Few things affect the day-to-day lives of everyone more than the economy. In this lesson, you’ll learn about economics, including some of its foundational topics and concepts. You’ll also have a chance to take a quiz after the lesson.
Economics – Allocation of Resources
Meet Joe. He is a typical entrepreneur in the United States who is about to start a new downtown coffee shop. We’ll be following Joe throughout this lesson to see how economics affects his life. Economics is about the allocation of resources available to fulfill people’s needs and wants for goods and services.
In a perfect world, we would have unlimited resources and everyone would have all their needs and wants fulfilled. But, we don’t live in a perfect world; resources are scarce or limited. Consequently, not all wants can be fulfilled, and decisions must be made about the allocation of resources. Economics is studying how everyone from an individual to an entire country makes these decisions.Joe lives in a market economy where most resources are held in the hands of individuals who have the right to decide what to do with them. Like everyone else, Joe both consumes resources in the economy and provides resources to the economy. For example, he supplies labor to the economy, and he also buys resources, such as food, transportation and housing.
Since he’s starting a coffee shop, he will have to obtain resources, such as espresso machines, grinders, coffee beans, milk and cups. He’ll also need electricity and water as well as labor from employees.
Since Joe wants to start a business, he’ll be particularly interested in microeconomics, which is the study of how consumers and businesses make economic decisions. One of the most important concepts of microeconomics is the law of supply and demand. This law states that if everything else stays the same, the price of a good or service will be high if the demand for it is high and the supply of it is low.
On the other hand, if the demand for it is low and the supply of it is high, the price will tend to be low. If the demand for java is higher than the supply, the price of a cup will go up. If the demand for it is lower than the supply, Joe will have to cut his prices to make sales.Some economists believe that the economy is guided by an ‘invisible hand ‘ – a term coined by English economist Adam Smith in his book The Wealth of Nations. Basically, the idea is that buyers and sellers will make decisions based upon what’s best for them – in their self-interest. And, the sum of these interests creates the best result for an economy.
Let’s look at the invisible hand at work. Joe will only buy a commercial-grade espresso machine at a price that is worth it to him. Vinny, the vendor, will only sell his espresso maker to Joe at a price that is worth it to Vinny. No one makes Joe buy what Vinny is selling. They each decide on their own if it is in their best interests to do the deal. The price at which Joe is willing to buy and the price that Vinny is willing to sell should be an efficient allocation of economic resources.
Joe will also be interested in macroeconomics. While microeconomics studies a piece of the economy, macroeconomics studies the entire economy. It looks at economic effects in the aggregate. A hint to the distinction between microeconomics and macroeconomics can be found in their prefixes. ‘Micro’ means ‘small’ and ‘macro’ means ‘big.’ Macroeconomics looks at the big picture.
Common areas of study include:
- Inflation, which is an increase in the general price-level in an economy
- Economic output, which is the aggregate output of goods and services in the economy
- Business cycle, which is the ups and downs of an economy, including growth, recession, depression and recovery
- Fiscal policy, which is the government’s decision on taxing and spending and its effect on an economy
- Monetary policy, which is a government’s decision regarding money supply and interest rates and its effect on an economy
- International trade
- Study of economic systems. Economists study different economic systems, such as free market economies, command economies and mixed economies
As you can see, macroeconomics helps us understand how the economy as a whole affects our lives. These macroeconomic matters affect everyone, but let’s focus on Joe. Business owners, like Joe, will be concerned with the unemployment rate and inflation rate because it will impact the costs of labor. Inflation also affects the costs of goods and services needed for his business.
Government taxation and spending will also affect Joe’s business. Taxes take money out of his pocket, and government spending means there are more people working providing goods and services to the government. These people will then have money to buy his coffee. The supply of money and interest rates will affect the price of goods and the costs of loans.
Growth vs. Sustainability
A current discussion in economics is economic growth and sustainability. Economic growth is simply increasing the economy’s ability to produce more goods and services.
Joe’s coffee shop adds to economic growth because more coffee, cappuccinos, lattés, mochas and espressos are produced and sold. The more Joe sells, the more employees he must hire to keep up with demand. He’ll also need to buy more goods and services. He can also increase growth by improving productivity – getting more goods and services out of the same or fewer resources than he used before.
However, there is a significant question whether growth can go on forever. Resources are limited – there’s only so much oil, timber, water, metals and the like to produce goods and services. Some of these resources cannot be renewed, and increases in productivity through technology may have limits. Additionally, unfettered economic growth can have adverse environmental consequences, such as pollution and depletion of nonrenewable resources, like a rainforest.Some advocate for a sustainable approach to economic development where economic growth takes into account the impact on the environment, so that economic growth is sustainable over time. Joe can contribute to sustainable growth.
For example, he can use recycled paper for his disposable coffee cups, purchase organically grown coffee beans and implement water and energy conservation policies at work.
Let’s review what we’ve learned. Economics is the study of efficiently allocating resources to fulfill the needs and wants of people. The study of economics is divided into two primary subdivisions.
Microeconomics is the study of the economic decision making of businesses and consumers, while macroeconomics is the study of the economy as a whole.Economic growth is an increase in the output of goods and services produced in an economy. Economic growth may be limited by a finite amount of resources and technological limits. Sustainable economic growth is an attempt to create economic growth in a way that is sustainable and limits the damage to the environment.
Upon completing this lesson, you will be able to:
- Define economics and market economy
- Distinguish between microeconomics and macroeconomics
- Identify common areas studied in macroeconomics
- Explain the importance of sustainable economic growth