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Economics 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:
Economics consists of two main categories: macroeconomics, which studies larger systems, and microeconomics, which studies smaller systems. Market Economy A market economy is based on supply and demand. Demand has to do with what customers want and need, as well as what 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. The following is a list of terms defined in the context of a market economy: Elasticity—this is based on how the quantity of a particular product responds to the price demanded for that product. If quantity responds quickly to changes in price, the supply/demand for that product is said to be elastic. If it does not respond quickly, then the supply/demand is inelastic. Market efficiency—this occurs when a market is capable of producing output high enough to meet consumer demand, that market is efficient. Comparative advantage—in the field of international trade, this refers to a country focusing on a specific product that it can produce it more efficiently and more cheaply, or at a lower opportunity cost, than another country, thus giving it a comparative advantage in production. Planned Economy vs. Market Economy In a market economy, supply and demand are determined by consumers. 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. Microeconomics While economics generally studies how resources are allocated, microeconomics focuses on economic factors such as the way consumers behave, how income is distributed, and output and input markets. Studies are limited to the industry or firm level, rather than an entire country or society. Among the elements studied in microeconomics are factors of production, costs of production, and factor income. These factors determine production decisions of individual firms, based on resources and costs. Classification of Various Markets by Economists The conditions prevailing in a given market are used to classify markets. Conditions considered:
Once these questions are answered, an economist can classify a certain market according to its structure and the nature of competition within the market. Market Failure When any of the elements for a successfully competitive market are missing, this can lead to a market failure. Certain elements are necessary to create what economists call 'perfect competition.' If one of these factors is weak or lacking, the market is classified as having 'imperfect competition.' Worse than imperfect competition, though, is a market failure. There are five major types of market failure:
Externalities are side effects of a market that affect third parties. These effects can be either negative or positive. Factors of Production and Costs of Production Every good and service requires certain resources, or inputs. These inputs are referred to as factors of production. Every good and service requires four factors of production:
These factors can be fixed or variable, and can produce fixed or variable costs. Examples of fixed costs include land and equipment. Variable costs include labor. The total of fixed and variable costs makes up the cost of production. Factor Income Factors of production each have an associated factor income. Factors that earn income include:
Each factor's income is determined by its contribution. In a market economy, this income is not guaranteed to be equal. How scarce the factor is and the weight of its contribution to the overall production process determines the final factor income. Kinds of Market Structures in an Output Market. The four kinds of market structures in an output market are: Perfect competition—all existing firms sell an identical product. The firms are not able to control the final price. In addition, there is nothing that makes it difficult to become involved in or leave the industry. Anything that would prevent entering or leaving an industry is called a barrier to entry. An example of this market structure is agriculture. Monopoly—a single seller controls the product and its price. Barriers to entry, such as prohibitively high fixed cost structures, prevent other sellers from entering the market. Monopolistic competition—a number of firms sell similar products, but they are not identical, such as different brands of clothes or food. Barriers to entry are low. Oligopoly—only a few firms control the production and distribution of products, such as automobiles. Barriers to entry are high, preventing large numbers of firms from entering the market. Types of Monopolies Four types of monopolies are: Natural monopoly—a single supplier has a distinct advantage over the others. Geographic monopoly—only one business offers the product in a certain area. Technological monopoly—a single company controls the technology necessary to supply the product. Government monopoly—a government agency is the only provider of a specific good or service. Actions Taken by the US Government to Control Monopolies The US government has passed several acts to regulate businesses, including: Sherman Antitrust Act (1890)—this prohibited trusts, monopolies, and any other situations that eliminated competition. Clayton Antitrust Act (1914)—this prohibited price discrimination. Robinson-Patman Act (1936)—this strengthened provisions of the Clayton Antitrust Act, requiring businesses to offer the same pricing on products to any customer. The government has also taken other actions to ensure competition, including requirements for public disclosure. The Securities and Exchange Commission (SEC) requires companies that provide public stock to provide financial reports on a regular basis. Because of the nature of their business, banks are further regulated and required to provide various information to the government. Marketing and Utility Marketing consists of all of the activity necessary to convince consumers to acquire goods. One major way to move products into the hands of consumers is to convince them that any single product will satisfy a need. The ability of a product or service to satisfy the need of a consumer is called utility. There are four types of utility: Form utility—a product's desirability lies in its physical characteristics. Place utility—a product's desirability is connected to its location and convenience. Time utility—a product's desirability is determined by its availability at a certain time. Ownership utility—a product's desirability is increased because ownership of the product passes to the consumer. Marketing behavior will stress any or all of these types of utility when marketing to the consumer. Producers Determining What Customers Desire for Their Products Successful marketing depends not only on convincing customers they need the product, but also on focusing the marketing towards those who already have a need or desire for the product. Before releasing a product into the general marketplace, many producers will test markets to determine which will be the most receptive to the product. There are three steps usually taken to evaluate a product's market: Market research—this involves researching a market to determine if it will be receptive to the product. Market surveys—a part of market research, market surveys ask consumers specific questions to help determine the marketability of a product to a specific group. Test marketing—this includes releasing the product into a small geographical area to see how it sells. Often test marketing is followed by wider marketing if the product does well. Major Elements of a Marketing Plan The four major elements of a marketing plan are: Product—this includes any elements pertaining directly to the product, such as packaging, presentation, or services to include along with it. Price—this calculates cost of production, distribution, advertising, etc., as well as the desired profit to determine the final price. Place—this determines which outlets will be used to sell the product, whether traditional outlets such as brick and mortar stores or through direct mail or Internet marketing. Promotion—this involves ways to let consumers know the product is available, through advertising and other means. Once these elements have all been determined, the producer can proceed with production and distribution of his product. Distribution Channels Distribution channels determine the route a product takes on its journey from producer to consumer, and can also influence the final price and availability of the product. There are two major forms of distributions: wholesale and retail. A wholesale distributor buys in large quantities and then resells smaller amounts to other businesses. Retailers sell directly to the consumers rather than to businesses. In the modern marketplace, additional distribution channels have grown up with the rise of markets such as club warehouse stores as well as purchasing through catalogs or over the Internet. Most of these newer distribution channels bring products more directly to the consumer, eliminating the need for middlemen. Distribution of Income in a Society Distribution of income in any society ranges from poorest to richest. In most societies, income is not distributed evenly. To determine income distribution, family incomes are ranked from lowest to highest. These rankings are divided into five sections called quintiles, which are compared to each other. The uneven distribution of income is often linked to higher levels of education and ability in the upper classes, but can also be due to other factors such as discrimination and existing monopolies. The income gap in America continues to grow, largely due to growth in the service industry, changes in the American family unit and reduced influence of labor unions. Poverty is defined by comparing incomes to poverty guidelines. Poverty guidelines determine the level of income necessary for a family to function. Those below the poverty line are often eligible for assistance from government agencies. Macroeconomics Macroeconomics examines economies on a much larger level than microeconomics. While microeconomics studies economics on a firm or industry level, macroeconomics looks at economic trends and structures on a national level. Variables studied in macroeconomics include:
The overall economic condition of a nation is defined as the Gross Domestic Product, or GDP. GDP measures a nation's economic output over a limited time period, such as a Types of Consumer Behavior The two major types of consumer behavior as defined in macroeconomics are: Marginal propensity to consume defines the tendency of consumers to increase spending in conjunction with increases in income. In general, individuals with greater income will buy more. As individuals increase their income through job changes or growth of experience, they will also increase spending. Utility is a term that describes the satisfaction experienced by a consumer in relation to acquiring and using a good or service. Providers of goods and services will stress utility to convince consumers they want the products being presented. Ways to Measure the Gross Domestic Product of a Country The two major ways to measure the Gross Domestic Product of a country are: The expenditures approach calculates the GDP based on how much money is spent in each individual sector. The income approach calculates the GDP based on how much money is earned in each sector. Both methods yield the same results and both of these calculation methods are based on four economic sectors that make up a country's macro-economy:
Types of Earnings Generated by an Economy Considered to Calculate GDP Several factors must be considered in order to accurately calculate the GDP using the incomes approach. Income factors are:
Entrepreneurial income consists of two forms. Proprietor's income is income that comes back to the entrepreneur himself. Corporate profit is income that goes back into the corporation as a whole. Corporate profit is divided by the corporation into corporate profits taxes, dividends, and retained earnings. Two other figures must be subtracted in the incomes approach. These are indirect business taxes, including property and sales taxes, and depreciation. Effects of Population of a Country on the Gross Domestic Product Changes in population can affect the calculation of a nation's GDP, particularly since GDP and GNP (Gross National Product) are generally measured per capita. If a country's economic production is low, but the population is high, the income per individual will be lower than if the income is high and the population is lower. Also, if the population grows quickly and the income grows slowly, individual income will remain low or even drop drastically. Population growth can also affect overall economic growth. Economic growth requires both that consumers purchase goods and workers produce them. A population that does not grow quickly enough will not supply enough workers to support rapid economic growth. Ideal Balance to be Obtained in an Economy Ideally, an economy functions efficiently, with the aggregate supply, or the amount of national output, equal to the aggregate demand, or the amount of the output that is purchased. In these cases, the economy is stable and prosperous. However, economies more typically go through phases. These phases are: Boom—GDP is high and the economy prospers Recession—GDP falls, unemployment rises Trough—the recession reaches its lowest point Recovery—unemployment lessens, prices rise, and the economy begins to stabilize again These phases tend to repeat in cycles that are not necessarily predictable or regular. Unemployment and Inflation When demand outstrips supply, prices are driven artificially high, or inflated. This occurs when too much spending causes an imbalance in the economy. In general, inflation occurs because an economy is growing too quickly. When there is too little spending and supply has moved far beyond demand, a surplus of product results. Companies cut back on production, reduce the number of employees, and unemployment rises as people lose their jobs. This imbalance occurs when an economy becomes sluggish. In general, both these economic instability situations are caused by an imbalance between supply and demand. Government intervention may be necessary to stabilize an economy when either inflation or unemployment becomes too serious. Different Forms of Unemployment Frictional—when workers change jobs and are unemployed while waiting for new jobs Structural—when economic shifts reduce the need for workers Cyclical—when natural business cycles bring about loss of jobs Seasonal—when seasonal cycles reduce the need for certain Technological—when advances in technology result in elimination of certain jobs Any of these factors can increase unemployment in certain sectors. Inflation is classified by the overall rate at which it occurs: Creeping inflation—this is an inflation rate of about 1-3% annually. Walking inflation—this is an inflation rate of 3-10% Galloping inflation—this is a high inflation rate of more than 10% but less than 1000% annually. Hyperinflation—this is an inflation rate over 1000% per year. Hyperinflation usually leads to complete monetary collapse in a society, as individuals become unable to generate sufficient income to purchase necessary goods. Government Intervention Policies that Can Help Mitigate Inflation and Unemployment When an economy becomes too imbalanced, either due to excessive spending or not enough spending, government intervention often becomes necessary to put the economy back on track. Government Fiscal Policy can take several forms, including:
These include increasing taxes and decreasing government spending to slow spending in the overall economy. Expansionary policies increase government spending and lower taxes in order to reduce unemployment and increase the level of spending in the economy overall. Monetary policy can take several forms, and affects the amount of funds available to banks for making loans. Study and Quantification of Populations and Population Growth Populations are studied by size, rates of growth due to immigration, the overall fertility rate, and life expectancy. For example, though the population of the United States is considerably larger than it was two hundred years ago, the rate of population growth has decreased greatly, from about three percent per year to less than one percent per year. In the US, the fertility rate is fairly low, with most choosing not to have large families, and life expectancy is high, creating a projected imbalance between older and younger people in the near future. In addition, immigration and the mixing of racially diverse cultures are projected to increase the percentages of Asians, Hispanics and African-Americans. Functions and Types of Money Money is used in three major ways: As an accounting unit - As a store of value - 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. 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. Types of Money Available in the US and Economists' Measure of It 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. Aspects of Monetary Policy and the Role of 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. How Banks Function 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. Open Market Operations The Federal Reserve System can also expand or contract the overall money supply through open market operations. In this case, the Fed can buy or sell bonds it has purchased from banks or individuals. When the Fed buys bonds, more money is put into circulation, creating an expansionary situation to stimulate the economy. When the Fed sells bonds, money is withdrawn from the system, creating a contractionary situation to slow an economy suffering from inflation. Because of international financial markets, however, American banks often borrow and lend money in markets outside the US. By shifting their attention to international markets, domestic banks and other businesses can circumvent whatever contractionary policies the Fed may have put into place. Major Characteristics of International Trade International trade can take advantage of broader markets, bringing a wider variety of products within easy reach. By contrast, it can also allow individual countries to specialize in particular products that they can produce easily, such as those for which they have easy access to raw materials. Other products, more difficult to make domestically, can be acquired through trade with other nations. International trade requires efficient use of native resources as well as sufficient disposable income to purchase native and imported products. Many countries in the world engage extensively in international trade, but others still face major economic challenges. Major Characteristics of a Developing Nation The five major characteristics of a developing nation are:
Developing nations often function under oppressive governments that do not provide private property rights and withhold education and other rights from women. They also often feature an extreme disparity between upper and lower classes, with little opportunity for the lower classes to improve their position. Stages of Economic Development Economic development occurs in three stages that are defined by the activities that drive the economy:
In developing countries, it is often difficult to acquire the necessary funding to provide equipment and training to move into the advanced stages of economic development. Some can receive help from developed countries via foreign aid and investment or international organizations such as the International Monetary Fund or the World Bank. Having developed countries provide monetary, technical, or military assistance can help developing countries move forward to the next stage in their development. Obstacles Developing Nations Face Regarding Economic Growth Developing nations typically struggle to overcome obstacles that prevent or slow economic development. Major obstacles can include:
Corrupt, oppressive governments often hamper the economic growth of developing nations, creating huge economic disparities and making it impossible for individuals to advance, in turn preventing overall growth. Governments sometimes export currency, called capital flight, which is detrimental to a country's economic development. In general, countries are more likely to experience economic growth if their governments encourage entrepreneurship and provide private property rights. Problems When Industrialization Occurs Too Quickly Rapid growth throughout the world leaves some nations behind, and sometimes spurs their governments to move forward too quickly into industrialization and artificially rapid economic growth. While slow or nonexistent economic growth causes problems in a country, overly rapid industrialization carries its own issues. Four major problems encountered due to rapid industrialization are:
Economic failures in Indonesia were largely due to rapid growth that was poorly handled. Importance of E-Commerce in Today's Marketplace The growth of the Internet has brought many changes to our society, not the least of which is the modern way of business. Where supply channels used to move in certain necessary ways, many of these channels are now bypassed as e-commerce makes it possible for nearly any individual to set up a direct market to consumers, as well as direct interaction with suppliers. Competition is fierce. In many instances e-commerce can provide nearly instantaneous gratification, with a wide variety of products. Whoever provides the best product most quickly often rises to the top of a marketplace. How this added element to the marketplace will affect the economy in the future remains to be seen. Many industries are still struggling with the best ways to adapt to the rapid, continuous changes. Knowledge Economy and Possible Effect on Future Economic Growth The knowledge economy is a growing sector in the economy of developed countries, and includes the trade and development of:
Knowledge as a resource is steadily becoming more and more important. What is now being called the Information Age may prove to bring about changes in life and culture as significant as those brought on by the Agricultural and Industrial Revolutions. Cybernomics Related to the knowledge economy is what has been dubbed 'cybernomics,' or economics driven by e-commerce and other computer-based markets and products. Marketing has changed drastically with the growth of cyber communication, allowing suppliers to connect one-on-one with their customers. Other issues coming to the fore regarding cybernomics include:
Many of the old ways of doing business no longer work, leaving industries scrambling to function profitably within the new system.
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