Economics is a social science about the allocation of scarce resources to meet unlimited human needs. It discusses production, consumption, and distribution. In a broader scope, it also discusses the variables that explain and influence the working economy, including the behavior of economic agents.
Basic idea of economics
Economics is rooted in the scarcity that humans face. Scarcity arises because the needs and wants are unlimited. Meanwhile, to fulfill them, humans face limited resources. The way and human behavior in allocating resources is the basic idea of economics.
Human needs and wants are unlimited. We need food, drink, clothes, and shelter. All that we fulfill through the consumption of goods and services.
To produce those goods and services, we face scarcity. Agricultural land is limited for us to grow wheat. Not all soil is suitable for growth.
Then, despite the vast rice fields, but it continues to shrink to meet the growing food needs. For this reason, technology is needed to increase productivity.
From this point of view, the main economic problems arise:
- What goods and services to be produced? Whether wheat, rice, or soy, it depends on our consumption needs.
- How to produce those goods and services? To do, we need production factors and technology.
- How to distribute goods? Not all wheat is available to consumers in all countries, but they need it.
The two main branches of economics are macroeconomics and microeconomics. Microeconomics is about the behavior and interactions of individual economic agents. Meanwhile, macroeconomics deals with the behavior and interactions of aggregate economic agents and how the economy works.
Sometimes, it difficult to distinguish the two because the boundaries are somewhat ambiguous. Macro and microeconomics intersect in discussing the behavior and interactions of economic agents. Both discuss economic agents that include individuals, businesses, and governments.
Aggregate economic agents are the focus of macroeconomics. While they, as individuals or groups, are macroeconomic topics. Behaviors and interactions at the micro-level affect the way markets work. And in the macro-level, they affect the way the economy works.
Textbooks explain that macroeconomics is the study of the economy as a whole. For example, it examines the factors that affect a country’s economic growth.
However, if we examine it correctly, it is rooted in the micro concept. Economic growth represents the production of goods from all markets in a country.
The next example is inflation. It represents an increase or decrease in prices in the aggregate. Inflation is a macroeconomic topic. But, the price of a good and service is a microeconomic topic.
Likewise, aggregate demand is the sum of demand from the household, business, and government sectors, both from domestic and abroad. Similarly, aggregate supply is representative of the production of all producers in a country.
Why do we study economics
Because it studies humans and their behavior, economics explains the everyday phenomena around us. Economists explain why economic aspects occur and how economic performance can improve.
They work for international organizations, research firms, investment companies, government institutions, central banks, and think tanks, where they study and analyze various economic problems. Their works often appear in newspapers, journals, annual reports, business plans, and other reports.
Economics is an important social science discipline. By studying it, you know how people, governments, businesses, households, and individuals allocate their scarce resources (such as time and money).
Economics also provides valuable knowledge for us to make decisions in our everyday life. You will know when you should save more than consume.
If you are a business owner, the economy tells you how much you have to sell a product to make a profit, and at what price?
Important concepts in economics
Departing from the basic ideas above, we summarize that in general, economics discusses four critical basic concepts, namely:
In addition to the four, economists also consider humans to be economically rational creatures by maximizing their respective interests. Consumers maximize the utility (or satisfaction) obtained from the consumption of goods and services. In contrast, producers maximize profits from the production of products and services.
When making choices, humans face opportunity costs. It represents the next best alternative that humans sacrifice when making resource allocation choices.
Economists also use the ceteris paribus assumption, which is to assume the constant of other determinants beyond the variables they examine. This assumption is important because economic phenomena are complex, and it is impossible to explain all the variables into a simple economic model.
Demand comes from the basic idea of consumption. It represents the needs of goods and services by economic agents (consumers, producers, and the government), which is supported by the ability to purchase. That means, if you want to buy an essential item, you must also have money.
While microeconomics deals with individual economic agents, macroeconomics is in their aggregate. They are households (consumers), businesses (producers), and government (central and regional governments). Macroeconomics combines demand from these agents to form aggregate demand, which consists of consumption, investment, and government spending. Furthermore, aggregate demand does not only come from within the country, but also from abroad, which is represented by exports.
From the topic of demand, economists spawn some ideas such as the demand function, the law of demand, and the demand curve. Economist uses them to explain the quantity of goods demand and the factors that influence it. Next, to explain why the demand curve is downward sloping, economists introduce the concept of utility.
Meanwhile, in macroeconomics, economists try to explain the relationship between aggregate prices and aggregate demand. From there came several concepts such as inflation, fiscal policy, monetary policy, expectations, investment.
Supply represents the basic idea of production, which goods we should produce, and how to produce. The set of output constitutes the supply, which can come from domestic or abroad.
In discussing supply, economists use some concepts such as:
- Law of supply
- Supply function
- Supply curve
- Production cost
- Production capacity
Such concepts are the main concepts in economics, both at the micro and macro levels (sometimes, they only differ in terms). From the economists’ efforts to explain them, we know several words such as the Cobb-Douglas and Solow production function, economies of scale, total productivity factors, short-run and long-run aggregate supply, aggregate output, production capacity, utilization rates, and gross domestic products(GDP). Economists also explain production determinants, both by the company or by the economy and the short or long term.
In supplying goods, producers and the economy face some constraints, i.e., the quantity and quality of resources (raw materials, capital, labor) and production technology. Therefore, there is a maximum output limit (we call it production capacity). The amount of output that can be realized from production capacity refers to the level of capacity utilization.
For the aggregate economy, real GDP represents the monetary value (price times quantity) of realized output. Meanwhile, potential GDP represents the maximum output of the economy. Changes in the output refer to economic growth.
In production, not all resources are usable because the quality does not meet or the quantity is more than we need, or they are in a place and time that we don’t need. In the case of workers, then, it emerges unemployment (structural, frictional, and cyclical).
When the economy is producing at its full capacity, it produces potential output. At that time, we call the economy at full employment or full capacity.
Furthermore, production may not be able to meet the needs of consumers in an area or country. To solve them, we develop regional and international trade. Specifically, for international trade, imports represent supplies for goods and services produced abroad.
Price and money
Price as a representation of the value of goods and services. In barter economy, it is difficult for us to judge the cost of an item.
Then, money emerges and develops, which makes it easy to value good and service. It also makes us easy to compare values between products, facilitating us to measure opportunity costs. In this case, money functions as a unit of account.
The price of an item is formed from the interaction of demand and supply. When the quantity supplied and the quantity demanded are equal, it creates the market price (or the equilibrium price) and the equilibrium quantity. Price deviations from the equilibrium point will cause a shortage or oversupply.
In macroeconomics, the interaction between aggregate demand and short-run aggregate supply forms the level of aggregate prices and aggregate output (represented by real GDP). The deviation of the two intersections around potential output (or potential GDP) forms the business cycle, which has implications for economic growth, inflation, and unemployment.
Apart from being a unit of account, money is also a means of payment. With it, we pay for the goods and services we buy. Next, by saving it, we can also transfer current wealth into the future (the function of money as a store of value).
Money-focused economics is what we call monetarism. We call the sum of money circulating in the economy as money supply.
Meanwhile, economists who believe that money is responsible for economic activity refers to monetarists. Monetarists believe that to change the economy; we should change the money supply. Change in the money would affect prices, the desire of economic agents to buy goods, the cost of borrowing money (interest rates), and the price of the domestic currency against other countries’ currencies (exchange rates). As demand changes, supply and equilibrium in the economy should also change.
Not all countries adopt a uniform currency. The Eurozone uses the Euro, the United States uses the US Dollar, Japan uses the Yen, China uses the Yuan, and Indonesia with its Rupiah. In international trade, export-import involves not only the exchange of goods and services but also currencies. In other words, exports and imports will also affect the demand and supply of currency. The demand-supply interaction of two currencies (domestic vs. trading partner) influences both the quantity and price of the two (we call the price as an exchange rate).
Not everyone has money. We need to borrow a bank if we don’t have enough money to buy goods. From this, the interaction of demand and supply of money brings up the concept of interest rates, which represent the price of lending money (or the cost of borrowing the money).
As with goods and services, the supply and demand for money not only comes from domestic but also from foreign markets. Once again, because it involves different currencies, lending, and borrowing money (represented by the flow of capital) also has an impact on the exchange rate.
Economists formulate a balance of payments to see the monetary flow of money, both related to the demand for goods and services or those related to the money supply (capital flow).