Preface
Journalists with little
insight in economics write on economic issues spreading confusion. College principles
courses tend to be vast surveys. As a result, economics seems either obscure or
obvious. This introduction to economics is meant to start you on the right foot
toward understanding the depth and focus of economics.
The foundation of human life is production and consumption of
goods and services that make it possible. The major theme of economics is that
markets provide these goods and services. During the past century living
standards rose remarkably worldwide due to increasing specialization and trade.
The role of government is to provide the legal structure for
property rights, produce public goods when markets fail, and redistribute
income. Political groups try to alter
market outcomes in their favor supporting politicians who pass laws
favorable to the group. The support is in the form of money and votes. Lobby
groups try to short circuit market outcomes with government policy favoring
their members.
There is plenty of room for disagreement over the role of
government in economics. Grasping the scope of what the government can do is
important for sound economic thinking.
economic$
Economics is the study of the production and
distribution of goods and services through the market system. Economics
studies the prices and outputs of goods and services. Sound economic thinking
defines the role of government
in the economy exposing the limits of government policy.
The basic lesson of economics is the benefits of free trade and free investment.
Economics explains why people save and
firms invest, and why
the economy grows. Two issues for the economy are unemployment and inflation.
Economics will not make you rich but might help you make wise
investments. Economics will help you understand why politicians pass laws
favoring various groups. Economics will help you understand and predict market
changes.
Economics can answer some puzzling questions. Why is gold mainly
for jewelry expensive, while water essential for life is cheap? What will
happen to the price of oil over the coming decades? How soon will there be a
sale on that new car you want? Which industries will expand?
market
basics
Markets produce and distribute goods and services. Goods are
scarce physical objects such as cars, shirts, gas, and wine. Services include
haircuts, doctor visits, and consulting provided directly between people. Goods
and services are produced requiring payments for the inputs of labor, machines,
and energy.
One side of a market is supply
that sums up production at various prices. As the price rises, the quantity
supplied increases. Higher wages decrease supply. Lower energy prices raise
supply.
The other side of a market is demand for the amount purchased at various prices. As the price
rises, the quantity demanded falls. Incomes and tastes of potential buyers
shift demand. Everyone is a potential buyer of everything but many goods and
services are beyond most consumers due to price, budgets, location, or timing.
Supply and demand are the two sides of a market together determining price and quantity.
Changes in demand and supply affect price and output. Increased income raises
demand leading to a higher price and more output. Improved technology increases
supply leading to lower prices and more quantity. Higher wages reduce supply,
raising price and lowering output.
markets
for productive factors
Labor, capital, and natural resources are the three general factors of production. Firms pay
owners of these inputs. In the economy, firms are input buyers and households
are sellers.
People sell their labor
and receives a wage. Labor supply
comes from individuals or households. While everyone would like a higher wage,
the labor market determines wages. People with their own businesses pay
themselves a wage.
Capital refers to the machinery,
equipment, and structures in production. Capital has to be produced and is
valuable because it contributes to firm revenue. Firms pay rent for capital input. Even if a
firm owns a machine, it could rent it to another firm. People own most of the
capital although the government also owns capital for production.
Natural resource inputs such as energy
resources, lumber, and iron are derived from the earth. The foundation of
natural resource inputs is land, air, and water. Natural resources are paid by
the firms using them in their production. Owners of the natural resources sell them
to firms for production. Either people or the government can own natural
resources.
The factor markets distribute income. Payments to labor,
capital, and natural resources are the components of household income. The
government uses various schemes to redistribute income, a basic issue of
political economy.
Markets for products and factors are the two sides of the
economy. People are demanders in the product markets and suppliers in the
factor markets. Firms are the opposite, suppliers in the product markets and
demanders in factor markets.
Prices for products and factors are determined by markets.
Markets are interrelated by price and output effects. For instance, an increase
in the price of gas will raise demands for bicycles and mass transit. Prices
send signals for what to produce, what can be afforded, which inputs to buy,
where to invest, and how many hours to work.
The economic system is complicated with markets constantly
distributing goods and services. The news is delivered, a hamburger served, the
internet provided. Economics boils this down to supply and demand.
international
economics
Households, firms, and governments across countries trade with
each other. When a scare good or service is cheaper in another country, arbitragers buy it in the cheap
location and transport it to the expensive location. The arbitrage rule
"buy low, sell high" results in profit. Trade leads to more goods and
services for both trading partners. With trade, production becomes more efficient
as countries do not waste valuable resources making products that other
countries make at lower cost.
Industries competing with imports want protection with tariffs and quotas of the government. A tariff
is a tax on imports, and a quota a limit on the quantity imported. These
government policies help the protected industries but hurt consumers of the
good or service. Protected industries are inefficient and cannot compete with
politicians providing protection in exchange for money and votes.
There is concern that other countries have lower wages or weak
environmental regulations with unfair trade. China might be better than Japan
at making appliances while Japan might be better at making cars. There will
always be plenty of goods and services for every country to produce. Relative
efficiency is all that is required to gain from trade. Comparative advantage is the relative efficiency that determines
efficient production.
International investment is vital for economic
growth naturally flowing across borders as industries look for better locations
for production. Some countries become international lenders, and others
borrowers. Governments limit international investment due to political pressure
from firms competing with the foreign investment. General Motors, for instance,
is hurt when Hyundai locates a new automobile plant in the country.
The exchange rate
translates prices from one currency to another. The level of the exchange rate
determines the direction of international trade, tourism, and investment. High
variation in the exchange rate discourages international trade and investment.
The exchange rate sets domestic prices of imports and foreign
investments. Governments may fix their exchange rate to please bankers or
investors. Governments can undervalue a fixed exchange rate to help their
export industry, essentially transferring purchasing power to foreign
consumers. The exchange rate is best determined in a free market.
economics
of the future
Households save now
so they can spend later. People save for college, a new car, retirement, or for
their descendants. Saving is money not spent on present consumption.
Firms invest in
capital to become more productive. Funds for investment are from retained
earnings, borrowing, or the sale of new stock ownership in the firm. Investing
this year helps produce more revenue next year.
Saving and investing determine the future of the economy
interacting in the credit market. The two sides of the credit market are saving
and investment as demand. Together saving and investment determine the price
and quantity of credit.
The price of credit is the interest rate that is the return to saving and the cost of borrowing.
The credit market, not the government, determines the interest rate. The
government only sets the federal funds rate that it charges banks that might
want to borrow.
The government also controls the money supply. The growth rate
of the money supply determines inflation. Higher inflation translates into a
higher nominal interest rate for lending and borrowing. The real interest rate
is the nominal rate less inflation. If the nominal interest rate of is 6% and
the inflation rate 5%, the real rate is 1%.
The economy as a whole might save or lend internationally. One
country might be a lender and the other a borrower. Reasons for lending and
borrowing internationally are the same as in the domestic credit market. Countries
grow through international saving and investment.
government
& business
The government provides some services and perhaps goods,
redistributes income, and enforces property
rights. If anyone could drive your car there would be little incentive
to buy on. Without property rights, the economy would collapse.
Governments use taxes
and subsidies to influence
economic activities. A tax involves paying the government leading to less of
the taxed good or service. With a subsidy, the government pays leading to more
of the subsidized product. Politicians accept cash and votes to enact taxes and
subsidies.
Governments create monopoly power with franchises. A legal monopoly is the only firm able
to produce a particular good or service. A monopoly sets price to maximize
profit with no competitors. Electric utilities are franchise monopolies. The
government regulates the
utilities receiving taxes and political support in exchange for the franchise.
Taxis, doctors, electricians, airport landing slots, cable
service, and beauticians are other examples of government franchised licensing.
Monopoly power restricts competition. The value of a license or franchise can
be high leading firms to pay lawmakers for the favor.
Some industries that were franchised and regulated by the
government have been deregulated. These include banking, trucking, airlines,
and telecommunications. As a rule, deregulated industries produce better
services at more competitive prices than regulated franchises.
environmental
economics
Pollution is a negative spillover
produced along with some outputs. Most pollution is attached to mining of
minerals and energy sources
including coal, oil, and gas. Pollution cost is external to the producing firm short of liability for damage.
The cost of pollution is paid by others outside the firm.
Controlling pollution is costly. Pollution from generating
electricity could be totally eliminated but monthly bills would at least
double. Firms can be taxed according to the pollution externality. The
political process of environmental laws determines who pays how much.
macromanagers
Macroeconomics concerned with managing the entire economy is described like a vehicle with accelerators,
brakes, fine tuning, takeoff, and soft landing. The desired illusion is that
the macromanagers are in control. Economic recovery packages try to recover
from previous recovery packages.
The ultimate macroeconomic plan was the series of Five Year
Plans in the Soviet Union. While the plans sounded good on paper, the socialist
system collapsed due to inefficiency leading to continued poverty.
People have different ideas about how much the government should
manage the economy but two things are certain. First, any plan should stress
market incentives. Second, the government requires tax revenue.
Free markets provide adjustment mechanisms for imbalances such
as unemployment, recession, bad weather, energy crises, financial crises,
pandemics, and so on.
Out of a sense of fair play, the government redistributes some
income. The iron law of economics is
that whatever you do to help somebody hurts due to the lost incentive to
help themselves. Welfare systems create a permanent underclass as the safety
net becomes a hammock.
Maromanagers are government bureaucrats perpetuating themselves.
Politicians are elected by making you think they can do something for you.