What Is Economics?
Economics is asocial science that focuses on the production, distribution, and consumption of goods and services, and analyzes the choices that individuals, businesses, governments, and nations make to allocate resources.
Key Takeaways
- Economics is the study of how people allocate scarce resources for production, distribution, and consumption, both individually and collectively.
- The two branches of economics are microeconomics and macroeconomics.
- Economics focuses on efficiency in production and exchange.
- Gross Domestic Product (GDP) and the Consumer Price Index (CPI) are widely used economic indicators.
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Understanding Economics
Assuming humans have unlimited wants within a world of limited means, economists analyze how resources are allocated for production, distribution, and consumption.
The study of microeconomics focuses on the choices of individuals and businesses, and macroeconomics concentrates on the behavior of the economy as a whole, on an aggregate level.
One of the earliest recorded economists was the 8th-century B.C. Greek farmer and poet Hesiod who wrote that labor, materials, and time needed to be allocated efficiently to overcome scarcity. The publication ofAdam Smith's 1776 book, An Inquiry Into the Nature and Causes of the Wealth of Nations sparked the beginning of the current Western contemporary economic theories.
Microeconomics
Microeconomics studies how individual consumers and firms make decisions to allocate resources. Whether a single person, a household, or a business, economists may analyze how these entities respond to changes in price and why they demand what they do at particular price levels.
Microeconomics analyzes how and why goods are valued differently, how individuals make financial decisions, and how they trade, coordinate, and cooperate.
Within the dynamics of supply and demand, the costs of producing goods and services, and how labor is divided and allocated, microeconomics studies how businesses are organized and how individuals approach uncertainty and risk in their decision-making.
Macroeconomics
Macroeconomics is the branch of economics that studies the behavior and performance of an economy as a whole. Its primary focus is the recurrent economic cycles and broad economic growth and development.
It focuses on foreign trade, government fiscal and monetary policy, unemployment rates, the level of inflation, interest rates, the growth of total production output, and business cycles that result in expansions, booms, recessions, and depressions.
Using aggregate indicators, economists use macroeconomic models to help formulate economic policies and strategies.
What Is the Role of an Economist?
An economist studies the relationship between a society's resources and its production or output, and their opinions help shape economic policies related to interest rates, tax laws, employment programs, international trade agreements, and corporate strategies.
Economists analyze economic indicators, such as gross domestic product and the consumer price index to identify potential trends or make economic forecasts.
According to the Bureau of Labor Statistics, 36% of all economists in the United States work for a federal or state agency. Economists are also employed as professors, by corporations, or as part of economic think tanks.
What Are Economic Indicators?
Economic indicators detail a country's economic performance. Published periodically by governmental agencies or private organizations, economic indicators often have a considerable effect on stocks, employment, and international markets, and often predict future economic conditions that will move markets and guide investment decisions.
Gross domestic product (GDP)
The gross domestic product (GDP) is considered the broadest measure of a country's economic performance. It calculates the total market value of all finished goods and services produced in a country in a given year. The Bureau of Economic Analysis (BEA) also issues a regular report during the latter partof each month. Many investors, analysts, and traders focus on the advance GDP report and the preliminary report, both issued before the final GDP figures because the GDP is considered a lagging indicator, meaning it can confirm a trend but can't predict a trend.
GDPNow
The GDPNow forecasting model, used by the Federal Reserve, provides a "nowcast" of the official estimate before its release by estimating GDP growth using a methodology similar to the one used by the U.S. Bureau of Economic Analysis.
Retail sales
Reported by the Department of Commerce (DOC) during the middle of each month, the retail sales report is very closely watched and measures the total receipts, or dollar value, of all merchandise sold in stores. Sampling retailers across the country acts as a proxy of consumer spending levels. Consumer spending represents more than two-thirds of GDP, proving useful to gauge the economy's general direction.
Industrial production
The industrial production report, released monthly by the Federal Reserve, reports changes in the production of factories, mines, and utilities in the U.S. One measure included in this report is the capacity utilization ratio, which estimates the portion of productive capacity that is being used rather than standing idle in the economy. Capacity utilization in the range of 82% to 85%is considered "tight" and can increase the likelihood of price increases or supply shortages in the near term. Levels below 80% are interpreted as showing "slack" in the economy, which may increase the likelihood of a recession.
Employment Data
The Bureau of Labor Statistics (BLS) releases employment data in a report called the nonfarm payrolls on the first Friday of each month. Sharp increases in employment indicate prosperous economic growth and potential contractions may be imminent if significant decreases occur. These are generalizations and it is important to consider the current position of the economy.
Consumer Price Index (CPI)
The Consumer Price Index (CPI), also issued by the BLS, measures the level of retail price changes, and the costs that consumers pay, and is the benchmark for measuring inflation. Using a basket that is representative of the goods and services in the economy, the CPI compares the price changes month after month and year after year. This report is an important economic indicator and its release can increase volatility in equity, fixed income, and forex markets. Greater-than-expected price increases are considered a sign of inflation, which will likely cause the underlying currency to depreciate.
Economic Systems
Five economic systems illustrate historical practices used to allocate resources to meet the needs of the individual and society.
Primitivism
In primitive agrarian societies, individuals produced necessities from building dwellings, growing crops, and hunting game at the household or tribal level.
Feudalism
A political and economic system of Europe from the 9th to 15th century, feudalism was defined by the lords who held land and leased it to peasants for production, who received a promise of safety and security from the lord.
Capitalism
With the advent of the industrial revolution, capitalism emerged and is defined as a system of production where business owners organize resources including tools, workers, and raw materials to produce goods for market consumption and earn profits. Supply and demand set prices in markets in a way that can serve the best interests of society.
Socialism
Socialism is a form of a cooperative production economy. Economic socialismis a system of production where there is limited or hybrid private ownership of the means of production. Prices, profits, and losses are not the determining factors used to establish who engages in the production, what to produce and how to produce it.
Communism
Communism holds that all economic activity is centralized through the coordination of state-sponsored central planners with common ownership of production and distribution.
Schools of Economic Theory
Many economic theories have evolved as societies and markets have grown and changed. However, three disciplines of economics, neoclassical, Keynesian, and Marxian, have influenced modern society.
The principles of neoclassical economics are often used as a framework to illustrate the virtues of capitalism, including the tendency of market prices to reach equilibrium as the volume of supply and demand changes. The optimal valuation of resources emerges from the forces of individual desire and scarcity.
John Maynard Keynes developed the theory of Keynesian economics during the Great Depression. Arguing against neoclassical theory, Keynes showed that the restrained markets and government intervention in markets create a stable and equitable economic system and advocated for a monetary policy designed to boost demand and investor confidenceduring economic downturns.
Marxian economics is defined in Karl Marx's work Das Kapital. Marxian economics is a rejection of theclassical view of economics arguing against the idea that the free market, an economic system determined by supply and demand with little or no government control, benefits society. He espoused that capitalism only benefits a select few and that the ruling class becomes richer by extracting value out of cheap labor provided by the working class.
What Is a Command Economy?
A command economy is an economy in which production, investment, prices, and incomes are determined centrally by a government. A communist society has a command economy.
What Is Behavioral Economics?
Behavioral economics combines psychology, judgment, decision-making, and economics to understand human behavior.
Who Has Influenced the Study of Economics in the 21st Century?
Since 2000, several economists have won the Nobel Prize in economics, including David Card for his contributions to labor economics, Angus Deaton for his study of consumption, poverty, and welfare, and Paul Krugman for his analysis of trade patterns.
