by Samari Ijezie, The Female Economist
If you have ever nodded during a conversation that includes the words “stock market”, “inflation” or “GDP” without truly knowing what those terms truly mean or how they work, it is Okay. You are not the only one! For a salesperson, the term, “CRM” is part of their everyday jargon. For a doctor, it would be “MRI”. Economists, use the terms mentioned above on a daily basis. Although, everyone should know the basic terms in economics, because it directly affects the way resources circulate our economy.
What Is Economics?
Many people think Economics and think Capitalism however; Economics is the study of how society uses its limited resources. The most accurate definition would be Economics is the study, description, and analysis of the ways in which societies produce and distribute goods and services. The basic concepts in economics Supply & Demand, Microeconomics & Macroeconomics, and GDP.
What is Supply And Demand?
In simple terms, supply means the things you produce, and demand means how much people want the product, good, or service. Equilibrium is where the supply is equal to the demand , but that is a very idealistic concept. Supply and demand is as predictable as the weather. The changes in supply and demand, along with their consequences often determine how the economy performs. Here are some key concepts in supply and demand:
- If prices go high, the demand goes low (not everyone can afford to buy over-priced items in large quantities)
- When demand is low, supply increases (supply as in- not the amount supplied, but the things produced. People will try to push their product, because no one is buying it)
- Low supply and high demand means increased prices (the cost of producing products to meet demands would be high, and people would also be ready to pay the price to get the in-demand product)
What Is Demand Elasticity?
This entire supply-demand dynamic was what led to the infamous “historic oil crash”, when countries over-supplied oil, leading to low demand and low prices, which meant losses for the suppliers. Demand elasticity is when the demand for something increases with time and interest, affecting the supply and the prices. There is no elasticity for demand for products like shampoo or bread. There can be sudden highs or lows for demand for products like Hanna Montana themed clothing and stationery items. There are some items, however, that defy this concept. Items like gold or designer items can have high prices, high supply and high demand! They are not as essential as shampoo, but they are not elastic, either. For an investor, it is important to know if an increase in demand is temporary, or if a low supply truly does mean high demand.
What is Microeconomics and Microeconomics?
There are two main branches of economics: Micro and Marco. While these two branches of economics appear to be different, they are actually interdependent and complement one another. Many overlapping issues exist between the two fields.
Since the economy is dictated by human behavior and human decisions, microeconomics studies this behavior. It does not predict anything, but it gives us the wisdom to understand the economy and make sound decisions. One of the main concepts of microeconomics is that the economy is driven by the human psyche that is dictated by unlimited desires with limited resources. A huge part of microeconomics just focuses supply and consumer behavior- if you can understand that, then you can understand demand, supply and price fluctuations. When you choose one product over another, you are picking one with a higher value and lower loss (in money or any sort of benefit). The “lower loss” is also known as an “opportunity cost”. Again, understanding opportunity cost can lead to sound business decisions.
Microeconomic models aim to increase efficiency and get as close as possible to bridging the gap between the endless needs and limited resources- for example, how coulda company maximize their output with the least input, so they get most profit?
While microeconomics looks at the finer details of economic movements, macroeconomics studies the economy on a larger scale- regional, national or global. The overall growth and behavior of an entire region or country gives us a bird’s eye view of the
bigger impact of the economy. Key concepts in macroeconomics include GDP, inflation, fiscal deficit and unemployment rates.
Macroeconomics is vital- it lets the government recognize when and where to take action- whether it is loans or increasing or decreasing interest rates. Such actions help in leading the overall economy in the right direction, so that it grows. In this field, there is no examining behavior, running surveys or experiments or any such experimental socio- economic measure. Decisions are made, based on the success and failures of previous decisions. Sometimes, unique situations arise (like a recession) and well calculated polices are rolled out to address issues, which are usually hard to tackle with. An example of such an issue could be low income for teachers, and some countries have introduced policies to increase the pay for teachers. This goes into “labor economics”.
What Is Labor Economics?
In the push and pull of supply and demand and the consumers, there is another force involved on the supply side, and that force is called “labor”. Labor economics focuses on the relationship of employers with employees and the corporations and how various
variables affect the growth of a company, or the entire economy. Factors involved in labor economics is wages, working conditions, unemployment rates, equal pay. Socio-economic factors like workplace productivity, employee incentives, and cost-reward analysis all come into play. In the end, a stable, productive labor force on a bigger scale contributes to the overall growth of a country.
What is GDP?
That term is synonymous with economics and macroeconomics. GDP (Gross Domestic Product) is a measure that determines a country’s overall economy in terms of health, growth and size. It calculates the total market value of domestic goods and services
produced annually. This helps in seeing the value of the goods and services in a country over a period.
How is GDP Measured and What Can It Show Us?
GDP is measured by adding everyone’s annual income and spend. Ideally, this should be almost equal. Other ways of measuring GDP is by measuring production, or adding total consumption, investment, exports and government spending. By measuring GDP, we can see if the economy is expanding or contracting. The latter would mean that we are spending or consuming more than we are producing. GDP is a vital aspect macroeconomics, which aids the governments, investors or businesses to make informed financial decisions. However, GDP is not a predictor, and it can help you understand how last year GDP has affected earnings, economic growth or the financial markets.
What is Inflation?
That is right! In addition, if you have heard the term inflation, you probably know it is a bad thing. Nevertheless, let us first get our facts right about inflation: In a few words, inflation is the rate at which the prices increase. You must have heard your parents say that it cost them a quarter to buy eggs back in their day. Now, the prices are high, and that is because of inflation. Inflation is also seen as the reduction of the value of currency, as you need to pay more to buy the same things. Governments actively work to
keep a stable inflation rate, which is ideally 2%. One of the ways is increasing the interest rates.
What Causes Inflation?
Two things because inflation- cost push or demand pull. A demand-pull is when the demand is high, and the supply is inefficient. If everyone in town wants that same divine coffee from that same shop, they would be ready to pay a higher price for it. To cover the costs for the inefficient supply, the prices would still have to be high. As for a cost-push, the coffeeshop owners might need more equipment or may have to pay a higher wage for their employees, which would increase the prices so that they could cover the production costs.
How Harmful Are The Effects Of Inflation?
Inflation is not that “bad”. That is because it encourages people to spend more, since the value of money decreases. More spending means more growth. It is only bad when prices rise too high, too soon, halting all economic activity. The opposite of inflation is deflation, which means value of our dollar is decreasing. If that happens it means our economy is lacking growth, lower consumption, production and ultimately, a high unemployment rate.
High GDP Is Bad. Really Bad.
If you think that the higher the GDP, the better- then you are wrong. A higher GDP is surely good, and it leads to drops in unemployment. That is good, right. However, imagine the employment rate getting low, because there are no more vacancies. The supply side of the market would slow down. As we know, a high demand means a higher price, so a high demand for employees means a higher wage. A higher wage would lead to the companies covering costs by increasing prices of products or services- and there you have it- inflation! Another way a fast GDP cause’s inflation is by creating an “asset bubble”. Investors invest too much in the few opportunities they have which show great promise and value because of increased prices. When those investments start going downhill, they pull out their shares, businesses go into loss, supply goes low, and you have inflation on your hands again. Therefore, a healthy GDP rate is around 2%. If an economy is growing too fast or too slow, it is bad. That is where the Federal Reserve, which is the nation’s central bank, comes in. It controls the growth by increasing the interest rates if the growth is too fast and decreasing them if it is too slow.
You are All Set!
Now that you are equipped with the knowledge about economics, you can be more confident in the financial world. If you have any more questions regarding finance or economics, feel free to reach out to us. We would love to help you!
Author: Samari Ijezie, www.thefemaleeconomist.com