Economics is the study of resource allocation, needs and wants of a society.
2 areas of economics is explored – Micro economics and Macro economics
Micro economics studies how industry and companies interrelate to each other through the use of resources available in the society. Determinants of demand and supply is heavily studied in this area of economics. Market structures tells us how the demand and supply reacts in different market environments. By understanding it, government can predict how the effects of certain policies Eg, subsidies, might affect the economy.
Macro economics studies how the overall economy (Market systems) works on a large scale. Areas such as Gross Domestic Product (GDP), inflation and government stimulus package are studied to understand the effect it had on the economy. Policies such as fiscal and monetary policies are explored to understand the resulting effect when government embark on it.
Demand and Supply
Demand and supply are the basic blocks in understanding economics. Demand is a downward sloping curve as the lower the prices, the more quantity demanded of the goods. Supply is a upward sloping curve as the higher the prices, the more quantity supplied by the suppliers. Both of the graphs are depicted below.
The intersection is known as the market equilibrium. At this point, the market is stabilized at the particular price (P’) and quantity (Q’).
GDP and inflation
Gross domestic product (GDP) refers to the output produced by a country. Imagine an individual’s income. GDP is the income of the country. Obviously, the higher the GDP of a country, the richer the country is suppose to be. Based on the expenditure approach, GDP consist of Consumption, Investment, Government Spending and Net Exports.
Inflation is the increase in price of goods and services over time. Inflation reduces the value of money as per dollar of income can purchase lesser amount of goods.
To measure inflation, the common indicator is consumer price index (CPI). CPI is a basket of goods and service that forms the basic needs of a society. Prices of the CPI items are tracked over time as a measurement of inflation.
Elasticity is the slope of the demand or supply curve. The slope of the curve will affect the rate of change ie. the response of quantity demanded or supplied changing as according to price changes.
There are 3 forms of elasticity for demand – Price elasticity income elasticity and cross elasticity.
Price elasticity of demand refers to the changes in quantity demanded with regard to changes in price. Income elasticity of demand refers to the changes in quantity demanded with regard to changes in consumer income. Cross elasticity refers to changes in quantity demanded with regard to changes in demand of substitutes and complements goods.
spending multiplier and fiscal policy
When a country spends domestically, there is a multiplying effect at the end. Think about a person spending $1000. Maybe $700 will be spent on food while $300 goes to transportation. The food seller that earned the $300, will in turn spend the money on school fees for his or her kids or other purposes. This spending round after round creates income opportunities for others to earn. The initial $1000 is now multiplied into many rounds of income for the country. This is the multiplying effect of spending.
Understanding the multiplier effect will help the government to set better policies. Fiscal policy refers to the use of taxes and government spending to stimulate or contract an economy. To stimulate the economy, the government can choose to reduce taxes or increase government spending while doing the opposite will contract the economy.
production possibility curve
A production–possibility frontier (PPF) or production possibility curve (PPC) is a curve which shows various combinations of the amounts of two goods which can be produced within the given resources and technology/a graphical representation showing all the possible options of output for two products that can be produced using all factors of production, where the given resources are fully and efficiently utilized per unit time.
In simple terms, it means all the different production combination of 2 products that a country may produce given its limited resources.
The following shows a PPF/PPC curve that produces 2 products. Along the line is the maximum quanitty that one can produce given the limited resources.
Instead of using fiscal policy to influence the economy, government may adopt monetary policy. Monetary policy refers to using tools to influence the money supply, thereby affecting the economy.
There are 3 forms of monetary tools the government may utilize to influence the economy – Open market operation, Interest rate and required reserve.
Government may issue or buy back government bonds or financial investment products to reduce or increase the money supply of the economy. Government may increase or decrease the lending rate to banks, which will lead to a hike or drop in interest rate. The increase or decrease in interest rate will affect money supply as interest rate represents the cost of using money. Lastly, government may increase or decrease required reserve by banks. Required reserves is the amount of money that the banks are required to put aside. The more the banks have to put aside, the lesser they can lend to the public, hence reducing money supply.
With money supply increase or decrease using the monetary policy tools, the government may control the economy.
Market structures refers to the different characteristics between buyers and sellers and within sellers.
There are 4 kinds of market structures – Perfect competition, monopolistic competition, oligopoly and monopoly.
Perfect competition refers to a market structure that has many small sellers competing against each other. Thus, there is no bargaining power by the seller.
Monopolistic competition refers to a market structure that has many sellers but there is some form of a differentiation from each of them. Hence, the sellers do exhibit some form of bargaining power.
Oligopoly refers to a market structure that is dominated by a few big players. They have bigger bargaining power as there is not much competition within the marketplace. The players could even form a “club” known as cartel, to control the market.
Monopoly is a market structure that is dominated by 1 big player. There is no other competitor and buyers have to be at the mercy of the seller. The seller has the biggest bargaining power among all other market structures.
Exchange rates and the economy
The most direct manner of how exchange rate influence the economy can be observed by looking at the relationship between exchange rates and net exports.
When exchange rate increases, consumers usually will buy lesser imports. The reduction in imports will mean that lesser money is spent to foreigners. With lesser money spent on foreigners, net exports will increase, hence leading to a higher GDP.
Not only do exchange rate affects the GDP of a country, exchange rates can be influenced by the different interest rates offered by the foreign country as compared to locally. This is known as the interest rate parity.
The interest rate parity takes into the account the demand and supply of currencies due to the interest rate offered by the foreign and local countries. Basically, if foreign countries offer a higher interest rate for deposits, local citizens will sell away their own currencies and buy more of the foreign countries currencies. This will push the value down for local currency and increase the value for foreign currencies. Thus, exchange rate is influence in this manner.
Economics = concepts + graphs
Through explaining the basics and applying it to the real life context, i will deliver the content in a manner whereby understanding is done through relating to real life events and not solely memorizing from the book.
Economics might be tough but it is definitely not boring.