Economic

Economic

EU ECONOMY
Economic System

Economic determinism is a theory for interpreting history which states that a society's economic system shapes its social, political, and religious institutions. The German social philosopher Karl Marx first fully devel­oped the theory in the mid-180o's, though other thinkers had introduced the idea earlier. It became one of the es­sential principles of his political philosophy, Marxism.

Marx rejected the idea that individuals, religion, or other factors cause political changes in society. Instead, he attempted to show that political changes result only from alterations in how a society produces and distrib­utes goods and services. For example, he believed the political systems of capitalistic countries resulted from the growth of factories and other economic develop­ments. Capitalistic countries include many European na­tions, the United States, and Canada.

Economic determinism also is related to Marx's the­ory of class struggle, which regards conflict between classes as inevitable. According to Marx, a society's eco­nomic system shapes its class structure. The class with the greatest economic power also possesses the great­est political power. Therefore, classes with little political strength can gain power only by changing the economic system.

See also Communism (Origins of Communism); Karl Marx.

The capitalist Economy

The distribution of money, goods, and services makes up the pattern of a capitalist economy.

The circle on the left illustrates how money flows from people to industry, and then back to the people. The circle on the right shows how people use their skills to produce goods and services. The finished goods and services then move from industry back to the people.

Economics is the social science concerned with the analysis of commercial activities and with how goods and services are produced. The field of economics studies how the things people need and want are made and brought to them. It also studies how people and na­tions choose the things they buy from among the many things they want.

                                   

In all countries, the resources used to produce goods and services are scarce. That is, no nation has enough farms, factories, or workers to produce everything that everyone would like. Money is also scarce. Few people have enough money to buy everything they want when they want it Therefore, people everywhere must choose the best possible way to use their resources and money. Children may have to choose whether to spend their al­lowance on a film or a hamburger. Shopkeepers may have to choose whether to take a summer holiday or to use their savings to buy more goods. A nation may have to choose whether to use tax-payers' money to build more roads or more submarines. In economic terms, the children, the shopkeepers, and the nation ali must economize in order to satisfy their most important needs and wants. This means they must try to use the resources they have to produce the things they most want.

Economists (specialists in economics) define econom­ics as the study of how goods and services get pro­duced and how they are distributed. By goods and serv­ices, economists mean everything that can be bought and sold. By produced, they mean the processing and making of goods and services. By distributed, they mean the way in which goods and services are divided among people.

Economics studies are usually divided into two kinds: macroeconomics and microeconomics. Macroeco­nomics is that part of economics which examines a com­plete economic system rather than individual sectors in it For example, a macroeconomic study of a nation would probably examine and analyse the gross national product (see Gross national product), national income, investment, employment, and money supply. It would look at the relationships between these important eco­nomic indicators and attempt to explain the changes which had taken place overtime.

With this information, economists are able to make predictions about what will happen if certain economic decisions are taken. These might be an increase in gov­ernment expenditure or a rise in interest rates.

A microeconomic study looks at an individual sector of the economy and the influences on it in great detail. The sector might be a group of consumers, a particular company, or commodity. A key objective of a microeco­nomic study is to find out how the decisions and activities of the consumer, company, or other unit being ex amined, affect the prices of a particular good or service.

A study of the commodity, rubber, for example, would look at the supply of it and the prices received by the producer for it and paid by the consumers (users). It would also look at any competitor to rubber, such as synthetic rubber, and its price. There is a price at which consumers would reduce their demand for rubber, and perhaps switch to an alternative. On the other hand, there is a price below which the producer cannot afford to sell rubber. If it goes down to a certain level, the pro­ducer will not be able to cover costs and will make a loss. The supply will then be stopped at least until the users are prepared to pay a price which covers the pro­ducer's costs and make a profit on which the producer can live and to meet new investment.

Econometrics, which is the use of mathematical and statistical analysis, is used in both macro- and microeco­nomic studies. See Econometrics.

Economic problems

Every nation must organize the production and distri­bution of goods and services wanted by its citizens. To do this, a nation's economic system must solve four basic problems: (1) What shall be produced? (2) How shall goods and services be produced? (3) Who shall get the goods and services? and (4) How fast shall the econ­omy grow?

What shall be produced? No nation can produce enough goods and services to satisfy all its people. But which goods and services are most important? Should land be used to rear animals or grow wheat? Should fac­tories be used to produce tractors, or television sets? How shall goods and services be produced? Should each family grow its own food and make its own cloth­ing? Or should special industries be developed to pro­vide these products? Should many workers be used in an industry'? Or should more machines be used instead?

Who shall get the goods and services? Should every­one have an equal share of goods and services? Which goods and services should go only to people who can afford to buy them? Which goods and services should be distributed in some other way?

How fast shall the economy grow? An economy grows when it produces more goods and services. A na­tion must decide what proportion of its scarce re­sources should be used to build factories and machines and provide more education, all of which will increase future production. How much of a nation's resources should be used to produce goods and services, such as food and clothing, for immediate use? In addition, the nation must decide how to avoid unemployment and other economic setbacks that waste resources.

How the economy grows

An economy must grow to provide people with an in­creasing standard of living— that is, more and better goods and services.

Making the economy grow. Four main elements make it possible for nations to produce goods and serv­ices. These elements, celled productive resources, are: (1) natural resources, (2) capital, (3) a labour force, and (4) technology. Economists define natural resources as all land and raw materials, such as minerals, water, and sunlight. Capital includes factories, tools, supplies, and equipment. Labour force means all people who work or are seeking work, and their education and skills. Tech­nology refers to scientific and business research and in­ventions.

In order to grow, a nation's economy must add to its productive resources. For example, a nation must use some of its resources to build factories, heavy equip­ment, and other capital goods. A nation also must de­velop additional natural resources, create new technolo­gies, and train scientists, workers, and business managers, who will direct future production. The knowl­edge of these people is known as human capita/.

Measuring economic growth. The value of all goods and services produced in any year makes up a nation's gross national product (see Cross national product). An economy's rate of growth is measured by the change in its gross national product over a period, usually year on year. In the period 1970 to 1988, the gross national products of different countries grew at widely different average rates, after adjustments were made for inflation. The following rates were achieved: the United Kingdom (UK) 2.2 per cent, the United States 2.9 per cent, Ireland 3.0 per cent, Australia 3.3 per cent, Canada 4.4 per cent, Malaysia 6.5 per cent, Singapore 8.0 per cent, and South Africa 9.2 per cent.

Another way of measuring a nation's economic growth is to study the standard of living of its people. To judge standard of living, economists sometimes divide a nation's total gross national product by its entire popula­tion. The resulting figure is called the per capita GNP. The per capita CNP of a nation is the value of goods and services each person would receive if all the goods and services produced in the nation that year were divided evenly among all the people. See Standard of living.

Kinds of economic systems

Different economic systems have developed because nations have never agreed on how to solve their basic economic problems. Three important economic systems today are (1) capitalism, (2) mixed economies, and (3) Communism. The economies of many countries include elements from several different economic systems.

Capitalism is the economic system of many coun­tries throughout the world. It is called capitalism be­cause an individual can own land and such capital as factories, buildings, and railways. Capitalism is also known as free enterprise because it allows people to carry out their economic activities largely free from gov­ernment control.

The Scottish economist Adam Smith first stated the principles of the capitalist system in the 1700's. Smith believed that governments should not interfere in most business affairs. Fie said the desire of business people to earn a profit, when regulated by competition, would work almost like an "invisible hand" to produce what consumers want. Smith's philosophy is known as laissez faire (noninterference). See Laissez faire.

Adam Smith's emphasis on individual economic free­dom still forms the basis of capitalism. But the growth and complexity of modern businesses, cities, and tech­nologies have led people to give the government more economic duties than Smith gave it.

Mixed economies involve more government control and planning than do capitalist economies. In a mixed economy, the government often owns and runs such im­portant industries as transport, electricity, gas, and water. Most other industries may be privately owned.

Businesses and the economy

Various kinds of businesses participate in the economy of capi­talist countries. They earn profits by selling the different goods and services that consumers need and want.

Communism, in its traditional form, is based on gov­ernment ownership of nearly ali productive resources and government control of all important economic activ­ity. Government planners make all decisions about pro­ducing, pricing, and distributing goods. However, in many countries where this system has been adopted, the economy has not prospered. In the mid-1980's,

China began to relax its governmental control over busi­ness activity and prices. In the late 1980's and early 1990's, governments rejecting Communist principles succeeded Communist governments in many Eastern European countries and the Soviet Union.

The capitalist economy

Every day, millions of men and women in capitalist countries work on farms and in factories and offices. They produce a vast wealth of goods and services. The governments do not tell the people where to work or what should be grown on the farms or where most of the factories should be built. Nor do the governments dictate what prices will be charged for most goods and services. Yet the work is done, the prices are set, and many people get the products they need.

For the most part, a capitalist economy runs by itself. That is, people act as consumers, workers and manag­ers. Individuals and private businesses, along with other institutions, make their own economic decisions. These decisions shape and are shaped by such economic forces as supply and demand, profits, markets, prices, competition, and the distribution of income.

Consumers are people who use goods and services. In a capitalist system, consumers jointly influence pro­duction by the things they choose to buy. Economists use the terms supply and demand to help explain how consumers influence production. Suppose, for example, that thousands of people begin to buy a new compact disc (CD). Record shops must order more copies of this CD from the company that makes it. The company pro­duces a larger supply of CD's because people have in­creased their demand for them. See Supply and de­mand.

Business and profits. Many kinds of businesses pro­duce the things consumers want. One person may own and operate a small business, such as a hairdressing salon or a petrol service station. Two or more people may form a partnership to carry on a business. Other businesses may be large companies, owned by many people. Some businesses produce goods, such as food or clothing. Others produce services, such as transpor­tation or TV shows.

The main goal of most businesses is to earn profits. Profits are earnings of a business over and above all costs. The cost of producing a suit includes the cost of the cloth, the wages of the workers who make the suit, the expense of buying tools and machinery, the cost of advertising the suit, and so on. The price of the suit must include all of these costs—as well as a profit for the company.

The profit motive influences executives to organize and operate their firms efficiently. By reducing waste of time or raw materials, a firm can lower its production costs. Lower costs mean higher profits. Executives help determine "how shall goods and services be produced?" by the way they organize production to make profits.

To make as big a profit as possible is not the only ob­jective of companies. Many economists believe that other objectives such as the achievement of maximum sales of a product, increasing the value of the company's assets, or being represented in as many countries as possible, are just as important to many companies. See Business; Profit.

Most hospitals, universities, charitable organizations, and many other institutions do not attempt to earn prof­its even though they supply goods and services that people want. Some of these nonprofit institutions sell their goods and services, and others give them away.

Markets, prices, and competition. Whenever goods and services are bought and sold, a market is cre­ated. A market may be a small local shop or a worldwide stock market. In large markets, most buyers and sellers never even see each other. They may conduct their busi­ness by telephone, telex, fax, or computer.

In a capitalist economy, market prices rise and fall as demand or supply increases and decreases. Suppose that 100,000 families want to buy new cars, but only 90,000 cars have been produced. The quantity de­manded is greater than the quantity supplied. Sellers might guess that many families would be willing to pay more for one of the limited number of cars. As a result, the sellers would raise the prices of cars. At the same time, manufacturers would begin to produce more cars in order to sell more and increase profits. Eventually, as more cars were produced, the quantity supplied would begin to catch up with the quantity demanded.

In a capitalist economy, businesses that provide simi­lar products compete with one another for buyers. As a result, businesses have to charge reasonable prices and keep quality high. For example, if a shop raises its price for a bag of sugar, its customers may choose to buy from a shop that offers the same amount of sugar at a lower price. Similarly, a business that offers consumers products of low quality may lose customers who prefer to buy products of higher quality from somewhere else.

Competition is so important in many capitalist econo­mies that the governments have passed many laws to enforce it. These laws prohibit agreements among sell­ers that interfere with competition. Some laws forbid most monopolies. In a monopoly, one company controls the supply of a particular product. Other laws prohibit most cartels and some trusts, which are combinations of businesses that control all or most of a particular indus­try. See Antitrust laws; Monopoly and competition; Cartel.

Distribution of incomes. Under capitalism, the amount of goods and services people can afford de­pends mainly on the size of the income they receive.

People earn income in a variety of ways. Most people receive income as wages or as salaries in exchange for , their work. Businesses receive income in the form of I profits, which belong to the owners. A company is owned by people who buy shares of stock and usually receive income in the form of dividends (see Stocks and shares; Capital). Owners of land and buildings receive rent Owners of bonds and savings accounts receive interest (see Interest). Many people benefit from govern­ment programmes and receive transfer income, such as social security and pension payments. The total amount | of all incomes received in a country is called the national income, In industrial countries, wages, salaries, and employee benefits usually make up about three- quarters of the national income.

Under capitalism, people earn income by producing the goods and services that consumers demand. The forces of supply and demand also influence the size of a person's income. For example, a firm would probably pay factory managers more money than it would pay un­skilled labourers. The firm pays managers more because the sales and profits of the firm depend to a large extent on the quality of the decisions the managers make. Man­agers are in shorter supply, so employers have to offer more money to attract such people.

In many industries, workers have joined together to try to increase their incomes. Through trade unions, workers bargain with employers to determine wages, hours of work, safety rules, and other conditions. Wage increases in such large industries as coal and steel can cause an increase in wages throughout the economy. Workers in some industries are protected by minimum wage laws, which set the smallest amount of money that an employer can pay a worker for doing an hour's worth of work.

In a free economy, private savings and investment have an important influence on economic growth. When people save part of their income, they spend less money on consumer goods and services. More money is then available for the construction of machines and factories. People who save may put money in banks, which lend to businesses. Or the savers may invest in stocks and bonds sold by corporations. In a capitalist system, "how fast shall the economy grow?" depends greatly on how much consumers and business companies save and in­vest. See Investment.

Government and the economy

Even under capitalism, the government takes part in many important economic activities. Capitalist govern­ments usually have four major roles. These governments (1) establish and enforce laws that affect economic activ­ity, (2) set up public service industries, (3) provide goods and services for the public, and (4) work for economic stability. Economists disagree on how far governments should go in carrying out each role.

Laws. Under capitalism, the people depend on the government to pass laws that ensure economic fair play. These laws aim at preventing individuals and companies from taking unfair advantage of each other, but do not always work very well.

In capitalist economies, many of the most important laws concern business competition. Other laws ban harmful or misleading advertising. Still others set stand­ards for proper working conditions, set minimum wages, and prohibit employers from refusing to hire people or lend money to them because of their race, sex, or age. In the 1970's and 1980's, many capitalist countries in Western Europe, for example, introduced regulations to protect the environment from further damage, particularly from pollutants.

Public utilities are companies that provide services essential to the public. These services often include electric power, water, gas, sewage, and telephone serv­ices. In many public utility businesses, competition would be wasteful.

Governments grant legal monopolies to public utility companies so they may operate without competition. But the prices and standards of service of most public utilities are usually strictly regulated by governments.

Public services. Central and local governments pro­vide many services that could not be furnished as well by private companies. These services include police and fire protection, schools, national defence, and roads. Governments also offer medical services, public hous­ing, and other economic aid to needy people.

All the goods and services provided by government make up the public sector of the economy. Govern­ments pay for most of the services that they provide with money they collect in taxes. There are many kinds of taxes. Individuals and corporations pay income taxes on their earnings. Consumers pay sales or value added taxes on many items they buy. See Taxation.

Economic stability. Sometimes a free market econ­omy rises to great heights of prosperity. At other times, it falls to low levels of production and employment. Peri­ods of above average business activity are called booms. Small declines in business activity are known as recessions. Lengthy and large drops are called depres­sions.

During a boom, total spending rises. Consumers de­mand many goods and services, and companies invest in new equipment that will increase production. But production cannot always keep up with consumer spending during a boom. If the supply of goods and services becomes smaller than the demand for them, a nation may experience a period of inflation (rising prices). If inflation becomes extreme, prices may rise so high that many people cannot afford products they need. See Inflation.

The economy does not grow at all during a recession or a depression. Total spending drops, production slows down, and people lose their jobs. See Depres­sion; Inflation; Recession.

Sometimes a government may use its own economic power to help check inflation and depression. During a depression, a government may spend more money on goods and services. It may build new public buildings or improve major roads. This additional government spending aims to create new jobs for unemployed peo­ple. Government spending also attempts to increase the general demand for goods and services. A government may also try to increase demand by cutting taxes so that the people have more money to spend. Inflation gener­ally occurs during a boom. A government may try to curb inflation by spending less money and, thus, reducing total demand. Or a government may try to reduce demand by raising taxes. Then people would have less money to spend on goods and services.

Government participation in the economy

In most capitalist economies, ail levels of government regulate business activities. These governments also provide public serv­ices that could not be furnished as well by private companies.

The world economy

Through world trade and finance, all nations depend on each other for many goods and services. Economists study economic relationships among nations. They look for ways to improve international trade. They also study the problems of developing countries in an effort to raise living standards in many parts of the world.

World trade. World production would be greater if each nation specialized in producing the goods it could provide most easily and imported the goods it found difficult and expensive to produce. Despite the advan­tages of world trade, nations have tried to limit imports and produce many of their own goods and services for hundreds of years. Many nations fear that specializing in a few products would make them too dependent on other countries. Some economists argue that a nation can increase employment and help avoid depressions by limiting imports and developing its own industries.

Nations use many methods to restrict trade. The two most important methods are         (1) tariffs and (2) import quotas. A tariff is a tax on imported goods. It raises the price of products from other countries. An import quota allows only a certain quantity of an item to be imported each year.

The United States, Japan, and many other nations have worked to increase world trade. In 1957, six Euro­pean nations formed the European Economic Commu­nity (EEC) to remove all trade barriers among themselves (see European Union). Many developing countries still use high tariffs to protect their industries. For more de­tailed information on world trade, see Exports and im­ports; International trade; Free trade; Tariff; Trade.

World finance. Trade within a country involves only one kind of currency, such as dollars in Australia or yen in Japan. Trade among countries may involve several kinds of currencies. For this reason, business firms and governments use an international system of banking and finance to exchange one kind of currency for another.

Suppose an Australian importer owes a Japanese manufacturer 1,000 yen for a shipment of Japanese mo­torbikes. The price in Australian dollars that the im­porter pays depends on the current exchange rate for Japanese yen. An exchange rate is the price of one cur­rency in terms of another kind of currency. See Ex­change rate.

Until the early 1970's, the governments of most na­tions specified the rate of exchange for their currencies. Sometimes governments devalued (lowered the value of) their money in an effort to increase foreign sales. But in the early 1970's, some nations adopted a system of floating exchange rates. Under this system, the price of a nation s currency rises and falls in relation to the world demand for it. For example, if the demand for British pounds falls, the price of the pound falls. See Devalua­tion.

Most nations keep records of their commercial and fi­nancial dealings with other nations. The total amount of goods and services plus money and gold that flow into and out of a country during a given period makes up the country's balance of payments. If a country pays out more money to other countries than it receives from other countries, it has a deficit in its balance of pay­ments. If a country receives more money than it spends, it has a surplus in its balance of payments.

Developing economies. About three-quarters of the world's people live in developing countries. Most such nations are in Africa, Asia, and Latin America. Conditions vary enormously among nations.

There are a number of problems which are common in developing countries. They may experience periods of extreme poverty or even famine. Often the distribu­tion of essential supplies is hindered by poor road and rail networks. There may be slum areas with poor hous­ing. Schools, medical centres and hospitals may be scarce. Inadequate family planning, together with gen­eral attitudes to the size of the family, results in high birth rates, so populations grow fast and create de­mands for food and housing which cannot be met.

Many of the richer industrial nations give aid to de­veloping countries. This may be technical assistance, help with educating the people, money to buy imports, or investment in new companies to employ local peo­ple. Help may be given from one nation to another or through international organizations.

The development of economics

Early beginnings. People have been interested in economic problems since earliest times. One of the ear­liest socio-economic systems (systems that involve both social and economic factors) was manoria/ism. Under the manorial system, landlords rented out land to ten­ants or employed people to do work on the land in re­turn for wages. This system still operates in some coun­tries today. Manorialism started at the end of the Roman Empire and became widespread in western Europe.

The first major theories about a nation's economy were not developed until the 1500's, the beginning of the period oi mercantilism. The mercantilists believed that a government should regulate economic activities to establish a favourable balance of trade. They said na­tions could increase money supply by exporting more products than they imported. See Mercantilism.

During the 1700's, a group of French writers known as physiocrats attacked mercantilism. The physiocrats be­lieved that governments should interfere less in eco­nomic life. They were the first economists to use the term laissez faire to mean noninterference by the gov­ernment. The physiocrats also began the first organized study of how economies work.

The classical economists. Most economists today consider Adam Smith to be the father of modern eco­nomics. Smith, a Scottish professor of philosophy, built on some of the ideas of the physiocrats. Smith's book The Wealth of Nations (1776) includes many ideas that economists still accept as the basis for private enter­prise. Smith believed that free competition and free trade help an economy grow. He said the government's main role in economic life should be to assure effective competition. Smith and his followers became known as classical economists.

Three British economists of the late 1700's and the 1800's wrote particularly influential works. David Ricardo published strong arguments for free trade among nations. Thomas Robert Malthus challenged some of Smith's ideas but developed others further. Malthus warned that if populations continued to grow, nations someday would not be able to produce enough to feed all the people. John Stuart Mill proposed that profits be divided more equally among employers and workers.

Karl Marx and Communism. Some writers dis­agreed with the idea that competition would lead to economic progress. The most influential was Karl Marx, a German philosopher of the 1800's. In his book Das Kapital [Capital], Marx interpreted human history as a struggle between the ruling class and the working class. He declared that free enterprise would lead to increas­ingly severe depressions, and eventually to a revolution by the workers. In the Communist Manifesto, Marx and his friend Friedrich Engels called for an economy in which the government would own most of the property. Marx's theories provided the basis for the development of Communism.

New solutions for old problems. During the late 1800's and the early 1900's, economists began to use sci­entific methods to study economic problems. In France, Leon Walras worked out a mathematical statement to show how each part of an economy is related to ail the other parts. Wesley Clair Mitchell, an American, urged economists to use statistics in testing their theories. Mitchell also studied booms and depressions.

The Great Depression of the 1930's caused econo­mists to seek a new explanation of depressions. John Maynard Keynes, a British economist, attacked the idea that free markets always lead to prosperity and full em­ployment. In The General Theory of Employment Inter­est and Money, Keynes suggested that governments could help end depressions by increasing their own spending.

During the 1960's and 1970's, a group of economists called monetarists rejected many of the theories of Keynes and his followers. Instead, the monetarists urged that governments increase the money supply at a con­stant rate to stabilize prices and promote economic growth. Milton Friedman, an American economist, be­came the leading spokesman for monetarism.

Research today generally centres on understanding the relationship between various parts of the economy. Economists base their findings on observation, on case studies, and on other methods of research. Many economists emphasize the use of mathematics and statistics in testing economic theories. Their method is known as econometrics. Economic analysis has been applied to many problems that seem unrelated to production, such as education, family life, and government. Whenever re­sources available to achieve an objective are limited, economic analysis may be useful.

Outline:

Economic Problems

How the economy grows

Making the economy grow, and Measuring economic growth

Kinds of economic system

Consumers, Business and profits, Markets, prices, and competition, and Distribution of incomes

Government and the economy

Laws,  Public utilities, Public services, and Economic stability

The world economy

World trade, World finance, and Developing economies

The development of economics

Early beginnings, The classical economists, Karl Marx and Communism, New solutions for old problems, and Research today.

Questions

How do supply and demand influence prices?

How do they in­fluence wages and salaries?

What is the meaning of (1) profit? (2) capital goods? (3) balance of payments?

What are the four basic problems of the economic system of a country?

Why is competition an important part of a capitalist economy? How do governments work to achieve economic stability?

What four main elements make production possible?

What are the three major economic systems?

What are the chief methods that nations use to restrict trade?

Who is the father of modern economics?