of a society’s economy, overall beliefs and considerations of individuals in society, and other factors.
In a market economy, supply and demand are determined by consumers.