Economics - The Basics










Introduction: What Is Economics?
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What It Means

Economics is a social science devoted to the study of how people and societies get what they need and want. Or, in more formal language, economics is the study of how societies divide and use their resources to produce goods and services and of how those goods and services are then distributed and consumed.

Resources are the basic ingredients that are needed to produce the goods and services that people buy. These ingredients can be physical things such as land and factory equipment, and they can be intangible things such as the intellectual and emotional capacities of people, whose work is necessary for the production of goods and services. Whether a society is rich or poor, large or small, resources are, from the viewpoint of economics, scarce. This means that almost everyone in every country would like more goods and services than can ever be produced. Given a limited supply of resources and an unlimited desire on the part of individual consumers and nations, choices must be made about what goods and services to produce, how to produce them, and for whom.

Economists study these often-difficult choices and their significance. They come up with theories about how such choices are made on both individual and collective levels, and they try to make predictions and find solutions to a wide range of societal problems.

Although thinkers in earlier societies sometimes addressed topics that today concern economists, economics as a field did not emerge until after the Middle Ages (a period that lasted from about 500 to 1500), when capitalism became a firmly established economic system. (In capitalism the economy is controlled by private individuals rather than the government.) Much of economic theory grew out of the ideas of Scottish philosopher Adam Smith, whose book An Inquiry into the Nature and Causes of the Wealth of Nations (1776) is generally considered the founding text of the field of economics. Later, as a result of the writings of English economist John Maynard Keynes in the 1930s, economics came to be subdivided into two main branches, microeconomics and macroeconomics. These branches focus, respectively, on individual and collective economic behavior. Since Keynes’s time many economists have worked on unifying these two branches of theory.

When Did It Begin

Throughout history many philosophers and religious thinkers have dealt with economic questions. In ancient Greece, for instance, the philosophers Plato and Aristotle addressed the issue of whether private property was a legitimate concept. Likewise, in the thirteenth century the Italian Christian philosopher Thomas Aquinas discussed the moral aspects of buying and selling goods and services. For much of history, religions such as Christianity and Islam opposed, on moral grounds, such economic trends as the charging of interest (fees paid to those who lend money). But the study of economics did not become systematic until after the Middle Ages.

In the sixteenth through eighteenth centuries, the nation-states of Europe (such as England, France, Spain, and Portugal) wanted to build up power partly by amassing wealth. Out of this desire grew economic theories that dictated the development of capitalism during that time. These theories, later grouped together under the label of mercantilism, generally held that a nation’s wealth was equivalent to its store of gold, silver, and other precious metals. This belief led nations to pursue wealth by maintaining an imbalance in foreign trade. If a nation sold more goods abroad than it imported, then that nation would bring in more gold than it would send outside of its borders through trade. In this way, the developing European nations competed with each other by trying to stockpile gold.

In the eighteenth century Adam Smith (1723–90) conceived of his book An Inquiry into the Nature and Causes of the Wealth of Nations as a rebuttal to the mercantilist viewpoint, but it was much more than that. Smith argued that a nation’s wealth should be measured not just by its horde of gold but also by all of the goods and services that it produces. He also examined the nature of that enormously sophisticated production of goods and services. One of his guiding insights was the notion of the “invisible hand.” This was the concept that, in a situation where buyers and sellers compete freely in the marketplace for what is in their own self-interest, the greatest good for all is consistently achieved, as if by the prodding of an invisible hand. The marketplace, in Smith’s view, was a self-regulating system in which market prices were determined by the forces of supply (what the sellers want) and demand (what the buyers want).

This, together with Smith’s many other crucial insights into the ways that societies use their resources, served as the foundation for much of the economic thought of the nineteenth century. Even in the twentieth and twenty-first centuries, economists continued to refine and reconsider Smith’s ideas in new ways.

More Detailed Information

Nineteenth-century thinkers, foremost among them the English economists David Ricardo (1772–1823) and Thomas Malthus (1766–1834), followed Smith’s lead, fleshing out the details of the self-regulating processes he had described and addressing some of the problems or omissions they saw in his analysis. Ricardo argued against barriers to foreign trade, as had Smith, but Ricardo focused on the ways in which the wages of workers, rent levels, and business profits interacted. Because of the complex effects each of these factors had on one another, Ricardo argued, laws that protected British farmers from outside competition were actually harmful to the wider economy. Malthus, meanwhile, examined the questions of overpopulation and the prospect of a general glut, in which an excess of production might lead to economic stagnation.

Karl Marx (1818–83), the German economist and philosopher best known as the author of the highly influential pamphlet The Communist Manifesto (1848), built on the ideas of Smith and Ricardo to critique capitalism in his lengthier work Das Kapital(1867). Among Marx’s wide-ranging conclusions was the influential idea that business owners essentially derived their profits by paying workers less than they deserved (given the value their labor added to the products). The English philosopher and economist John Stuart Mill (1806–73), meanwhile, also saw flaws in capitalism, but he used Ricardo’s ideas to suggest ways of correcting rather than abolishing the system, as Marx wanted to do.

The theories of these and other thinkers are now commonly grouped together under the heading classical economics. Most economists throughout the late nineteenth and early twentieth centuries continued to accept the basic ideas of the classical economists. The leading figures in the field during this time often focused less on wide-ranging theories than on supporting preexisting theories with sophisticated mathematical principles. During this time economics moved away from its origins in pure theory and observation and became dependent on highly sophisticated mathematical analysis.

Ideas such as the invisible hand (which guided the marketplace, ensuring the greatest good for all) continued to dictate the study and implementation of economic theory. The United States, for instance, had no cohesive economic policy prior to the Great Depression (the severe worldwide economic decline that lasted from 1929 to about 1939). Instead it largely trusted the self-regulating market to take care of itself. But the Great Depression presented economists with problems that their existing theories could not answer.

During the Depression roughly one-third of the U.S. labor force was out of work, which meant that people did not have the money to buy many of the basic necessities of life. Thus, it did not matter that new, enlarged factories with the latest technology were capable of producing goods in previously unimaginable quantities; there was no demand for those goods. The marketplace offered no solution to problems such as this.

It was in this climate that the British economist John Maynard Keynes (1883–1946) offered insights that revolutionized the field. His book The General Theory of Employment, Interest, and Money (1936) proposed that the economy, in certain conditions, might not have the capacity to correct itself. In such a situation, he argued, only a national government had the ability to provide solutions. The government could address the lack of demand created by high unemployment (joblessness) by spending money in a variety of ways. He reasoned that when a government spends money, that money goes into the hands of private citizens, who use it to buy what they want and need. This spurs the growth of business.

Keynes’s ideas, which overturned many of the classical economists’ assumptions, provided an intellectual foundation for many government programs aimed at reducing poverty and regulating the economy. His ideas also led to the creation of a new approach to the study of economics.

Before Keynes introduced his ideas, most economic theory concerned the choices of individual consumers and businesses; in other words, such theories built a picture of the larger economy from the bottom up. After Keynes this way of studying the economy came to be known as microeconomics.

Keynes’s arguments showed the necessity of looking at the economy in another way as well: from the top down. He believed that by analyzing trends at the national level (especially factors such as the economy’s growth, employment, prices, and the money supply), economists might be able to make discoveries that they were unable to see at the microeconomic level. This top-down view of the economy came to be known as macroeconomics. The field of economics today remains subdivided into these two basic ways of looking at economic activity.

Recent Trends

Keynesian economics dominated the academic world and government policymaking through the 1960s, but thinkers such as the American economist Milton Friedman(1912–2006) began to point out flaws in the idea that a government could fine-tune a national economy. Friedman and others brought back classical economic notions of the self-regulating market, arguing that an economy worked best in the absence of government interference. One of the only spheres in which Friedman believed a government should have a role in managing the economy was the money supply (the amount of money in circulation). Friedman’s ideas continued to have influence at the close of the twentieth and the beginning of the twenty-first century, but they were never followed to their full extent.

Today many mainstream economists are engaged in uniting macroeconomic and microeconomic concepts. Whereas Keynesian economists had taken a macro view of the economy that was largely independent of the well-established principles of microeconomics, in the 1970s and beyond economists began finding microeconomic explanations for phenomena that are apparent at the macro level. There are also numerous alternative approaches to economics today, many of which are built on the ideas of nineteenth-century thinkers such as Marx, whose ideas other economists have since left behind.






What Is Economics ?
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Economics is a social science concerned with the production, distribution, and consumption of goods and services. It studies how individuals, businesses, governments, and nations make choices about how to allocate resources. Economics focuses on the actions of human beings, based on assumptions that humans act with rational behavior, seeking the most optimal level of benefit or utility. The building blocks of economics are the studies of labor and trade. Since there are many possible applications of human labor and many different ways to acquire resources, it is the task of economics to determine which methods yield the best results.

Economics can generally be broken down into macroeconomics, which concentrates on the behavior of the economy as a whole, and microeconomics, which focuses on individual people and businesses.

KEY TAKEAWAYS

  • Economics is the study of how people allocate scarce resources for production, distribution, and consumption, both individually and collectively.
  • Two major types of economics are microeconomics, which focuses on the behavior of individual consumers and producers, and macroeconomics, which examine overall economies on a regional, national, or international scale.
  • Economics is especially concerned with efficiency in production and exchange and uses models and assumptions to understand how to create incentives and policies that will maximize efficiency.
  • Economists formulate and publish numerous economic indicators, such as gross domestic product (GDP) and the Consumer Price Index (CPI).
  • Capitalism, socialism, and communism are types of economic systems.

Understanding Economics 

One of the earliest recorded economic thinkers was the 8th-century B.C. Greek farmer/poet Hesiod, who wrote that labor, materials, and time needed to be allocated efficiently to overcome scarcity. But the founding of modern Western economics occurred much later, generally credited to the publication of Scottish philosopher Adam Smith's 1776 book, An Inquiry Into the Nature and Causes of the Wealth of Nations.

The principle (and problem) of economics is that human beings have unlimited wants and occupy a world of limited means. For this reason, the concepts of efficiency and productivity are held paramount by economists. Increased productivity and a more efficient use of resources, they argue, could lead to a higher standard of living.

Despite this view, economics has been pejoratively known as the "dismal science," a term coined by Scottish historian Thomas Carlyle in 1849. He used it to criticize the liberal views on race and social equality of contemporary economists like John Stuart Mill, though some commentators suggest Carlyle was actually describing the gloomy predictions by Thomas Robert Malthus that population growth would always outstrip the food supply.

Types of Economics 

The study of economics is generally broken down into two disciplines.

Microeconomics focuses on how individual consumers and firms make decisions; these individual decision making units can be a single person, a household, a business/organization, or a government agency. Analyzing certain aspects of human behavior, microeconomics tries to explain how they respond to changes in price and why they demand what they do at particular price levels. Microeconomics tries to explain how and why different goods are valued differently, how individuals make financial decisions, and how individuals best trade, coordinate, and cooperate with one another. Microeconomics' topics range from the dynamics of supply and demand to the efficiency and costs associated with producing goods and services; they also include how labor is divided and allocated; how business firms are organized and function; and how people approach uncertainty, risk, and strategic game theory.

Macroeconomics studies an overall economy on both a national and international level, using highly aggregated economic data and variables to model the economy. Its focus can include a distinct geographical region, a country, a continent, or even the whole world. Its primary areas of study are recurrent economic cycles and broad economic growth and development. Topics studied include foreign trade, government fiscal and monetary policy, unemployment rates, the level of inflation and interest rates, the growth of total production output as reflected by changes in the Gross Domestic Product (GDP), and business cycles that result in expansions, booms, recessions, and depressions. 

Micro- and macroeconomics are intertwined. Aggregate macroeconomic phenomena are obviously and literally just the sum total of microeconomic phenomena. However these two branches of economics use very different theories, models, and research methods, which sometimes appear to conflict with each other. Integrating the microeconomics foundations into macroeconomic theory and research is a major area of study in itself for many economists.

Schools of Economic Theory 

There are many competing, conflicting, or sometimes complementary theories and schools of thought within economics.

Economists employ many different methods of research from logical deduction to pure data mining. Economic theory often progresses through deductive processes, including mathematical logic, where the implications of specific human activities are considered in a "means-ends" framework. This type of economics deduces, for example, that it is more efficient for individuals or companies to specialize in specific types of labor and then trade for their other needs or wants, rather than trying to produce everything they need or want on their own. It also demonstrates trade is most efficient when coordinated through a medium of exchange, or money. Economic laws deduced in this way tend to be very general and not give specific results: they can say profits incentivize new competitors to enter a market, but not necessarily how many will do so. Still, they do provide key insights for understanding the behavior of financial markets, governments, economies—and human decisions behind these entities. 

Other branches of economic thought emphasize empiricism, rather than formal logic—specifically, logical positivist methods, which attempt to use the procedural observations and falsifiable tests associated with the natural sciences. Some economists even use direct experimental methods in their research, with subjects asked to make simulated economic decisions in a controlled environment. Since true experiments may be difficult, impossible, or unethical to use in economics, empirical economists mostly rely on simplifying assumptions and retroactive data analysis. However, some economists argue economics is not well suited to empirical testing, and that such methods often generate incorrect or inconsistent answers.

Two of the most common in macroeconomics are monetarist and Keynesian. Monetarists are a branch of Keynesian economics that argue that stable monetary policy is the best course for managing the economy, and otherwise often have generally favorable views on free markets as the best way to allocate resources. In contrast, other Keynesian approaches favor fiscal policy by an activist government in order to manage irrational market swings and recessions and believe that markets often don’t work well at allocating resources on their own.

Economic Indicators 

Economic indicators are reports that detail a country's economic performance in a specific area. These reports are usually published periodically by governmental agencies or private organizations, and they often have a considerable effect on stocks, fixed income, and forex markets when they are released. They can also be very useful for investors to judge how economic conditions will move markets and to guide investment decisions.

Below are some of the major U.S. economic reports and indicators used for fundamental analysis.

Gross Domestic Product (GDP) 

The Gross Domestic Product (GDP) is considered by many to be the broadest measure of a country's economic performance. It represents the total market value of all finished goods and services produced in a country in a given year or another period (the Bureau of Economic Analysis issues a regular report during the latter part of each month). Many investors, analysts, and traders don't actually focus on the final annual GDP report, but rather on the two reports issued a few months before: the advance GDP report and the preliminary report. This is because the final GDP figure is frequently considered a lagging indicator, meaning it can confirm a trend but it can't predict a trend. In comparison to the stock market, the GDP report is somewhat similar to the income statement a public company reports at year-end.

Retail Sales 

Reported by the Department of Commerce during the middle of each month, the retail sales report is very closely watched and measures the total receipts, or dollar value, of all merchandise sold in stores. The report estimates the total merchandise sold by taking sample data from retailers across the country—a figure that serves as a proxy of consumer spending levels. Because consumer spending represents more than two-thirds of GDP, this report is very useful to gauge the economy's general direction. Also, because the report's data is based on the previous month sales, it is a timely indicator. The content in the retail sales report can cause above normal volatility in the market, and information in the report can also be used to gauge inflationary pressures that affect Fed rates.

Industrial Production 

The industrial production report, released monthly by the Federal Reserve, reports on the changes in the production of factories, mines, and utilities in the U.S. One of the closely watched measures included in this report is the capacity utilization ratio, which estimates the portion of productive capacity that is being used rather than standing idle in the economy. It is preferable for a country to see increasing values of production and capacity utilization at high levels. Typically, capacity utilization in the range of 82–85% is considered "tight" and can increase the likelihood of price increases or supply shortages in the near term. Levels below 80% are usually interpreted as showing "slack" in the economy, which might increase the likelihood of a recession.

Employment Data 

The Bureau of Labor Statistics (BLS) releases employment data in a report called the non-farm payrolls, on the first Friday of each month. Generally, sharp increases in employment indicate prosperous economic growth. Likewise, potential contractions may be imminent if significant decreases occur. While these are general trends, it is important to consider the current position of the economy. For example, strong employment data could cause a currency to appreciate if the country has recently been through economic troubles because the growth could be a sign of economic health and recovery. Conversely, in an overheated economy, high employment can also lead to inflation, which in this situation could move the currency downward.

Consumer Price Index (CPI) 

The Consumer Price Index (CPI), also issued by the BLS, measures the level of retail price changes (the costs that consumers pay) and is the benchmark for measuring inflation. Using a basket that is representative of the goods and services in the economy, the CPI compares the price changes month after month and year after year. This report is one of the more important economic indicators available, and its release can increase volatility in equity, fixed income, and forex markets. Greater-than-expected price increases are considered a sign of inflation, which will likely cause the underlying currency to depreciate.

Types of Economic Systems 

Societies have organized their resources in many different ways through history, deciding how to use available means to achieve individual and common ends.

Primitivism 

In primitive agrarian societies, people tend to self-produce all of their needs and wants at the level of the household or tribe. Families and tribes would build their own dwellings, grow their own crops, hunt their own game, fashion their own clothes, bake their own bread, etc. This economic system is defined by very little division of labor and resulting low productivity, a high degree of vertical integration of production processes within the household or village for what goods are produced, and relationship based reciprocal exchange within and between families or tribes rather than market transactions. In such a primitive society, the concepts of private property and decision-making over resources often apply at a more collective level of familial or tribal ownership of productive resources and wealth in common.

Feudalism 

Later, as civilizations developed, economies based on production by social class emerged, such as feudalism and slavery. Slavery involved production by enslaved individuals who lacked personal freedom or rights and were treated as the property of their owner. Feudalism was a system where a class of nobility, known as lords, owned all of the lands and leased out small parcels to peasants to farm, with peasants handing over much of their production to the lord. In return, the lord offered the peasants relative safety and security, including a place to live and food to eat.

Capitalism 

Capitalism emerged with the advent of industrialization. Capitalism is defined as a system of production whereby business owners (entrepreneurs or capitalists) organize productive resources including tools, workers, and raw materials to produce goods for sale in order to make a profit and not for personal consumption. In capitalism, workers are hired in return for wages, owners of land and natural resources are paid rents or royalties for the use of the resources, and the owners of previously created wealth are paid interest to forgo the use of some of their wealth so that the entrepreneurs can borrow it to pay wages and rents and purchase tools for hired workers to use. Entrepreneurs apply their best judgement of future economic conditions to decide what goods to produce, and are earn a profit if they decide well or suffer losses if they judge poorly. This system of market prices, profit, and loss as the selection mechanism as to who will decide how resources are allocated for production is what defines a capitalist economy

These roles (workers, resource owners, capitalists, and entrepreneurs) represent functions in the capitalist economy and not separate or mutually exclusive classes of people. Individuals typically fulfill different roles with respect to different economic transactions, relationships, organizations, and contracts which they are a party to. This may even occur within a single context, such as a employee-owned co-op where the workers are also the entrepreneurs or a small business owner-operator who self-finances his firm out of personal savings and operates out of a home office, and thus acts as simultaneously as entrepreneur, capitalist, land owner, and worker.

The United States and much of the developed world today can be described as broadly capitalist market economies.

Socialism 

Socialism is a form of cooperative production economy. Economic socialism is a system of production where there is limited or hybrid private ownership of the means of production (or other types of productive property) and a system of prices, profits, and losses is not the sole determinant used to establish who engages in production, what to produce and how to produce it. Segments of society band together to share these functions

Production decisions are made through a collective decision making process, and within the economy some but not all economic functions are shared by all. These might include any strategic economic functions that effect all citizens. These would include Public Safety (police, fire, EMS), National Defense, resource allocation (utilities. like water, and electric), education, and more. These are often paid for through income or use taxes levied on the remaining tactically independent economic functions (individual citizens, independent businesses, foreign trade partners, etc).

Modern socialism contains certain elements of capitalism, such as a market mechanism, and also some centralized control over some resources. If more of the economic control is centralized in ever increasing ways, it may eventually become more akin to communism. Note that socialism as an economic system can and does occur under various forms of government, from the Democratic Socialism of the Nordic countries to more authoritarian strands found elsewhere.

Communism 

Communism is a form of command economy, whereby nearly all economic activity is centralized, and through the coordination of state-sponsored central planners. A society's theoretical economic strength can be marshaled to the benefit of the society at large. Executing this in reality is far more difficult than in theory, in that it requires no conflicting or competing entities within the society to challenge the allocation of resources. Note that instances of economic communism in the modern era have also been coupled with an authoritarian form of government, although this need not be the case in theory.





Economics: Theory Through Applications

v. 1.0

Table of Contents














Economics

    History, branches and classification



    Concepts, theory and techniques



    By application



    Notable economists


    Lists

    Glossary







    Economic Systems

    By ideology

    By coordination

    By regional model

    Sectors

    Property types

    Transition

    Coordination

    Other types




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