Introduction
Modern economies have multiple agents. A proper understanding of economic principles enables agents to work successfully in their endeavors. Mankiw (2015) describes economic principles which will be used in this paper to answer specific questions.
How economists are both scientists and policymakers and what principles society uses to allocate its scarce resources
Scientists develop different hypotheses and models to explain world phenomena. Likewise, economists attempt to create models which describe reality and, more significantly, use those to make predictions that guides people, businesses, and governments (Mankiw, 2015). Since economists can hardly use a laboratory as in a physical experiment – although there has been mock economic experimentation – they usually refer to the natural experiments offered by history (Mankiw, 2015). Furthermore, as a natural consequence of economists attempting to foresee events or the behavior of economic agents, they can become policymakers. In this role, they suggest – rather than analyze –policies and actions taken by the leading economic agents to foster a desired result (Mankiw, 2015).
The main principles society uses to allocate scarce resources were described by Mankiw (2015). They include: “Trade can make everyone better off.” This principle leverages on specialization and comparative advantages, which allow for trade to happen and benefit everyone involved. Another principle is “markets are usually a good way to organize economic activity” (Mankiw, 2015). This is dramatically shown by the different standards of living enjoyed by South Korea (a market economy) and North Korea (a communist, planned economy). Lastly, “governments can sometimes improve market outcomes” (Mankiw, 2015). The response given by governments to the recent Great Recession shows their ability to improve the economic outlook.
Using the circular flow model, explain the flow of money and goods in an economy.
Mankiw (2015) describes a simple version of the circular flow model, using the example of a cup of coffee. A person spends a few dollar bills purchasing coffee in a shop. The coffee shop uses this revenue to pay to the landlord (rent) and workers (wages). Landlord and workers spend these dollar bills on other goods and services. The companies which receive this income will also pay other people. Hence, there is a circular flow of income and expenses linking firms and households.
Figure: the circular flow model
Source: Mankiw (2015)
The circular flow model is depicted as a diagram indicating the movement of money, goods and services in an economy. Businesses offer goods and services, produced using the factors of production supplied by households (labor, land, and capital). The trades happen in the market for goods and services – where the firms are sellers and households are buyers – and in the market for factors of production, where their roles reverse, as families sell and companies buy (Mankiw, 2015).
How the economy coordinates society's independent economic actors.
As long as the markets are trustworthy and there is freedom of trade, demand and supply will balance out in the vast majority of instances. Each actor (firms and households) will supply or demand factors of productions or goods and services, as posited by the circular flow of the economy. Little formal coordination is required since both actors know their strengths and weaknesses, their needs and values. Ultimately, goods and services (or factors of production) in high demand will have higher prices, which work as a stimulus for increasing supply and finding substitutes (which will eventually lower demand). Conversely, if anything is in lower demand, prices will be lower, and supply will decrease. In other words, the coordination is ‘built-in’ in the price system (Mankiw, 2015).
There is, however, the need for an agent to enforce rules and standards, such as criminal and civil laws, money supply, police force, primary education, and so on. Such functions are provided by the government, which requires payment for its services by the imposition of taxes on both households and firms.
A country's gross domestic product (GDP) and how it is defined and calculated.
The GDP is the “market value of all final goods and services produced within a country in a given period of time” (Mankiw, 2015). It is a paramount measure because the level of production of goods and services of a country will determine how well-off its inhabitants are. In fact, if the GDP decreases from one year to the other, we can ascertain that the country has become poorer, and its citizens likely suffered the ill effects of a recession. The standard formula for the Gross Domestic Product is:
GDP= C + G + I + NX,
Where C is household consumption, G is the government consumption, I is Private Investment, and NX is the nation’s net exports (Exports minus Imports). This formula yields the GDP of a country for a given period, usually a year.
How the consumer price index (CPI) is constructed and why it is an imperfect measurement of the cost of living.
The CPI measures the change in the average prices of goods and services during a period, normally a year (Mankiw, 2015). The CPI is based on sampling goods and services, as it would be impossible to track every single price item in a modern economy, despite the significant advances in information technology. Such samples represent a larger whole, as in the price of a small car used as a proxy for the prices of all small cars.
It is an imperfect measure because it does not gauge the effect of substitute items (as in using Uber instead of regular taxi service, or Netflix instead of cable) and differences in quality (as watching a 3D film instead of a regular movie).
Conclusion
The principles and concepts discussed in the previous sections are fundamental for students and researchers to understand how the economy operates. Albeit simple, their consequences are far-reaching and impact the lives of nearly every person on the planet.
References
Mankiw, N. G. (2015). Principles of Macroeconomics (7th ed.). Stamford, CT: South-
Western Cengage Learning.
