If you’ve ever nodded during a conversation that includes the words “stock market”, “inflation” or “GDP” without really knowing what those terms truly mean and how they work, it’s alright- and you’re not the only one! For a salesperson, the term, “CRM” is part of their everyday jargon. For a doctor, it would be “MRI” and for economists, it’s terms like the ones I’ve mentioned above. Although we don’t find the immediate need to learn doctor or sales terms, every person needs to know some important terms in economics, because financial literacy is something that directly impacts our short-term and long-term lives. According to Bank of America, only 16% of Americans (aged 18-26) are confident about their financial future. 43% of the American population is still currently financially illiterate.
What Is Economics?
Some say it’s got everything to do with money and how much money a country earns. Others say it’s about people and how the country grows. But the most accurate definition would be- economics is the study of people and how they use their resources. It’s classified as a social science. The basic concepts in economics include consumption, production and distribution.
What’s Supply And Demand?
In simple terms, supply means the things you produce, and demand means how much people want what’s being produced. “Equilibrium” is where supply is equal to demand, but that’s a very idealistic concept. Supply and demand is as predictable as the weather. The changes in supply and demand, along with their consequences often determine how the economy performs. Here are some key concepts in supply and demand:
· If prices go high, the demand goes low (not everyone can afford to buy over-priced items in large quantities)
· When demand is low, supply increases (supply as in- not the amount supplied, but the things produced. People will try to push their product, because no one is buying it)
· Low supply and high demand means increased prices (the cost of producing products to meet demands would be high, and people would also be ready to pay the price to get the in-demand product)
What Is Demand Elasticity?
This entire supply-demand dynamic in economics was what led to the infamous “historic oil crash”, when countries over-supplied oil, leading to low demand and low prices, which meant losses for the suppliers. Demand elasticity is when the demand for something increases with time and interest, affecting the supply and the prices. There’s no elasticity for demand for products like shampoo or bread, for example (they’re called Giffen goods). But there can be sudden highs or lows for demand for products like Hanna Montana themed clothing and stationery items. There are some items, however, that defy this concept. Items like gold or designer items can have high prices, high supply and high demand (they’re called Veblen goods)! They’re not as essential as shampoo, but they’re not elastic, either. For an investor, it’s important to know if an increase in demand is temporary, or if a low supply truly does mean high demand (and not the fact that the product is simply bad and that’s why no one wants it, even if it was as cheap). If something truly and consistently is in demand and sells at a higher price, then a higher supply would be ideal. You can’t expect to sell a lot of hand sanitizer after the Cornavirus pandemic is over and done with!
What Is Trading?
The Psychology Behind Trading
Essentially, trading means to give or take goods at a specified price. For successful trading or to study trading, you need to understand human behavior. That’s why economics falls into a social science, as it focuses a lot on behavioral psychology to understand and predict people’s actions in the trading market. After all, the entire market is driven by human decisions.
The Stock Market: Explained
When you start a business, you need money. The ideal situation is that the investor would use all their own money to start their business. In reality, they often borrow from banks or use investors. Even established businesses “go public”. This means offering people to invest in a small portion of their company. These people are called “shareholders” Whatever the business earns, you also get a small percentage of it. This small portion of their company is called the stock or the share.
The stock market is where these stocks are traded. This could be a physical place (auction style) or online, through online brokers. Brokers are the licensed third parties who carry out these transactions between investors and business owners. Brokers or online broker websites often offer financial advisory services as well. If you’re interested to know more about brokers, you can take a look at Best Online Brokers in 2020.
The stock-market is unpredictable. Prices fluctuate as product quality, revenue, demand or a company’s reputation change. If the company you’re investing in is facing losses or seems to be facing losses in the near future, people pull out their investments, leading to actual losses. However, losses and gains are part of the game, and a seasoned investor isn’t fazed by these small fluctuations and knows when to invest and when to pull out the investments. If you’re interested in being an investor, take a look at the 10 Mistakes First-Time Investors Make.
In economics, investment, buying, selling and even working (called labor) are all behaviors that lead to growth of an economy. This growth can be within businesses, and on a bigger scale- the growth of a country.
What’s Microeconomics and Macroeconomics?
As you must have figured out, economics can be complicated. It’s the study of all kinds of behaviors that lead to growth or recession in more ways than one. There are two main branches of economics:
Since the economy is driven by human behavior and human decisions, microeconomics studies this behavior. Economics doesn’t predict anything, but it gives us the wisdom to understand the economy and make sound decisions. One of the main concepts of microeconomics is that the economy is driven by the human psyche that is dictated by unlimited desires with limited resources. A huge part of microeconomics just focuses supply and consumer behavior- if you can understand that, then you can understand demand, supply and price fluctuations. When you choose one product over another, you’re picking one with a higher value and lower loss (in money or any sort of benefit). The “lower loss” is also known as an “opportunity cost”. Again, understanding opportunity cost can lead to sound business decisions.
Microeconomic models aim to increase efficiency and get as close as possible to bridging the gap between the endless needs and limited resources- for example, how could a company maximize their output with the least input, so they get most profit?
While microeconomics looks at the finer details of economic movements, macroeconomics studies the economy on a larger scale- regional, national or global. The overall growth and behavior of an entire region or country gives us a bird’s eye view of the bigger impact of the economy. Key concepts in macroeconomics include GDP, inflation, fiscal deficit and unemployment rates.
Macroeconomics is vital- it lets the government recognize when and where to take action- whether it’s loans or increasing or decreasing interest rates. Such actions help in leading the overall economy in the right direction, so that it grows. In this field, there’s no examining behavior, running surveys or experiments or any such experimental socio-economic measure. Decisions are made, based on the success and failures of previous decisions. Sometimes, unique situations arise (like a recession) and well-calculated polices are rolled out to address issues, which are usually hard to tackle with. An example of such an issue could be low income for teachers, and some countries have introduced policies to increase the pay for teachers. This goes into “labor economics”.
What Is Labor Economics?
In the push and pull of supply and demand and the consumers, there’s another force involved on the supply side, and that force is called “labor”. Labor economics focuses on the relationship of employers with employees and the corporations and how various variables affect the growth of a company, or the entire economy. Factors involved in labor economics is wages, working conditions, unemployment rates, equal pay. Socio-economic factors like workplace productivity, employee incentives, cost-reward analysis all come into play. In the end, a stable, productive labor force on a bigger scale contributes to the overall growth of a country.
What is GDP?
It’s that term that’s most synonymous with economics and macroeconomics. GDP (Gross Domestic Product) is a measure that determines a country’s overall economy in terms of health, growth and size. It calculates the total market value of domestic goods and services produced annually. This helps in seeing the value of the goods and services in a country over a period of time.
How is GDP Measured, and What Can It Show us?
GDP is measured by adding everyone’s annual income and spend. Ideally, this should be almost equal. Other ways of measuring GDP is by measuring production, or adding total consumption, investment, exports and government spending.
By measuring GDP, we can see if the economy is expanding or contracting. The latter would mean that we’re spending or consuming more than we’re producing. GDP is a vital aspect macroeconomics, which aids the governments, investors or businesses to make informed financial decisions. However, GDP isn’t a predictor, and it can help you understand how last year’s GDP affected earnings, economic growth or the financial markets.
What is Inflation?
That’s right! And if you’ve heard the term inflation, you probably know it’s a bad thing. But let’s first get our facts right about inflation:
In a few words, inflation is the rate at which the prices increase. You must have heard your parents say that it cost them a quarter to buy eggs back in their day. Now, the prices are high, and that’s because of inflation. Inflation is also seen as the reduction of the value of currency, as you need to pay more to buy the same things. Governments actively work to keep a stable inflation rate, which is ideally 2%. One of the ways is increasing the interest rates.
What Causes Inflation?
Two things cause inflation- cost push or demand pull. A demand pull is when the demand is high, and the supply is inefficient. If everyone in town wants that same divine coffee from that same shop, they would be ready to pay a higher price for it. To cover the costs for the inefficient supply, the prices would still have to be high. As for a cost-push, the coffeeshop owners might need more equipment or may have to pay a higher wage for their employees, which would increase the prices so that they could cover the production costs.
How Harmful Are The Effects Of Inflation?
Inflation isn’t really that “bad”. That’s because it encourages people to spend more, since the value of money decreases. More spending means more growth. It’s only bad when prices rise too high, too soon, halting all economic activity. The opposite of inflation is “deflation”, which means lower prices- but even that’s a terrible idea, because deflation means poor growth, lower consumption, production and ultimately, a high unemployment rate.
A Really High GDP Is Bad. Really Bad.
If you think that the higher the GDP, the better- then you’re wrong. A higher GDP is surely good, and it leads to drops in unemployment. That’s good, right? But imagine the employment rate getting low, because there are no more vacancies. The supply side of the market would slow down. As we know, a high demand means a higher price, so a high demand for employees means a higher wage. A higher wage would lead to the companies covering costs by increasing prices of products or services- and there you have it- inflation! Another way a fast GDP causes inflation is by creating an “asset bubble”. Investors invest too much in the few opportunities they have which show great promise and value because of increased prices. When those investments start going downhill, they pull out their shares, businesses go into loss, supply goes low, and you’ve got inflation on your hands again. Therefore, a healthy GDP rate is around 2%. If an economy is growing too fast or too slow, it’s bad. That’s where the Federal Reserve, which is the nation’s central bank, comes in. It controls the growth by increasing the interest rates if the growth is too fast and decreasing them if it’s too slow.
You’re All Set!
Now that you are equipped with the knowledge about economics, you can be more confident in the financial world. If you have any more questions regarding finance or economics, feel free to reach out to us. We would love to help you!