Introduction to Economics

 

What Is Economics?

 

Did you know?
  • One of the earliest recorded economists was the 8th-century B.C. Greek farmer and poet Hesiod who wrote that labour, materials, and time needed to be allocated efficiently to overcome scarcity.
  • The publication of Adam 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

What Are Economic Indicators?

  • Economic indicators detail a country’s economic performance, and are published periodically by governmental agencies or private organizations.
  • The commonly used Economic Indicators are as follows:
    • Gross domestic product (GDP)
      • It is the total market value of all finished goods and services produced in a country in a given year.
    • Industrial production
      • The reports published by Government entities, changes as according to the production of factories, mines, and utilities in the country.
      • This data is an indicator of price increases or supply shortages in the near term, Slack/Tightening of the Economy, etc.
    • Employment Data
      • Sharp increases in employment indicate prosperous economic growth and potential contractions may be imminent if significant decreases occur.
    • Consumer Price Index (CPI)
      • This measures the level of retail price changes, and the costs that consumers pay, and is the benchmark for measuring inflation.
      • This report is an important economic indicator and its release can increase volatility in equity, fixed income, and forex markets.

Economic Systems

  • The following five economic systems illustrate historical practices used to allocate resources to meet the needs of the individual and society.
    1. Primitivism
      • In primitive agrarian societies, individuals produced necessities from building dwellings, growing crops, and hunting game at the household or tribal level.
    2. Feudalism
      • This 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.
    3. 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.
    4. Socialism
      • Socialism is a form of a cooperative production economy.
      • Economic socialism is a system of production where there is limited or hybrid private ownership of the means of production.
      • In this system, 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.
    5. Communism
      • Communism holds that all economic activity is centralized through the coordination of state sponsored central planners with common ownership of production and distribution.

 

List of terms one should be familiar with to understand the concepts going further

TermsDetails/Significance
AppreciationA rise in the value of an asset
ArbitrageBuying an asset in one market and simultaneously selling an identical asset in another market at a higher price.
AssetsThings that have earning power or some other value to their owner.
Balance of paymentsThe total of all the money coming into a country from abroad less all of the money going out of the country during the same period.
BankruptcyWhen a court judges that a debtor is unable to make the payments owed to a creditor.
BarterPaying for goods or services with other goods or services, instead of with money.
BondsA bond is an interest-bearing security issued by governments, companies and some other organisations. Bonds are an alternative way for the issuer to raise capital to selling shares or taking out a bank loan.
BubbleWhen the price of an asset rises far higher than can be explained by fundamentals, such as the income likely to derive from holding the asset.
BudgetAn annual procedure to decide how much public spending there should be in the year ahead and what mix of taxation, charging for services and borrowing should finance it.
Business cycleThe long-run pattern of economic growth and recession.
Buyer’s marketA market in which supply seems plentiful and prices seem low; the opposite of a seller’s market.
CapitalMoney or assets put to economic use, the life-blood of Capitalism.
Capital controlsGovernment-imposed restrictions on the ability of CAPITAL to move in or out of a country.
Capital marketsMarkets in securities such as Bonds and Shares. Governments and companies use them to raise longer-term Capital from investors.
CartelAn agreement among two or more firms in the same industry to co-operate in fixing prices and/or carving up the market and restricting the amount of output they produce.
Central bankA guardian of the monetary system. A central bank sets short-term Interest Rates and oversees the health of the Financial System, including by acting as Lender of Last Resort to commercial banks that get into financial difficulties.
Closed economyAn economy that does not take part in inter­national trade; the opposite of an Open Economy.
CollateralAn asset pledged by a borrower that may be seized by a lender to recover the value of a loan if the borrower fails to meet the required Interest charges or repayments.
Command economyWhen a Government controls all aspects of economic activity (see, for example, Communism).
CommodityA comparatively homogeneous product that can typically be bought in bulk. It usually refers to a raw material – oil, cotton, cocoa, silver – but can also describe a manufactured product used to make other things, for example, microchips used in personal computers.
ConcentrationThe tendency of a market to be dominated by a few big Firms.
Crony capitalismAn approach to business based on looking after yourself by looking out for your own.
Crowding outWhen the state does something it may discourage, or crowd out, private-sector attempts to do the same thing
Currency pegWhen a Government announces that the Exchange Rate of its currency is fixed against another currency or currencies.
DefaultFailure to fulfil the terms of a loan agreement.
DeflationIt is a persistent fall in the general price level of goods and Services.
DepreciationA fall in the value of an asset or a currency; the opposite of appreciation.
DepressionThe textbook definition of a recession is two consecutive quarters of declining Output. A slump is where output falls by at least 10%; a depression is an even deeper and more prolonged slump.
DeregulationCutting red tape. The process of removing legal or quasi-legal restrictions on the amount of Competition, the sorts of business done, or the prices charged within a particular industry.
DerivativesFinancial assets that ‘derive’ their value from other assets.
DevaluationA sudden fall in the value of a currency against other currencies.
DisinflationA fall in the rate of Inflation. This means a slower increase in prices but not a fall in prices, which is known as Deflation.
DividendThe part of a company’s profit distributed to shareholders.
DollarisationWhen a country’s own money is replaced as its citizens’ preferred currency by the US dollar.
DumpingSelling something for less than the cost of producing it. This may be used by a Dominant Firm to attack rivals, a strategy known as Predatory Pricing.
Economies of scaleBigger is better. In many industries, as output increases, the average cost of each unit produced falls. One reason is that overheads and other Fixed Costs can be spread over more units of Output.
ElasticityA measure of the responsiveness of one variable to changes in another.

Price Elasticity measures how much the quantity of supply of a good, or Demand for it, changes if its price changes.

Income elasticity of demand measures how the quantity demanded changes when income increases.

 

EquilibriumWhen supply and demand are in balance. At the equilibrium price, the quantity that buyers are willing to buy exactly matches the quantity that sellers are willing to sell. So everybody is satisfied
Exchange controlsLimits on the amount of foreign currency that can be taken into a country, or of domestic currency that can be taken abroad
Exchange rateThe price at which one currency can be converted into another.
Factor costA measure of output reflecting the costs of the factors of production used, rather than market prices, which may differ because of indirect tax and subsidy.
Factors of productionThe ingredients of economic activity: land, labour, capital and enterprise.
Financial instrumentCertificate of ownership of a financial asset, such as a bond or a share
Fiscal dragFiscal drag is the tendency of revenue from taxation to rise as a share of GDP in a growing economy
Fiscal neutralityWhen the net effect of taxation and public spending is neutral, neither stimulating nor dampening demand.
Free ridingGetting the benefit of a good or service without paying for it, not necessarily illegally. This may be possible because certain types of goods and services are actually hard to charge for–a firework display, for instance.

Another way to look at this may be that the good or service has a positive externality. However, there can sometimes be a free-rider problem, if the number of people willing to pay for the good or service is not enough to cover the cost of providing it.

Free tradeThe ability of people to undertake economic transactions with people in other countries free from any restraints imposed by governments or other regulators.
Frictional unemploymentThat part of the jobless total caused by people simply changing jobs and taking their time about it, because they are spending time on job search or are taking a break before starting with a new employer.
Giffen goodA good for which demand increases as its price rises. But such goods may not exist in the real world.
Gini coefficientThe Gini coefficient measures the inequality of income distribution within a country. It varies from zero, which indicates perfect equality, with every household earning exactly the same, to one, which implies absolute inequality, with a single household earning a country’s entire income.
Gold standardA monetary system in which a country backs its currency with a reserve of gold, and allows currency holders to exchange their notes and coins for gold.
HedgeReducing your risks. Hedging involves deliberately taking on a new RISK that offsets an existing one, such as your exposure to an adverse change in an Exchange Rate, Interest Rate or Commodity Price.
Horizontal equityOne way to keep taxation fair. Horizontal equity means that people with a similar ability to pay taxes should pay the same amount.
Hot moneyIt is the money that is held in one currency but is liable to switch to another currency at a moment’s notice in search of the highest available returns, thereby causing the first currency’s Exchange Rate to plummet. It is often used to describe the money invested in currency markets by speculators.
Human capitalThe stuff that enables people to earn a living. Human capital can be increased by investing in education, training and health care.
Laffer curveInitially, higher tax rates would increase revenue, but at some point further increases in tax rates would cause revenue to fall, for instance by discouraging people from working. The curve became an icon of supply-side Economics.
Laissez-faireIt is the belief that an economy functions best when there is no interference by Government.
LiquidityHow easily an ASSET can be spent, if so desired. Cash is wholly liquid. The liquidity of other assets is usually less; how much less may be measured by the ease with which they can be exchanged for cash (that is, liquidated).
Market forcesShorthand for the pressures from buyers and sellers in a market, rather than those coming from a Government planner or from Regulation.
Mixed economyA market economy in which both private-sector firms and firms owned by Government take part in economic activity.
MonopolyWhen the production of a good or service with no close substitutes is carried out by a single firm with the Market Power to decide the price of its output.
MultiplierShorthand for the way in which a change in spending produces an even larger change in income. For instance, suppose a Government loosens Fiscal Policy, increasing net Public Spending by pumping an extra INR 10 Lakhs into education. This has an immediate effect by increasing the income of teachers and of people who sell educational supplies or build or maintain schools.
OffshoreWhere the usual rules of a person or firm’s home country do not apply. It can be literally offshore, as in the case of investors moving their money  to a Caribbean island Tax Haven.
OligopolyWhen a few firms dominate a market. Often they can together behave as if they were a single Monopoly, perhaps by forming a cartel.
Open economyAn economy that allows the unrestricted flow of people, capital, goods and services across its borders; the opposite of a closed economy.
Phillips curveIn 1958, an economist from New Zealand, A.W.H. Phillips (1914-75), proposed that there was a trade-off between inflation and unemployment: the lower the unemployment rate, the higher was the rate of inflation.
Pigou effectA sort of Wealth effect resulting from Deflation. A fall in the price level increases the real value of people’s savings, making them feel wealthier and thus causing them to spend more. This increase in demand can lead to higher employment.
Price elasticityA measure of the responsiveness of demand to a change in price. If demand changes by more than the price has changed, the good is price-elastic. If demand changes by less than the price, it is price-inelastic. Economists also measure the elasticity of demand to changes in the income of consumers.
Public goodsThings that can be consumed by everybody in a society, or nobody at all. They have three characteristics. They are:

·         non-rival – one person consuming them does not stop another person consuming them;

·         non-excludable – if one person can consume them, it is impossible to stop another person consuming them;

·         non-rejectable – people cannot choose not to consume them even if they want to.

Purchasing power parityA method for calculating the correct value of a currency, which may differ from its current market value. It is helpful when comparing living standards in different countries, as it indicates the appropriate Exchange Rate to use when expressing incomes and prices in different countries in a common currency.
RecessionA measure of the value of money that removes the effect of inflation.
ReflationPolicies to pump up demand and thus boost the level of economic activity.
ReservesMoney in the hand, available to be used to meet planned future payments or if some other need arises. Firms may put their reserves in a Bank, as a deposit. For a bank, reserves are those deposits it retains rather than lending them out.
SecuritiesFinancial contracts, such as bonds, shares or derivatives, that grant the owner a stake in an asset. Such securities account for most of what is traded in the Financial Markets.
SeignorageTraditionally, the profit rulers made from allowing metals to be turned into coins. Now it refers in a loosely defined way to the power of a country whose notes and coins are held by another country as a reserve currency.
Social capitalThe amount of community spirit or trust that an economy has gluing it together. The more social capital there is, the more productive the economy will be.
StagflationTerm coined in the 1970s for the twin economic problems of stagnation and rising inflation.
Structural unemploymentThe hardest sort of unemployment to cure because it is caused by the structure of an economy rather than by changes in the economic cycle.
Tangible assetsAssets you can touch: buildings, machinery, GOLD, works of art, and so on.
TariffOften used to describe a tax on goods produced abroad imposed by the government of the country to which they are exported. Many countries have reduced such tariffs as part of the process of freeing up world trade.
Tax havenA country or designated zone that has low or no taxes, or highly secretive banks, and often a warm climate and sandy beaches, which make it attractive to foreigners bent on tax avoidance or even Tax evasion.
Transfer pricingThe prices assumed, for the purposes of calculating tax liability, to have been charged by one unit of a multinational company when selling to another (foreign) unit of the same firm.
Treasury billsA form of short-term Government Debt. They are used for managing fluctuations in the government’s short-run cash needs.
Unemployment trapWhen unemployed people who receive benefits, either from the government or from private charity, are deterred from taking a new job because the reduction or removal of benefit if they do will make them worse off.
Venture capitalPrivate Equity to help new companies grow. A valuable alternative source of finance for Entrepreneurs, who might otherwise have to rely on a loan from a probably risk averse bank manager.
Vertical equityOne way to keep taxation fair. Vertical equity is the principle that people with a greater ability to pay should hand over more tax to the Government than those with a lesser ability to pay.
VolatilityThe most widely accepted measure of risk in financial markets is the amount by which the price of a security swings up and down. The more volatile the price, the riskier is the security.
YieldThe annual income from a security, expressed as a percentage of the current market price of the security. The yield on a share is its dividend divided by its price. A bond yield is also known as its interest rate: the annual coupon divided by the market price.