Economics

Economics is the scientific study of scarce resources, in particular the exchange, ownership, and use of these resources. This social science, which is also known as the science of scarcity, examines the actions of groups, individuals, and organizations and tries to make sense of why they act. Unlike many scientific studies, economics is limited in how it may conduct controlled experiments. Much of the information gathered is made through observation and deduction. Economists may also use abstract models.

Economics includes a diverse number of specialized fields. The most basic distinction is between macroeconomics, which is the study of economic systems as a whole, and microeconomics, which is the study of an individual market. Other subdivisions include money and interest rates, game theory and bargaining theory, econometrics, labor and demographic economies, economic history, and public economics, taxation, and government spending. It encompasses personal and global actions and influences, and may rely on various models and draw from various social sciences, including the fields of psychology and sociology. For example, behavioral economists examine how people respond to scarcity of a product.

Scarcity, which is a central concept of economics, refers to the pressure between resources and demand. Resources include individual funds, skill, and time, as well as a nation's capital, labor force, natural resources, and technology. Purchasing and manufacturing decisions are based on scarcity; for example, a company may choose to manufacture a good of higher quality than the competition is producing, based on the idea that the market lacks a top-tier product. A consumer may choose this high-quality item rather than purchase an inferior item if the individual expects to purchase a replacement when the low-quality product eventually wears out or breaks. The opposite may also be true; an individual may purchase an inexpensive item of trendy clothing, knowing that it will be out of fashion long before it wears out.

Background

The earliest economies were simple. A tribe, village, or family produced necessities required by its members. The group worked together in activities such as hunting, farming, building shelters, caring for livestock, and producing clothing. Later, society shifted toward a class system. Peasants and slaves provided the labor and produced goods that the upper classes needed as well as items they wanted, getting very little for themselves. As societies interacted, they began to trade, creating larger economies. Markets arose naturally out of human behavior as individuals exchanged goods and services, including labor. Sellers seek to make a profit, and buyers attempt to satisfy their desires and needs.

The Industrial Revolution that began in the eighteenth century drastically changed the economic system. Goods became more readily available. Many more workers earned wages, which they might choose to spend in more ways. For example, workers might spend money on necessities as well as entertainment, which would support that industry. At the same time, a large number of people moving into an area to work in a factory could create scarcity of housing, and this demand could drive up housing costs.

Eighteenth-century Scottish philosopher Adam Smith explored the reasons why nations experienced poverty or prosperity in the field then known as the political economy. His An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776, presented his theory of the invisible hand of the market. This idea proposes that free markets usually adjust themselves through competition—meeting the needs of the market—and through self-interest. This hands-off approach is known as laissez-faire, a French term meaning "allow to do." Smith, known as the father of modern economics, explored the influence of the Industrial Revolution and the rise of capitalism. Capitalism is a system of production in which the business owner produces goods for sale and profit rather than for personal use; the workers are paid wages rather than goods. Smith collected many ideas about the changes society was experiencing because of industry and explained them in a way that made sense to most people of his time. He viewed his theories from the perspective of social benefit. He believed, for example, that although merchants sell food and other goods for their own financial gain, their actions benefit society by helping to create and maintain a healthy, thriving population.

Smith is also credited with the concept of gross domestic product (GDP), a means of measuring a nation's wealth. He argued against measuring wealth based on a country's deposits of gold and silver in favor of calculating the value of the nation's commerce and production. He also supported import and export systems. This was at odds with tradition because in the past, nations had been slow to accept such trade unless it promised a clear advantage.

Another eighteenth-century philosopher, Thomas Malthus, did not predict economic growth. Instead, he warned against scarcity. He believed that available resources would prove inadequate for the world's growing population and predicted catastrophe. Industry continued to advance, however, and production increased, proving him wrong, but economic discussion continued to focus on scarcity rather than demand. Philosopher Karl Marx also developed theories of economics. He believed that capitalism was doomed to fail. He believed that communism was the natural result of historical systems including feudalism, which enslaved the proletariat, or working class, for the benefit of the capitalists. Marx believed that the capitalists would continue to control increasing amounts of wealth until the system failed.

By the late nineteenth century, economics was a recognized field of study known as classical economic theory. A few decades later, when the economy struggled through the Great Depression of the 1930s, researchers tried to apply mathematical models and statistical methods to economics. This neoclassical economics approach supposes humans act rationally, businesses strive to maximize profit, and markets are efficient. Scholars realize, however, that humans often act based on emotions and other factors influence decisions.

A growing number of economists in the late twentieth century and twenty-first century have stressed the need to consider inequalities of income distribution and social well-being when evaluating the effectiveness of economic policies. Anthony Atkinson (1944–2017) researched income redistribution within national economies, while 1998 Nobel laureate Amartya Sen was recognized for his research on global inequality and ethical behavior.

Overview

In basic terms, the economy is the system that produces goods and services and provides them to members of society. This system includes both necessities, such as food, and luxuries, such as entertainment and fashions.

Economic systems are classified by the way they produce goods or how goods are distributed. Self-sufficient systems, such as villages or family groups throughout early history, were economic systems based on production. Goods such as crops or clothing were produced by the group for the group, so goods were community property. Other systems, such as feudalism and the global market, are distribution based.

Economists recognize three types of production systems. Capitalism, which is the system of much of the developed world, produces goods for sale that are distributed through a market. The market is the crossroads of buyers and sellers, where prices are established. Capitalism is based on the idea of private property—the business owner owns the factory, tools, and materials, including the finished product. Socialism is a system of collective ownership of the business, tools, and goods produced. The workers equally own the business and share the profits. Some socialist systems operate in capitalist societies. Farm cooperatives, for example, are small-scale socialist systems, which may involve collective marketing, equipment sharing, or other forms of cooperation. Communist production systems reject the idea of private property. All members of a society collectively own items involved in production. A communist system is run by a central planner who determines which workers perform which jobs and allocates goods based on need.

Microeconomics is closely linked to supply and demand, and is the basis of many subfields of economics. International economics, for example, is focused primarily on imports and exports. Labor economics is the study of supply and demand of workers in various fields. Agricultural economics involves the supply and demand of a variety of factors, including agricultural products and labor. Any examination of supply and demand may be undertaken as a study of microeconomics.

The economics of supply and demand often spur innovation. When consumers perceive a new product to be better or less expensive than an existing product, the old offering may be rejected and the industry could collapse. Performance fabrics, for example, have replaced much of the exercise clothing made from natural fibers because consumers believe the new fabrics work better. Natural fiber producers may develop new markets, such as the manufacture of organic cotton fabrics for consumers who support natural agricultural methods and products.

Price is determined by the supply—how much a producer is willing to provide at a price point—and demand. According to the law of demand, if all things are equal, the quantity bought of a good or service is a function of price. If nothing changes, people buy less of a good when the price increases, and buy more when the price decreases. In other words, the higher the price, the lower the quantity demanded, because many consumers would have to give up something else to make the purchase.

The demand curve depicts the connection between the quantity demanded of a product (good or service) and its price. The demand curve charts the demand schedule, or how many units consumers will buy at each price. Price becomes irrelevant under certain conditions, such as a shift in the demand curve. This involves a change in the determinant of demand other than the price: buyer incomes; consumer trends; expectations of future changes in needs, price, supply, or other factors; and the price of related goods, such as an inexpensive store label product or a complementary item (for example, a shift in the price of milk could alter demand for cold cereals). If a determinant causes demand to decrease (a shift to the left), less of the product is demanded at every price. If a determinant causes demand to increase (a shift to the right), more of the product is demanded at every price. If the consumer's income increases, the demand for some products shifts to the right. If consumers become concerned about the safety of the beef supply, the demand curve for beef shifts to the left. When consumers anticipate a price increase, they often stock up on an item, causing the demand curve to shift right. If the cost of a product increases, but the cost of a related product remains the same, the price increase shifts the demand curve for the related product right. (For example, an increase in beef prices may cause consumers to buy more chicken, although the price of chicken has not changed.)

Supply and demand economics may break down as a result of artificial distortion, such as that caused by the cost of taxes on goods. In a balanced supply and demand economy, the seller accepts a price that includes profit, but may be close to the cost of production. The buyer will pay what he or she believes the goods to be worth, up to a certain point at which the buyer judges the cost is too high. Taxes distort this balance. A tax creates an obstacle, a gap between the seller's price and what the buyer pays. The tax may cause the buyer to decide the price is too high. Price controls may also create distortions by keeping prices on a product artificially low. Manufacturers may supply less of the good, creating scarcity.

Macroeconomics is concerned with economics on national and international scales. It examines the GDP, or a nation's output, and how the nation distributes resources, such as capital, labor supply, and land. GDP involves many factors including fiscal policies, inflation, international trade, and unemployment evaluated during a specific period, such as annually or quarterly. Factors in GDP include consumption, investments, construction costs, and the foreign balance of trade.

As a uniform calculation, GDP is used to evaluate a nation's economy and standard of living and compare it to other nations. It is also used to measure GDP from year to year, although this requires adjustment for inflation. This statistic determines whether a nation's economy is in recession, which is usually defined as two consecutive quarters of negative GDP growth.

GDP is determined using one of three methods, but all should reach the same result. The expenditure (spending) approach calculates spending by various participants in the economy, including consumers, manufacturers, and governments. It also includes net exports and imports of goods and services. The formula is GDP = C + G + I + NX, if C is consumer spending, G is government spending, I is the country's investment, and NX is total net exports (total exports minus total imports).

The output (or production) approach estimates the total value of economic output, minus costs of intermediate goods (materials, services, etc., consumed in the process). It measures economic activity that has been performed.

The income approach is based on income earned throughout production, including wages, rent, interest earned on capital, and profits. Other factors, such as depreciation, are also included in the tally.

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