MICROECONOMICS AND MACROECONOMICS
Functions of Money
The earliest form of trade was by barter. Barter is the exchange of one good or service for another without money. Barter works satisfactorily in very simple economies where there is little specialization and few different goods to trade, but for economies with greater specialization, money plays an important role in the exchange. It makes it easier for people to exchange. Today, money has three important functions: a medium of exchange, a store of value, and a measure of value.
A Medium of Exchange.Money economies differ from barter economies. In a barter economy you must find someone who has what you want. In a money economy people can sell what they have to anyone, then use the money to buy what they want. With money as a medium (means) of exchange, exchanging labour for goods and services is much easier.
A Store of Value.Money enables us to use the value of something that we sell today to make a purchase some time in the future. We save its buying power for future use. Money is completely liquid which means that it can be converted into goods and services without any inconvenience or cost.
A Measure of Value.Money indicates the relative value of e products and resources. In a barter system a product would have as many different prices as there are other products that could be exchanged for it. When money is used in exchange, each product or resource has a single money price. Money enables people to state the price of something in terms that everyone can understand. It is a unit of account. People can compare money prices to find the best value for what they are selling or buying. Again, money makes exchange easier.
So, we can say that money is anything that is generally accepted as payment in exchange for goods and services. It also serves as a standard of value, and a store of value.
Types of Money
Commodity Money.Our current monetary system has developed over hundreds of years. Money as a medium of exchange first came into human history in the form of commodities.
In the primitive or less organized societies, various kinds of commodities were used as money. People used such things for their money as tobacco, salt, shells, stones, etc. Precious metals - such as gold, silver, or copper - were the most popular forms of money. All the items that serve the functions of money are called commodity money. The commodity that served as money had intrinsic value, i.e. value in itself (e. g. if not used as money, tobacco could be smoked).
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By the nineteenth century, commodity money was almost exclusively limited to metals like silver and gold. These forms of money had intrinsic value, so there was no need for the government to guarantee its value. The quantity of money was regulated by the market through the supply and demand for gold or silver.
Fiat Money.The age of commodity money gave way to the age of paper money. In the course of history commodity money was first replaced by full-bodied paper money - paper certificates that were backed by gold or silver of equal value. Then the full-bodied paper money was replaced by certificates that were only partially backed by gold and silver. Finally, we arrived at our present system, in which paper money has no "backing" We use the so-called fiat money.
Fiat money is money that is accepted as a medium of exchange because of government decree. It has no intrinsic value as a commodity.
Coins and paper currency are always fiat money. It is of little value as a commodity, but it has its value as a medium of exchange. The government states that coins and paper currency are legal tender, which must be accepted for all debts, public and private.
Bank Money.Today is the age of bank money - cheques written on funds deposited in a bank or other financial institutions. Cheques are accepted in place of cash payment for many goods and services. Nowadays there are various innovations in the different forms of money. Credit cards and traveller cheques can be used for money transactions.
Purchasing Power of Money. Economists use the term purchasing (buying) power, or value, to describe the quantity and quality of goods and services one can buy with money. When prices increase, money cannot buy as much. Its purchasing power declines. When prices fall, the opposite occurs. Or, to put it another way, when prices rise, the value of money falls; when prices fall, its value rises. When the price level remains the same, we say that prices have been stable.
Inflation
A rise in the price level over a period of time is called inflation. If the rise in prices is very large and quick, the situation is known as hyperinflation. A fall in the price level over a period of time is called deflation. The value of money decreases during periods of inflation, and increases during periods of deflation. The situation when there is excessive demand for goods and services is called demand-pull inflation. Demand is excessive when people are willing and able to buy more output then the economy can produce.
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Demand-pull inflation is characterized as "too much money chasing too few services". When demand for goods and services increases faster than industry is able to satisfy that demand, prices increase.
A period of rising prices due to an increase in the cost of production is called cost-push inflation. Cost-push inflation may be caused by one of the following factors: costs, wages, and/or monopoly power.
Inflation affects people differently: some suffer, others benefit. Those, who most suffer from inflation, are people living on fixed incomes, savers, lenders, and businesses.
MICROECONOMICS AND MACROECONOMICS
Economics is the study of how people make choices to use scarce resources to satisfy their unlimited wants and needs.
Economic analysis is divided into two main branches: microeconomics and macroeconomics. Both are important in dealing with the problem of scarcity. Macroeconomics is one branch of economics that tries to explain how and why the economy grows and fluctuates over time.
The subject matter of macroeconomics is the performance of the economy in the aggregateand the underlying relationships between broad economic aggregates, and how those relationships alter over time. It is to be contrasted with microeconomics, which focuses primarily upon the rational decision-making processes of the individual unit. Macroeconomics is essential for good economic policy.
The other branch of economics is microeconomics – the study of the behaviour of individual consumers, firms, and markets. Microeconomics is concerned with how one market differs from another. Macroeconomics explains the determination of variables that microeconomics considers given. These variables include national income, the price level, and interest rates. Macroeconomics employs the basic ideas of microeconomics. When macroeconomists try to explain growth and fluctuations, they must look at the behaviour of consumers and firms, the organization of labour markets and industry.
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THE FACTORS OF PRODUCTION
Resources are basic elements used to produce goods and services.
Economists call all the resources that go into creating goods and services the factors of production.
The factors are natural, capital, human resources and entrepreneurship. Each factor of production has a place in an economic system, and each has an important function.
Natural Resources or Land. Natural resources are what nature provides to create goods and services. They include minerals, the soil, water, timber, wildlife and air. Economists also use the term land when they speak of natural resources as a factor of production.
The price paid for the use of land is called rent. Rent is income to the owner of the land.
Human Resources or Labour. Physical and mental effort of people in the production of goods and services are called labour or human resources.
The price paid for the use of labour is called wages. Wages are income to workers, who own their labour.
Capital resources represent human creations that are used to produce goods and services. There are two kinds of capital: human and physical. Human capital consists of the individual knowledge, talents and skills that people acquire. Physical capital is something which people create to produce other goods and services. Factories, tools, buildings, equipment, machines, roads, etc. are physical capital resources.
Payment for the use of someone else's money is called interest.
Some economists include management or entrepreneurship on the list of productive resources. Entrepreneurship is the imagination, innovative thinking, management and organization skills which are needed to start and operate a business.
The reward to entrepreneurs for the risks, innovative ideas, and efforts that they have put into the business are profits.
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The science of economics
The science of economics is based upon the facts of our everyday lives. Economists study our everyday lives and the general life of our communities in order to understand the whole economic system of which we are part. They try to describe the facts of the economy in which we live, and to explain how it all works. The economist's methods should of course be strictly objective and scientific.
We need food, clothes and shelter. We probably would not go to work if we could satisfy these basic needs without working. But even when we have satisfied such basic needs, we may still want other things. Our lives might be more enjoyable if we had such things as radios, books and toys for the children. Human beings certainly have a wide and very complex range of wants. The science of economics is concerned with all our material needs: it is concerned with the desire to have a radio as well as the basic necessity of having enough food to eat.
Most people work to earn a living, and produce goods and services. Goods are either agricultural (like maize and milk) or manufactured (like cars and paper). Services are such things as education, medicine and commerce. Some people provide goods; some provide services, other people provide both goods and services. For example, in the same garage a man may buy a car or some service which helps him to maintain his car.
The work people do is called economic activity. All economic activities together make up the economic system of a town, a city, a country or the world. Such an economic system is the sum-total of what people do and what they want. The work people undertake either provides what they need or provides the money with which they can buy essential commodities. Of course, most people hope to earn enough money to buy commodities and services which are non-essential but which provide some particular personal satisfaction, like toys for children, visits to the cinema and books.
TYPES OF ECONOMIC SYSTEMS
The way a society answers three fundamental economic questions is known as its economic system. The economic system is the set of mechanisms and institutions that resolve the What, How, and Who questions. In other words, it is the way in which the economic activity in a country is organized. Economic systems generally fall into one of the following categories: traditional, command, market and mixed economies.
Traditional System. Traditional economic systems typically are found in remote countries. Such systems may characterize isolated tribes or groups, or even entire countries. People of traditional economic systems live in rural areas and engage in agriculture or other basic activities such as fishing or hunting.
The goods and services produced in traditional economies are usually those which have been produced for many years or even generations.
Command System. A command economy is an economic system characterized by centralized planning and public ownership of resources. A command economy differs from a market economy in two important ways:
1. In a command economy the state owns productive resources, including natural resources, land, factories, financial institutions, retail stores, etc. Private property and private enterprise are reduced to a minimum.
2. In a command economy resources are directed and production coordinated through some form of central planning rather than by market..
Thus, in a command economy, productive resources are usually owned by the government, which regulates all economic activities through a central plan.
Market System. A market economy is generally associated with private ownership of economic resources, free enterprise, and exchange of goods and services in markets.
Private property means that individuals and business firms have the rights to own the means of production. Although markets exist in traditional and command economies, the major means of production (such as firms, factories, farms and mines) typically are publicly owned. In a market economy anyone is free to use economic resources to start a business and sell a product in the market. Government's role is quite limited. The right of business owners to use private economic resources for whatever purpose they want is called freedom of enterprise.
In a market economy, firms themselves choose the most efficient production technique, guided by the price system. Market economies do not guarantee an equitable distribution of income. In this area planning has some advantages.
Mixed System. A mixed economy is an economic system which combines elements of public control of the means of production with private ownership. In a mixed economy the government and private sector cooperate in solving economic problems. The government controls production through taxation and orders for goods and services for the army, the police force, administration and other needs. In a mixed economy the government may also be a producer of goods.
Market
Economic activity occurs in markets. A market is a means by which buyers and sellers carry out exchange. It is a way in which they can do business together.
Economists define markets as mechanisms or systems for exchanging money for goods and services. Markets are often physical places suchas a supermarket. department store, or shopping mall.
Many market transactions are conducted without buyers and sellers actually meeting. For example, buyers can look through catalogues and then order goods by mail or telephone, without face-to-face contact with sellers. Others use their computers to shop on the Internet, where they can trade with people and businesses all over the world. They are still in a market because they are making exchanges.
Goods and services are bought and sold inproduct markets;resources are sold inresource markets. The most important resource market is thelabour market orjob market.
In a free market, competition takes place among sellers of the same commodity, and among those who wish to buy that commodity. Such competition influences the prices in the market. The price system basically operates on the principle that everything that exchanges - every good, every service and every resource - has its price. In a free market with many buyers and sellers, the prices of these things reflect the quantities that sellers want to sell and the quantities that buyers want to purchase. Prices fluctuate, and such fluctuations are affected by current supply and demand. Prices provide consumers and producers with the information they need to make economic decisions.
BANKING
Banks are institutions dealing with money. In developed countries banking systems usually consist of a central bank, clearing banks and commercial banks.
The central bank is responsible for the monetary policy of the country. It also acts as the banker for the government and keeps the country’s reserves in gold and other currencies. It issues notes and coins, controls inflation and supervises all banking institutions in the country.
Clearing banks clear cheques and settle the difference in the banks’ accounts with central bank.
Commercial banks constitute the largest group of banks. They are usually limited companies which have the licence to accept deposits and to store and transfer money on behalf of their customers. Commercial banks are businesses rendering services to the general public and to companies at a profit. The main functions of these banks include accepting deposits, granting credits and transferring money. As for deposits they are kept on personal accounts (which may either be current or deposit) and on business accounts. Commercial banks also provide a variety of other financial and advisory services. These cover foreign exchange, foreign trade financing, insurance, pension funds, safe custody for valuables, mortgage loans, investment portfolio management, income tax management, factoring, leasing. Banks also handle the affairs of a deceased person and execute his or her will.
For these services banks charge fees and commissions. But the main part of the profit generated by commercial banks comes from credits extended to individual customers and to companies. A person or institution obtaining a loan must pay a price for it – interest. When calculating interest rates banks must consider not only their profits but also inflation and competition from other banks. On the other hand, when granting loans banks must also assess the creditworthiness of the borrower. Remember that because of bad loans a bank may go bankrupt!
BUDGETS
A budget is a financial plan. Specifically, a budget sets forth management's expectations for revenues and, based on those financial expectations, allocates the use of specific resources throughout the firm. You may live under a carefully constructed budget of your own. A business operates in the same way. A budget becomes the primary basis and guide for financial operations in the firm.
Most firms compile yearly budgets from short-term and long-term financial forecasts. There are usually several budgets established in a firm:
• An operating budget
• A capital budget
• A cash budget
• A master budget
An operating budget is the projection of dollar allocations to various costs and expenses needed to run or operate the business, given projected revenues. How much the firm will spend on supplies, travel, rent, advertising, salaries, and so forth is determined in the operating budget.
A capital budget highlights the firm's spending plans for assets whose returns are expected to occur over an extended period of time (more than one year). The capital budget primarily concerns itself with the purchase of such assets as property, buildings, and equipment.
A cash budget is the projected cash balance at the end of a given period (for example monthly, quarterly). Cash budgets can be important guidelines that assist managers in anticipating borrowing, debt repayment, cash disbursements, and short-term investment expectations. Cash budgets are often the last budgets that are prepared.
A master budget ties in all the above-mentioned budgets and summarizes the proposed financial activities of the firm. Clearly, financial planning plays an important role in the operations of the firm. This planning often determines what long-term investment to make, when specific funds will be needed, and how the funds will be generated.
Once a company has projected its short-term and long-term financial needs and established budgets to show how funds will be allocated, the final step in financial planning is to establish financial controls.
Supply and demand
Supply and demand is perhaps one of the most fundamental concepts of economics
Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price.
Price, therefore, is a reflection of supply and demand.
In market economy theories, demand and supply theory will allocate resources in the most efficient way possible.
The four basic laws of supply and demand are:
1. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and quantity.
2. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and quantity.
3. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
4. If supply decreases and demand remains unchanged, then it leads to higher price and lower quantity.
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