Report
Report
Nowadays, the basic knowledge of economic principles is crucial for everyone, even for those who are not professional economists. The economy is the mechanism that affect everyone: the probability of find the desirable job, getting mortgage loan in the bank, the amount of rent payments are all variables that are determined by economic processes. The conscious understanding of economics helps policymakers to take appropriate and timely actions; allows firms and investors correctly forecast interest rates, in order to make profitable investments, to the households and individuals to properly plan their savings, to the scientists – develop actual models and make useful advices as for policymakers and firms, as for individuals. Therefore, economics and, particularly, economics that has been developed as separate branch almost one century ago, has not only theoretical, but, actually, to the more extent, practical value. The aim of this report is to introduce and discuss main principles and concepts of economics.
An economist is a scientist and policymaker at once. This might seem tricky at the first sight. Though economists have no deal with labs, microscopes etc., however the methods they use are the same as in physics, biology and other sciences – first, developing a theory, hypothesis made from observations and then testing this theory. On the other hand, economists are policymakers. The tax rates, trade tariffs, amount of pension payments are all set (or advised) by economists. As there are two types of statements, positive – attempt to describe the world as it is; and normative – the opinion about how it should be, an economist, as policymakers, usually makes normative statements. In other words, he or she points on the way how to reach desirable outcome: stabilize prices, lower unemployment, increase productivity of economy etc. However, this is not as simple as it might pretend to be. The reason is that economists could completely disagree with each other because of differences in scientific judgments or differences in values. Nevertheless, as the economics is relatively young discipline, constant debates and disagreements are inevitable. Moreover, the society and economic relations are constantly changing and becoming more complicated, therefore economists, both as scientists and as policymakers, are facing new challenges and issues.
Nevertheless, the whole theory of economics is built upon one obvious fact: all resources are limited. Actually, we have some resources in bigger amounts than other ones; however, none of them is infinite. Scarcity of resources forces individuals and society in general, make constant decisions on how to allocate them. How to spent time (to work or not to work), what to buy (TV or computer), where to invest money (property or stocks) are all examples of such decisions. Thus, economists studies how individuals make these decisions, what forces them, what are general trends, in other words, how society allocates scarce resources (Mankiw, 2011, p.2).
Actually, there are some principles that society uses to manage scarcity. They can be divided into three groups: how individuals make decisions, how they interact and how economy works in general. Thus, when individual makes the decision this is always a tradeoff, such for example “guns and butter” tradeoff ; the cost of something is determined by opportunity costs – this is what you give up in order to get that; rational individuals think at margin and people are likely to respond to incentives. The next three principles outline how people interact: firstly, the trade might bring benefits to everybody; second, market economy is the most efficient type of economic system and finally, as market economy has disadvantages, the government could and should help to eliminate them. General economic principles are the following: the standards of living, wealth in a country depends on its productivity – ability to produce goods and services; inflation is the result of printing money and there is always short-run tradeoff between inflation and unemployment.
The following circular-flowing diagram would help to understand the economic mechanism more precisely(Figure 1):
Figure 1. The circular flow diagram. Source: Mankiw, 2011. p. 21.
Thus, according to the diagram, there are two main actors in the economy. The first one is firms, that consume factors of production and produce and sell goods and services. The second actor is households that provide these factors of production: labor, land and capital and consume goods and services produced by firms. That is why there are two types of markets: markets for factors of production, where households are seller and firms are buyer, and markets for good and services, where, conversely, households are buyer and firms are seller. This determines the two flows: flows of money and flows of goods and services. Households sell factors of production and receive income that they use further to purchase goods and services. Firms sell goods and services and receive revenue that they use to purchase factors of production. Thus, this is the simplified model of how economy works in general, how independent economic actors interact with each other. The more comprehensive and actual model includes other crucial factors and actors, such as government interference, the role of international trade etc.
There are different measures of economy, its productivity, efficiency etc., that are called economic indicators. Two main indicators are GDP and consumer price index. The first indicator, GDP reflects the market value of all final goods and services produced within the country and in a given period. This means that GDP does not include the value of intermediate goods and services, that goods and services produced earlier are not relevant and that only those produced within the country are taken into consideration, even if they are produced by foreign firms and products produced by domestic firms in other countries are not considered. GDP is calculated as the sum of consumption (C), investments (I), government purchases(G) and net exports(EX).
Consumer price index (CPI) is the average cost of goods and services purchased by the common consumer. The Bureau of Labor Statistics (in the US) calculates this indicator by defining the cost of consumer basket and measuring the change in the cost comparative to another (base) year. This indicator allows determining inflation, as the percentage change of the index. However, the indicator is not perfect measure of the cost of living. Firstly, there is a substitution bias: when one good becomes more expensive, consumer prefer substitute it by the cheaper alternative. As the basket is fixed, the actual cost of living will be less than actual. The second reason is introduction of new items: the technological improvements eventually decrease cost of living that are not reflected by CPI. Finally, the last problem is the change of quality that might occur disregarded to change in prices. As quality is hard to measure, there is always a gap between actual cost of living and the index.
Thus, this report briefly has briefly outlined main economics principles and ideas that are crucial for the further understanding and studying economics. The main idea is that all resources are scarce and economics is studying how society, including different actors – individuals, firms, government acts and interacts, in order to manage scarcity and how the whole mechanism is working.
Reference list:
Mankiw, N.G. (2011). Principles of Economics (5th edition). South-Western Cengage Learning.
