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This section will examine some basic ideas about economics, including the concepts of exchange, supply and demand, overhead, and other key points.
The principle of exchange—of give and take—is central to the development and maintenance of any economic system. Producers cannot exist without consumers. If every entity within an economy were a producer, no exchange would exist. If every entity in an economy were a consumer, a dearth of supply would drive the system into the ground. A functional economic system requires some to produce and others to consume. Equilibrium of give and take allows economies to flourish.
The original economic model worked on a system of barter. The barter system allowed for each individual entity in the system to be both producer and consumer, since most people consumed what others produced and produced what others consumed. The invention of currency as a universal standard of value led to the dominance of price-based economies, where a certain amount of currency—affected by supply of commodities, demand for commodities, and other factors—could be exchanged for any available good or service. One of the factors outside of supply and demand that affects the price of goods and services is overhead. In order for the producer to have a comfortable seat in any economic system, the producer must cover his or her overhead and reap at least a little profit in the process.
Economic systems that include great numbers of people can be scaled up in three different tiers.
Chuck leases a 300-square foot shop to Benny for $678 per month. In this case, $678 is considered
Answer D is correct. Recall that overhead is the amount of money it takes just to keep a business operational. While there are nonmonetary examples of overhead (time, for example), its value is mostly measured in cash.
Other important economic terms to remember are scarcity and opportunity cost.
Scarcity means not having enough resources to fulfill demand. Scarcity of product is usually beneficial to the producers of goods, such as businesses. In times of extreme scarcity, the government must often step in and see that no one business holds dramatic dominance of the supply and therefore the market. Opportunity cost is another important economic concept; it is less concrete than the concept of scarcity. Whenever a decision is made, there are two costs involved: the direct value of making the decision and the opportunity cost of not being able to make a different decision.
For instance, the opportunity cost to a city building a hospital on a certain plot of land would be the potential profit from building a factory, or the various other benefits that the citizens would reap if the structure were to become a repair shop or an employment agency. If a decision strongly benefits too few entities within a system or takes too much away from too many, the opportunity cost of that decision is too high. Regulators must step in to ensure a less extreme decision.
Economics is a field filled with theorists and their ideas. Click here to learn more about one of them, the “parable of the broken window.”
Another economic concept that has great effect on decisions in any economic system is the concept of trade-off. In order to increase one aspect of an economic system, another must often be decreased or neglected. Trade-offs such as efficiency for labor cost, quantity for quality, and energy supply for environmental solidity are common. The concept of trade-offs is related to opportunity cost. Whenever the trade-off is too heavily weighted on one side against the equilibrium of the system, amendments to the decision must be made to see that equilibrium is maintained.
Spending, saving, and investing are important components of an economy. Spending means the acquisition of commodities, but it also means the consumer has less currency. Saving means the consumer keeps his or her currency, but whatever the consumer could have bought remains on the shelf. Investing is a less cut-and-dry proposition; investing means that the consumer has less money and no commodity to show for his or her money, but that in the future, the consumer hopes to have more money for having invested the money that he or she did. It would not be a stretch to say that the commodity purchased in an investment is the commodity of earning potential.
Modern economies, more often than not, feature the possibility of credit. It is important for the consumer to be careful when spending money that he or she does not have. If he or she has a good record of handling credit, the consumer is more likely to be extended credit in the future, but his or her privilege of credit may be revoked altogether if his or her record is bad.
Commodity-producing businesses need employees to help keep them running. The factors of production, and, subsequently, the wages of employees, are determined in much the same way as prices on the market—with the laws of supply and demand. When demand is great for a product that any certain business is pumping out, that business is required to increase production and therefore raise the amount of money spent on wages (this is an example of a trade-off—quantity for labor cost). Should there be a glut of supply for the product that any certain business produces, production, wages, and sometimes the number of employees must be cut back. High demand is most often seen with low supply, and high supply is most often seen with low demand. Free market economies function mainly on supply and demand.
Sometimes it is easier for one party to produce something than it is for another party to produce the same thing. This simple concept is the basis for specialization and exchange, a system whose benefits include greater overall efficiency for all parties and the ability of all parties to be utilized within a system to their fullest potential. Take the following table as an example:
| 1 unit of clothing | 1 unit of food | |
|---|---|---|
| Country X | 6 hours | 2 hours |
| Country Z | 3 hours | 9 hours |
The table shows that Country X has the advantage in ease of food production, while Country Z has the advantage in ease of production of clothing. Country X produces one unit of clothing in the same amount of time that it takes to produce three units of food. Conversely, it takes Country Z three times as long to produce a unit of food as it does to produce a unit of clothing. The simplest conclusion to draw from this table is that if X focused most of its resources on producing food and Z most of its resources on clothing, the two could trade their surpluses of their chief product. Both economies would flourish with less labor loss than would occur without specialization and exchange.
What is the basic concept behind the above clothing/food graph?
The correct answer is B—the economically sound plan of specialization and exchange.
The U.S. economy is a multifaceted system, with each aspect playing a vital role. These systems include private ownership of businesses, public and private banks, the stock market, labor unions, and government agencies. Allowing businesses to be privately owned and operated, for instance, provides choice to the consumer and competition within the market. The presence of both private and government banks allows for the safekeeping of real value for both individual consumers and conglomerate businesses and industry. The stock market is a way to track the performance of companies as well as consumer confidence in them. The stock market also provides investment opportunities for consumers. A labor union is a collective at the employee level that keeps in mind the best interests of its workers. Labor unions see to it that businesses and governments do not allow their own interests to conflict with the interests of the people who make those institutions what they are. Government agencies are many and various, providing essential services to one feature or another of a national economy.
Government policy also puts a great deal of pressure on economic movements within any given country. Inflation, the swelling of the price index, can negatively affect an economy when it rises beyond nominal levels. Governments can institute policies that tax held currency such as savings, making it just as expensive to hang on to your money as to spend it. This policy can energize a stagnant economy and slow down inflation when it threatens to become rampant. An unfavorable consequence of anti-inflation policies is that they can either create or exacerbate unemployment. In order to reconcile the contradictory aims of anti-unemployment and anti-inflation policy, the government often focuses its energies on economic growth, which is conventionally measured as an increase in the real gross domestic product.
These quantities are examples of macroeconomic quantities. Due to the grand nature of what they describe, macroeconomic quantities are difficult to measure. Unemployment is measured by counting all the nonworking people actively seeking employment and dividing that number by the number of total citizens eligible for the work force. The price index is calculated by dividing the sum of the price in one period and the quantity in a second by the sum of price and quantity in the second period. The gross domestic product is calculated by subtracting the sum of national consumption, government expenditures, aggregate investments, and exports from all products imported into the national economy.
Most national economies in the world today are market economies, where goods and services are traded freely among citizens according to their exchange values. Eighteenth-century economist and philosopher Adam Smith, credited with instituting economics as an academic and political discipline, considered the free market to be a self-regulating system due to the natural influence of the laws of supply and demand. Smith believed that if each citizen in a free market acted in his or her own best interest, the free market would flourish.
Smith also argued that the only regulatory measures necessary in a free market were the naturally occurring factors of competition and the desire to advance the human species. Buyers would be prudent in acquiring proper things, and sellers would be prudent in regulating prices in order to, if for no other reason, continue their own advancement. Buyers would compete with one another in their acquisition, and sellers would compete with one another in the quality and availability of their products and facility to provide them, all in order to see themselves and their successors at the head of the next generation.
The driving force in capitalist systems is currency, and in a global economy, multiple currencies are traded. If a citizen of one country with one currency chooses to trade with a citizen of another country with another currency, the currency of one must be translated, like a language, into the currency of the other before any transaction can be made. This principle necessitates exchange rates, standardized conversions of one currency to another. Exchange rates are prices of individual currencies in the world market and are determined much in the same way as production prices within an individual economy; great demand increases price, surplus or lack of demand reduces it.
The United States dollar (USD) is a very important unit currency in the world economy. Its movements affect financial matters across the globe, but fluctuations in the price of the dollar on the world market are most significant to the U.S. economy. As the value of the dollar drops, the United States loses influence in the global economy and some of its avenues for international business. Imported goods become more expensive while exports drop in price. A rising dollar has exactly the opposite effect: more international influence and cheaper imports, with exports going at a higher rate. The quality of life in any capitalist country participating in a world economy is very closely related to the perceived quality of its currency in that economy.
A consumer is willing to buy four compact discs for $15 but will buy six if the discs are priced at $12 per piece. Which economic force is being described in this scenario?
The correct answer is A. Demand affects the price of something that a consumer is not only willing to buy but also has the capacity to buy (depending on the price).
