What is Economics?
Economics is a social science that studies how the society employs its scarce (limited) resources for alternative uses. It also looks into how people make decisions, use wealth and respond to incentives. There are different definitions for economics, given by Adam Smith, Alfred Marshall and Lord Robbins, but fundamentally, they have many points in common. Economics is a very vast discipline that includes many concepts. It’s a subject that affects individuals, states and nations in different ways.
The basic concepts, terms and definitions in economics.
Microeconomics and Macroeconomics
Economics is broadly divided into two branches, Microeconomics and Macroeconomics. Microeconomics is the study of actions of individuals or small groups of individuals. It focuses on decisions and resource allocations of households, small firms and industries. This branch of economics analyses demand and supply of goods and studies individual price mechanisms. Macroeconomics studies the economy as a whole, in a wider perspective. It looks into topics like national income, aggregate demand and supply, unemployment, wealth and resource allocation of nations, inflation, national budget and balance of payments etc. Economics can be further divided into subfields such as International Economics, Monetary Economics, Developmental Economics, Econometrics, Agricultural Economics and so on. It’s a very interesting subject which is logical, rational and also technical. The field of economics is also a good career path to choose, as it is spread across multiple disciplines, from finance to research.
Major Concepts in Economics
Economics is a vast subject that contains within its various major and minor concepts that are used in micro and macro levels in the economy. Let’s take a lot at the different major concepts in Economics and also their practical applications.
Demand and Supply – the two basic factors in determining equilibrium market prices of goods
- Demand and Supply are two basic, major concepts in Economics that play major roles from price-fixing decisions taken in small markets to decisions made regarding the Budget of an economy. Adam Smith’s concept of ‘Invisible Hand’ which says that the constant interplay of individual pressures on market supply and demand causes the natural movement of prices and the flow of trade in an economy, is very relevant in this context.
- Demand refers to the quantity of a good the consumers are willing and are able to buy at each given price. Demand is based on the needs, wants and the ability to pay, of the customer.
- The law of demand states that ‘As the price of good increases, the quantity demanded of that good decreases and vice-versa’.
- Demand curve/Demand schedule is a downward sloping graph that shows the inverse relationship between price and quantity of good demanded.
- Supply refers to the quantity of a good that a supplier is willing and able to supply at each given price.
- The law of supply states that ‘As the price of a good increases, the quantity supplied of that good also increases’.
- Supply curve/Supply schedule is an upward sloping graph that shows the positive relationship between the price and quantity of good supplied.
We say that the market reaches ‘equilibrium’ when the quantity demanded of a good equals the quantity supplied of the same. At equilibrium, there will be neither shortage nor surplus of goods. When the demand for a good is greater than its supply, it results in a shortage of goods. When the quantity supplied of a good exceeds the quantity demanded of that good, it results in a shortage of goods.
Utility of Goods and ‘Trade-off’ – key concepts that affect the decision making of individuals in all levels
- Utility is another concept in Economics, which is defined as the capacity of a commodity to give satisfaction to the buyer. That is, it measures the gain that a buyer gets, from owning the particular good. For example, the utility may measure how much one enjoys playing cricket or how much a person benefits from owning a mobile phone. Utility is individual, relative and can’t be measured physically.
- The concept of “trade-off” is closely linked with utility. Trade-off refers to the practice of giving up one good of lesser utility for another good of greater utility. For example, if a person has the ability to pay for either an orange or an apple that are worth the same amount of money, s/he will choose which one to buy, depending on the level of utility he gets from each of them. In this case, we say, he trades off the good of lower utility for the good of higher utility.
- The concept of opportunity cost is related to the concept of trade-off. ‘Opportunity cost’, in simple words, refers to the benefits that a person loses out on, in the process of choosing one alternative over the other.
- The concepts of utility, trade-off and opportunity cost play very important roles in the lives of individuals while making decisions on what to buy and what not to buy. A consumer, may it be an individual, a government or a country, has to be fully aware of the utility of any good that it buys and should also have an idea on trade-offs and opportunity costs that are involved while choosing goods from the market.
Elasticity – the concept in economics that helps in analysing the responses to change in prices of goods
- The term ‘price’ refers to the value of a good and can be expressed in terms of money, other goods or services.
Elasticity is a concept that measures the proportional change in one variable that results due to a change in another. Elasticity of demand/supply looks at how demand and supply change in response to fluctuations in prices, respectively.
- The concept of elasticity of demand and supply affects markets a lot. Traders fix prices and quantity to be sold after examining the percentage of change that would happen in quantity demanded by consumers as a result of the proportional change in the price of goods.
Wealth, Money, Bonds – concepts that every individual , organisation or institution has to have to decide how to hold your assets as
- The concepts of wealth, money and bonds are very basic and are applied in our day-to-day lives. Any person should have an idea on how to use and where to invest their income on, no matter how small an amount it is.
- When we talk about economic wealth, we essentially refer to the assets that a person possess, economically. Wealth is a stock variable. People hold wealth either in the form of money or in the form of bonds.
- Money, which is also called ‘currency’ or ‘cash’ and comes as notes and coins, is the most liquid asset, which can be used to buy goods and services The zero transaction cost and zero risk associated with money make it easy for people to handle it.
- In economics, the bond is a loan to a firm/company/government, for a period of time, with a promise of repayment of that money, plus the rate of interest. There are different types of bonds in the financial market that vary in the rate of interest, maturity period and risk associated.
Inflation – increase in price levels in the economy
- The level of prices keeps fluctuating in any economy, depending on demand, supply and other external factors. Sometimes, there occurs a sustained, increase in the general price level of goods in an economy over a time period. As the price level increases, the purchasing power of consumers decreases. Economies often end up in a lot of financial trouble and instability as a result of inflation. It makes the economy highly unstable. Inflation can be either expected or unexpected. A very extreme degree of inflation is known as ‘hyperinflation’.
- Inflation is a key concept which determines the overall working of an economy. Economists and policymakers always keep in mind the level of inflation that could be expected in the near future, while making important decisions.
Taxes and Subsidies – two of the most important aspects of an economy
- Taxes and Subsidies are two main financial aspects of countries. Taxes are compulsory amounts that are charged by the government from individuals, institutions or corporations in order to finance the activities of the government. Taxes can be direct or indirect, according to their mode of payment to the government. Certain taxes, such as the income taxes are given directly to the government, as sum of money. The case of certain other taxes, like the tax on packed food items, is different. The customer pays a fixed amount of money as tax to the goods, which then goes to the government. These are indirect taxes.
- Subsidies are the direct opposite of taxes. Sometimes, the government extends financial support to people, institutions or corporations, aimed at promoting their activities, as a part of the decisions and policies made by the government. These financial incentives are called ‘subsidies’.
Gross Domestic Product – the measure that determines the economic growth of a nation
- Gross Domestic Product, or GDP, is one of the most important concepts in economics. GDP is the key factor that determines the economic growth of nations. By definition, ‘GDP is the monetary value of all finished goods and services produced within the territories of a country during a specified period, say, one year’. GDP is a valid and official expression of the worth of the total output in a country and thus measures the economic growth or decline in a country. GDP growth can be positive, zero or negative according to the prevailing economic conditions of a nation.
- When the value of assets a nation receives from abroad are also added to the nation’s GDP, we obtain the GNP or the Gross National Product of the country.
Perfect Competition and Monopoly – market structures
A market is said to be perfectly competitive, if it satisfies the following properties :
(1) The market has a large number of buyers and sellers
(2) The products sold are homogeneous in nature
(3) Free entry and exit are granted to everybody involved in the market
(4) Everybody has perfect knowledge of the market
(5) There is full mobility if factors of production and goods in the market
(6) There is no price control
- In a perfectly competitive market, the forces of supply and demand determine the equilibrium level of prices. This reduces disparities and unfairness. Both buyer and seller are benefited from competitive form of markets.
- The definition of monopoly is exactly the converse as that of competitive markets. Monopoly is a market structure with a single seller who has total control in the market, the goods sold and the price of the goods. As all the power rests in the hands of the single buyer, there are high chances of unfairness in monopolistic markets.
Once we have an understanding of the basic concepts in Economics, we can look into various deeper aspects and principles of Economics. Economics, according to George Mankiw, are based on 10 principles, which are:
(1)People face trade-offs
(2)The cost of something is what you give up to get it
(3)Rational people think at the margin
(4)People respond to incentives
(5)Trade can make everyone better off
(6)Markets are usually a good way to organize economic activity
(7)Governments can sometimes improve market outcomes
(8)A country’s standard of living depends on its ability to produce goods and services
(9)Prices rise when the government prints too much money
(10)Society faces a short-run trade-off between Inflation and unemployment.
We have just come through a very brief introduction on the subject of Economics. As said already, it is a very vast subject that is constantly updated. You should have a clear grip on the basic concepts of the subject, to go into deeper aspects of the same.