The Nature of Economics

The Nature of Economics

• Economics studies how individuals, businesses, governments, and societies use resources to fulfill competing needs and wants given scarcity

• Economics addresses what goods/services to produce, how to produce them, and who will consume them.

• Economic goals include:

  • Using resources efficiently without waste
  • Having the freedom to make choices about production and distribution without government interference
  • Ensuring goods and services are available when needed
  • Having a safety net for economic disasters
  • Having a fair distribution of wealth
  • Economic growth through new ideas and improved living standards

Types of Economies

• An economy is a system for distributing available resources to meet society's needs and wants

• Traditional economies shape goods/services and distribution based on customs and beliefs, often in rural, farm-based countries

• Advantages: Families know their economic roles, and leaders distribute resources impartially

• Disadvantage: New technology is often not adopted

• Planned/Command economies involve governmental planning groups making basic economic decisions such as production, prices, and wages (e.g., Cuba, North Korea)

  • Advantages: Focus on equality via impartial distribution of resources, directing resources to national goals, economic stability, and lack of high unemployment/inflation
  • Disadvantages: Enforcement of unpopular policies, limited freedom in employment/purchases, and compromised quality for quantity

• Free Market economies guide economic decisions based on price changes from interactions between buyers and sellers (also called a price system, free enterprise, capitalism, laissez-faire); prices guide economic activity (e.g., United States, Singapore, Japan)

  • Advantages: Free operation without government-coordinated plans, easy company response to demand changes, and inhabitant responsibility for their well-being
  • Disadvantages: Basic needs may not be met, resulting in class structure/poverty, unstable economy with unemployment/inflation/recessions, and lack of job security

• Mixed Economies exhibit characteristics of both free market and planned systems

  • In the United States, the government makes important economic decisions while the price system is predominant
  • Private individuals engage in market activities even in strict command economies
  • Advantages: Maintained social, political, business ownership, and profit earning freedoms, higher quality products/services through competition, and public/private sectors working together
  • Disadvantages: Potential for government influence via policies affecting interest rates/taxes/money supply, potential instability and private sector dominance

Scarcity, Choice, and Cost

• Scarcity is the problem that makes economics necessary because factors of production such as land, labor, and capital are limited and lead to the reality of making choices
• Opportunity cost is the value of the next best alternative sacrificed when making a decision, while monetary cost is the market price
• A production possibility frontier is a graph showcasing possible combinations of goods a producer can manufacture with available resources and technology

Production, Resources, and Allocation

• Production transforms resources into goods/services, while productivity is a measure of efficiency in production

• Productivity is the ratio of output to input

• Factors of production are inputs required for goods/services

• Factors of production include :

  • Land (natural resources) is rewarded by rent
  • Labour (human input) is rewarded by wages/salaries
  • Capital (man-made inputs) is rewarded by interest on investment
  • Entrepreneurial talent

• Division of labor assigns different tasks to different people to improve efficiency

  • Advantages: Mastery of tasks/efficiency, potential for higher pay, reduced production time, and increased invention
  • Disadvantages: Monotony, limited employee diversification, and risk of unemployment

Costs of Production

• Variable costs increase/decrease with productivity

• Fixed costs exist regardless of the production level

• Total cost is the sum of fixed and variable costs (TC = TFC + TVC)

• Average cost is total cost divided by output (AC = TC/Q)

• Marginal cost is the increase in total cost from producing an additional unit (MC = ΔTC/ΔQ)

• Economies of scale occur when inputs increase by X%, and output increases by more than X%

• Diseconomies of scale refer to rising average total costs as output increases

Markets and Prices

• Market systems allocate resources, production, consumption, and prices based on individual/organizational self-interest
• Demand is the quantity of a good/service consumers desire
• Supply is the quantity producers offer at a given price

Supply & Demand

• Ceteris paribus means "all other things being unchanged or constant"
• The law of demand states there is an inverse relationships between price and quantity demanded
• As prices for goods/services fall, consumers are willing to purchase more
• The demand curve illustrates the relationship between price and quantity demanded (ceteris paribus)
• The law of supply states that as the price of a commodity rises, so does the quantity supplied (ceteris paribus)
• The supply curve graphically represents the direct relationship between price and quantity supplied.

Factors Shifting Demand Curve

• Non-price determinants of demand that shift the demand curve include:

  • Disposable income
  • Consumer preferences
  • Changes in population size
  • Changes in the price of substitutes or complements

• A rightward shift occurs with increased substitute prices, decreased complement prices, and increased (or decreased) income

• A leftward shift occurs with decreased substitute prices, increased complement prices, and decreased (or increased) income

Factors Shifting Supply Curve

• Factors impacting quantity supplied:

  • Input prices
  • Improvements in technology
  • Number of suppliers
  • Prices of related goods

• A rightward shift happens with reduced input prices, improved technology, increased suppliers, increased complementary good prices, or decreased substitute prices.

• A leftward shift happens with increased input prices, increased substitute prices, decreased complement prices, or decreased suppliers.

Market Equilibrium & Elasticity

• Market equilibrium occurs where supply and demand curves intersect, resulting in the most efficient market

• Market failure occurs when the market does not allocate resources efficiently

• Price elasticity of demand measures how responsive quantity demanded is to price changes (% change in quantity demanded / % change in price)

• Customer demand is elastic if very responsive to price changes as when elasticity is > 1 (flat demand curve)

• Customer demand is inelastic if it's not responsive to price change, elasticity is < 1 (steep demand curve)

• The availability of substitute goods increases elasticity

• The necessity goods are inelastic while luxury goods are elastic

• Price elasticity of supply measures the response of quantity supplied to a price change (% change in quantity supplied / % change in price)

• Supply is elastic if highly responsive to price changes so elasticity is > 1 where the supply curve is flat

• Supply is inelastic if not very responsive to price changes so elasticity is < 1 where the supply curve is steep

Elasticity of Demand

• Income elasticity shows how changes in consumer income affect the quantity of products demanded (% change in quantity demanded to % change in income)
• Cross elasticity of demand measures how the demand for one product (X) is affected by a change in the price of another (Y)
• (Percentage change in quantity demanded of X / percentage change in the price of Y)
• Cross elasticity determines if goods are complements (negative) or substitutes (positive)

The Financial Sector

• The financial sector involves the interaction of markets regulated to entail lending and borrowing.

• Financial intermediaries(banks) link households, firms, and governments by transferring funds.

• Functions of a financial sector include:

  • Mobilizing savings by providing secure places to save lent accumulated funds to others
  • Managing risk by lending to many borrowers
  • Giving expert advice by providing information about investments
  • Monitoring borrowers' performance
  • Facilitating the exchange of goods/services via information and transaction costs

• Money is defined as anything accepted as payment

• The four main functions of money are:

  • Medium of exchange - paying for goods/services
  • Unit of account - recording values
  • Standard of deferred payment - debt contracts
  • Store of value - maintaining wealth

• Characteristics of money:

  • Liquidity - easily transferred
  • Transportable/Storable - lightweight and malleable
  • Uniformed - standardized size and quality
  • Easily Recognized

• Money supply is the total money circulating in a country's economy

• A Central Bank is a nation's primary monetary authority, regulator, lender, monetary policy implementer, fiscal policy implementer, and reserve holder

Financial Institutions

• Commercial Banks raise funds by accepting deposits and using them for loans and securities

• Credit Unions are non-profit, member-owned financial institutions offering services to specific groups and issuing loans from shares/deposits

• Insurance Companies obtain funds from premiums and provide protection for life, health, and automobile

• Mutual Funds are investment companies that sell shares ,and using the funds to buy stocks/bonds/money market instruments

• Building Societies institutions raise funds via deposits and provide loans, typically mortgages

• Development Banks are government-owned financial institutions funding new businesses for growth, providing financial structuring, and leading privatization efforts

• A Stock Exchange provides a place for registered companies to buy/sell stock

• Treasury bonds are long-term debt with > 7-year maturities and receive semi-annual interest

• Corporate bonds are issued by corporations with higher rates than municipal bonds, 1-30 year maturities, principal repaid at maturity

• Municipal bonds are issued by governments for specific projects and the bond holders receive tax-exempt interest

• Equity securities are shares representing firm ownership paying dividends that fluctuate in market value

Economic Management

• A national budget shows forecasted government expenses over a set period, usually annually

• National income is the sum of incomes earned by individuals before tax deductions

• Disposable income is available for spending after tax deductions

• National debt is the government's total borrowings

• Fiscal policy manages government spending and taxation to lower unemployment/inflation

• Fiscal deficit occurs when the government spends more than it collects

• Monetary policy manages money supply and interest rates for stability/growth

• Economic growth indicates an increase in a country's production of goods and services

• Economic development indicates changes in a country's socio-economic structure leading to higher living standards

• The Balance of payments accounts record international transactions for a specific period comparing domestic currency paid out versus foreign currency received

• Gross Domestic Product (GDP) measures the total money value of final goods and services produced in a domestic economy, GDP = C + I + G + (EX-IM)

• Gross National Product (GNP) measures the total value of final goods/services by an economy's residents

Unemployment

• Unemployment occurs when individuals are able and willing to work but they can't find a job

• Frictional unemployment occurs when people are temporarily unemployed while changing jobs/careers

• Structural unemployment occurs when workers are jobless because their industry has reduced demand or technological advancements

• Cyclical unemployment is caused by reduced economic production

• Seasonal unemployment occurs in industries with labour demand linked to certain times of the year

• Real Wage Unemployment occurs when wages for Services in a particular firm or industry are forced above regular market level

Inflation & Gov't Intervention

• Inflation is a general and sustained increase in prices over time

• Deflation occurs when there is a continued decrease in general price levels.

• Inflation can result from demand growth over supply (demand-pull), increased operational costs (cost-push), or changes in exchange rates

• Consequences of inflation can include:

  • Creditors losing value
  • Borrowers gaining through repayment with less valuable funds
  • Reduced purchasing power for those with fixed incomes
  • Businesses struggle with increased operational costs
  • Exports become less competitive

• Governments can reduce inflation by:

  • Implementing fiscal policies to reduce spending and increase taxes
  • Implementing monetary policies to reduce money supply or increase interest rates
  • Designing policies to spur productivity/reduce operational costs

Savings, Investment, and Recession

• Savings is disposable income not spent on consumption

• Investment increases capital stock (factories/machinery, etc.)

• Nominal output values goods/services at their selling price, while real output adjusts for yearly inflation

• A recession is a period of general economic decline with a GDP drop for two or more quarters

• Consequences of a recession include:

  • Declining economic growth
  • Increased unemployment
  • Financial market failure of collapse/poor performance of stock exchange markets
  • Business failures

• Governments can lessen the impacts of a recession by:

  • Implementing fiscal policies which increase government spending and decrease taxes,
  • Implementing monetary policies which increase money supply or decrease interest rates
  • Creating available jobs in order to reduce unemployment rates and increase spending

Trade Unions

• Trade Unions represent their members' rights in negotiations with employers/managers
• Roles include:
  • Representing members in wage negotiations
  • Questioning grounds for suspensions/firings
  • Representing harassed/victimized members

International Trade

• Balance of trade is the difference in value between a country’s exports and imports

• Current account is the sum of trade balance, cross border interest, dividends, and gifts

• Capital account reflects changes in ownership of fixed/non-financial assets

• Financial accounts record inward/outward flows of investment

• Balance of payments summarizes international transactions over time, comprising current, capital, and financial accounts

• It is a surplus when a country sells more to foreign countries or can be a deficit when a country buys more than it sells to them

• A tariff is a tax on imported products

• A Common External Tariff (CET) is a uniform tariff implemented by multiple countries on imports from outside their union

• A quota limits the amount of foreign products allowed in a domestic economy

• Exchange rate is the price at which one currency is exchanged for another

• Exchange rate regime is how exchange rates between currencies are determined

• World Trade Organization (WTO) regulates trading between countries

Comparative Advantage

• Comparative advantage occurs when a country has a lower opportunity cost in producing a good/service compared to another
• Trading countries benefit from exporting goods where they have a comparative advantage
• Terms of trade represent the relationship between prices paid for imports and received for exports
• Favorable terms means fewer exports are needed for imports
• Unfavorable terms means more exports are needed to purchase imports

Exchange Rates

• Exchange rate is the price at which one currency can be exchanged for another

• Exchange rate level is influenced by:

  • Inflation
  • Interest rates
  • Political/economic factors
  • Current account

• Types of exchange rates:

  • Fixed exchange rate is set/maintained at a specific level
  • Floating exchange rate is determined by market forces
  • Managed exchange rate is influenced by monetary authorities

• Currency appreciation increases currency value, and depreciation decreases currency value

Caribbean Economies In Global Trade

• Debt burden is the amount of money to be paid in interest on accumulated debt,

• Structural adjustments are the changes governments must make on receiving Developmental aid to their political and economic practices

• Economic integration merges economies by reducing trade barriers like tariffs

• Protectionism protects domestic industries by enforcing tariffs/quotas

• Economic union combines characteristics of a common market, combines monetary and fiscal policies by a central authority

• Customs union allows free trade between members with agreed tariff rate for non-members

Trade Agreements

• Globalization interconnects economies/societies via trade, communication, and technology
• Trade liberalization reduces government intervention in trade
• Bi-lateral agreements bind two countries for favorable trading terms
• Multi-lateral agreements contract several outlining trading preferences
• The International Monetary Fund (IMF) stabilizes economies/facilitates trade

Groups in The Caribbean

• Caribbean Community (CARICOM) coordinates economic policies/development plans and handles trade disputes between 15 countries
• African, Caribbean and Pacific Group (ACP)'s obtains sustainable economic development among 79 member countries
• Free Trade Area of the Americas (FTAA) lowers barriers across Americas, except Cuba
• Association of Caribbean States (ACS) consults/cooperates on Caribbean issues.
• Caribbean Single Market and Economy (CSME) integrates CARICOM economies by Free movement of services/goods and Common trade policy

World Trade

• Trade and globalization
• World Bank assists developing countries with low-interest loans for sustainable growth to alleviate poverty
• The Organisation of Eastern Caribbean States (OECS) seeks unity and solidarity among nine member states.
• European Union promotes regional integration and harmonizes policies between members

Economic Development and Trade

• Caribbean Basin Initiative (CBI) fosters economic advancement in Central America and the Caribbean
• The Caribbean Development Bank (CDB) aids members in poverty reduction
• Foreign Direct Investment (FDI) has Country A invest in Country B for the long-term period
• Market Size, Resources, and the Nature of Dependency influence Caribbean economies.
• Issues which affect Caribbean economies include high inflation/unemployment, falling exchange rates, social problems, and little or no economic growth

Preferential Trade and Tariffs

• Preferential tariff reduces/eliminates duties on imports from free trade partners with each other
• It benefits importers by low prices and by encouraging consumer countries to continue purchasing those tariffs.
• It also protects the exporters economy

E-Commerce

• E-commerce is online buying/selling of goods.

• Advantages:

  • Reduced costs
  • Eliminated errors
  • increased Efficiency

• Disadvantages:

  • Reliance on company reputation
  • Delivery concerns
  • Credit Card risk of hackers