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What is Economics? Factors, Types, Indicators, Demand and Supply

Economics

People assume economics is all about money. This is wrong. Simply put, economics is a social science that studies human behaviour in relation to the allocation and scarcity of resources. Scarcity refers to how limited the availability of a resource is. If a resource is scarce, it means that there is a very small amount of it available. Allocation is where we decide to use the resources (i.e. what good we produce with that resource.). 

Given that our wants are unlimited and resources are limited, allocating them efficiently is important as misusing these finite resources will mean they will run out without meeting enough wants. Economics aims to allocate these scarce resources in the most effective manner.  However it’s much more complex than that: the allocation and scarcity of resources are dependent on several other factors. Firms, individuals and governments make decisions and choices that alter these factors on a daily basis.  

Factors

The factors in question are:

  1. Production
  2. Distribution
  3. Consumption
Factors of Economics

Firms and governments produce and distribute the goods and services that we, the individuals, consume. Let’s look at these factors in depth.

  1. Production

Production is the process through which goods and services are made. In the production process of any good or service, factors of production are needed. They are:

  1. Capital: The money needed to pay workers, buy resources and several other day to day business activities. 
  2. Labour: The workers who perform the tasks to create the goods and services.
  3. Land: The physical place where the goods or services are produced.
  4. Enterprise : This factor arranges the rest of the three factors. Entrepreneurs take the financial risks that provide the capital needed to buy labour and land.

Every firm and government operate differently so the emphasis they put into each factor will be different and so the quantity and quality of goods and services differ greatly.

  1. Distribution

Distribution is the way in which the good or service is sold to individuals. This includes several decisions such as what price should be charged, how the product should be marketed and what location the product should be sold. These decisions, again, differ greatly between firms and governments.

  1. Consumption

Consumption is the act of buying a good or service. It is also defined as using up a resource. This is because the resources used in the production process are now in the hands of the consumers and they will use it for other purposes, thus “using up” the resource completely, ie there will be none of it left.

These factors are interdependent and a single decision made by any member of the society can cause a ripple effect and make these factors vary greatly. Economics studies these ripple effects and what motivates these decisions.

Types of Economics

Economics can often be divided into two parts:

  1. Macroeconomics: dealing with the economy as a whole
  2. Microeconomics: dealing with the economy part by part.
Types of Economics
Types of Economics

 People make this distinction to isolate sectors of the economy and study them separately as analysing the whole economy can be quite confusing. Another way people do that is by using the phrase “ Ceteris Paribus” which means “all other things being equal” in latin. This is a very important topic in advanced economics and so is the distinction between macro and micro economics. We won’t be learning about them here as they are very complex concepts and are not needed to understand the basics of economics.

Economic indicators

When judging a country’s economic performance, there are several indicators that determine whether it is a developed or developing country. A developed country must excel in all the fields mentioned in the indicators.

Economic Indicator
Economic Indicator
  1. Gross Domestic Product (GDP): GDP is the final value of all the goods and services in a country. A high GDP means that the economy is utilising its resources and thus is developed.
  2. Consumer Price Index (CPI): CPI measures the rate at which the prices in a country rise. This rise is called inflation. A high inflation is a sign of instability discouraging entrepreneurship.
  3. Employment rate : In a developed country, people who are looking for jobs but can’t find them should be low. These people are said to be unemployed. Unemployment is seen negatively as the skills of these people are going unutilised.
  4. Retail Sales : A retail sale occurs when a business sells a product or service to an individual consumer for his or her own use. A high retail sale figure indicates an active economy and thus is seen as a good indicator.
  5. Size of tertiary sector  : The tertiary sector refers to the market of services (ie intangible goods) as opposed to the primary sector (raw materials) and the secondary sector (manufacturing). A larger tertiary sector is a common trait of developed countries as services are more demanded and thus create more jobs and earn more money. 

Demand and Supply

Now that we know what economics is, we can understand one of the fundamental concepts of economics: demand and supply.

Supply and Demand
Supply and Demand

Demand is the quantity of a good that consumers will be willing to buy at a given price while supply is the quantity of a good that a seller is willing to sell at a given price. These concepts are closely related however it is important to study each of them individually before delving into their intricate relationship.

Demand

Demand is another word for want. It is quite important as it largely motivates the decisions of a consumer. Demand is dependant on several factors such as:

  1. Tastes and fashion: Different goods and services are trendy at different times. For example; in the 1990s, sweater vests were highly coveted but, as people’s likes and dislikes have changed over the last few decades, people barely wear them now, showing a huge fall in demand. 
  2. Population: If a country has more people, the quantity of goods and services bought will definitely be higher. However, the size of each sector of the population should also be considered. For example; a country with a high female population will have a high demand for dresses and one with a high child population will have a high demand for toys.
  3. Income: Income is the amount of money that an individual makes. If a person has a high disposable income (i.e. income after taxes), they are more willing to buy at high prices. Thus, a higher income should always lead to a higher demand.
  4. Substitutes and competitors: Substitutes are similar alternatives to a product while a competitor is the same product sold by a different seller. If they are cheaper and/or are of higher quality, the good or service in question will have low demand. For example: Nescafe Coffee has a competitor in Bru and a substitute in tea. So, if tea or Bru are cheaper or better, Nescafe coffee won’t have high demand.  
  5. Speculations: Speculations are predictions about the market in the future. If people speculate that prices will fall in the future, demand will be low at the present and vice versa.

Supply

Supply is simply the availability of a good. Producers determine how much they sell on the following variables:

  1. Cost of production: This is the main factor. Several costs need to be incurred. These costs include the cost of raw materials, labour wages, transportation and equipment. A product that is expensive will likely have low supply.
  2. Government policies: Governments often encourage the production of some products, such as food, and discourage the production of others, such as cigarettes. They tax goods that they discourage and subsidize ( help pay for ) goods they encourage.
  3. Technology: Some producers desire to produce more goods but are simply unable to due to technological restraints. For example; farmers could not mass produce carrots as quickly as they can today back when tractors weren’t invented.

Relationship between Supply and Demand

Now that we have a basic understanding of both concepts, we can analyse the relation between them. If the demand of a good is high, then the supply of demand will be high. This is because sellers know their goods will be sold so they don’t hesitate producing high quantities of that good. In some cases, however, goods are highly demanded because they are low in supply such as limited edition sneakers or concert tickets. The relationship is complex and hard to predict. Adam Smith, known as “the fathers of economics”, described them collectively as the “invisible hand” of the economy, meaning they governed all our decisions in a market. This is just one school of thought. We will view several more as we discuss the history of economics.

History of Economics

Economics is an ancient concept and can be traced back to earlier Mesopotamian, Greek, Roman, Indian subcontinent, Chinese, Persian, and Arab civilizations. We won’t be going that far back though.

History of Economics
History of Economics

We’ll be taking a look at the more recent advances in economics and how they impacted the subject as a whole.

Classic Economics

Much of our modern understanding of economics can be attributed to one man, Adam Smith, the revolutionary Scottish author. His legendary book “ The Wealth of Nations” can be attributed as the source of several fundamental theories of economics. That book inspired an important dialogue among freethinkers and sparked plenty of debate among scholars, introducing the world to several more intellectual “economists” such as  Rev. Thomas Robert Malthus, David Ricardo, John Stuart Mill and many other brilliant minds who changed our understanding of the world. 

Marxian Economics

Believe it or not, the father of communism, Karl Marx, is also one of the pioneers of modern economics. Classic economics had a free market ideology, meaning it supported capitalism, where the aforementioned “invisible hand” was solely responsible for distributing resources. His book “Das Kapital” questioned this, calling out the labour exploitation that took place because of the lack of governance. This not only advanced economics into new unknown territories but gave birth to a concept called “marxism” which is the main inspiration of modern-day communism.

Neoclassical Economics

The present day derivative of classic economics shifted the focus away from the three factors  of production, distribution and consumption.  In his Essay on the Nature and Significance of Economic Science, Lionel Robbins argued that economics was more of a study of human behaviour in relation to scarcity, which is the generally accepted modern definition. This definition caused people to view it  modern as a behavioural science and create models that tested this theory. Modern mainstream economics borrows mostly from this variant.

Keynesian Economics

Another major contributor to modern mainstream economics was John Maynard Keynes. His book, The General Theory of Employment, Interest and Money  was the first to present a proper distinction between micro and macroeconomics. He can be attributed with the advancement of studies and emphasis on macroeconomics in modern times.

Economic Systems

Most debates relating to economics are on the topic of these systems. The two major systems are Socialism and Capitalism.

Socialism

Socialism suggests that the free market won’t be efficient in allocating resources and all resources should be state owned as it can distribute resources fairly and with minimum loss. This system’s main criticism is that it would be crippled by corruption and thus would need moral and ethical leaders which can never be guaranteed.

Capitalism

Capitalism believes in the “invisible hand” and discourages controlled economies as they tend to restrict the market forces of supply and demand in some cases. The case against capitalism comes from several moral standpoints such as it doesn’t restrict harmful goods, creates huge gaps between the rich and the poor or ignores environmental damage.

Few countries are entirely planned or free market as cases against both systems are fair and widely accepted. Most countries adopt a mixed economy, using minimal government intervention at the very least. They differ in the ratio of the mixture of course.

Conclusion

 Economics studies choices and is thus a highly debatable subject. It is not a rigid concept, it flows and progresses along with society. To understand economics, you need to keep up with every day as it is constantly changing and what you know today can mean nothing tomorrow.  

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