Economics: Principles and Applications
1.1 Introduction to Economics
The word “economy” originates from the Greek words “Oiko” and “nomos,” meaning “housekeeping” or “household management.” For centuries, economy referred to a set of rules for wise household management. In modern times, this idea has become intertwined with economic politics.
Classical economics defines the field as the study of wealth creation, distribution, and consumption to meet societal needs. Other perspectives emphasize prices and their fluctuations, or the management of scarce resources and choices.
A more general definition might be: Economics is the study of how individuals and society choose to employ scarce productive resources, which have alternative uses, to produce various goods over time and distribute them for consumption.
Modern economics primarily aims to describe, analyze, and explain the behavior of output, unemployment, and prices.
1.2 Methodology of Economic Science
Economics utilizes various scientific methods.
- Inductive Method: Derives general propositions from observations and analyses of individual behavior.
- Deductive Method: Starts with a general proposition to explain individual behavior, emphasizing the abstraction of typical economic elements.
The Classical School employed the deductive method. Following them, Carl Menger and Cournot also advocated for deduction in constructing general theories.
Both methods are necessary. We must begin by observing economic phenomena to formulate hypotheses and abstract laws. Then, using this scientific knowledge gained through induction, we can build further.
Constructing an economic theory involves three stages:
- Observation of economic phenomena.
- Establishment of hypotheses.
- Verification of hypotheses.
1.3 The Problem of Scarcity
Scarcity, the central problem of every society, implies limited or low availability of economic resources. These resources encompass various types of labor, capital, land, businesses, and organizations used to produce goods and services.
Due to scarcity, all societies face these fundamental questions:
- What to produce?
- How to produce?
- For whom to produce?
- How to rationalize products over time?
- How to maintain and grow the system?
In a free enterprise economy, the price mechanism addresses these questions. In a mixed economy, the government sometimes modifies or replaces the price mechanism’s role in maximizing social good. In a centralized economy, a planning committee decides what, how, and how much to produce.
Regarding the fourth question, society must determine the optimal resource utilization and plan its rationalization over time. For the fifth, the economic system must be flexible and adaptable to changes.
2.1 Economic Systems
An economic system encompasses the legal institutions and social forms that organize economic activity, determining how it is performed and what motivates the agents involved.
2.1.1 Socialist Directed Economy
In this system, the state dictates a single economic plan. A higher authority decides how to satisfy the group’s needs. Production techniques replace free enterprise, and technicians replace entrepreneurs.
Administrative assessments replace market prices and currency calculations. The state determines production planning, costs, means of production values, and prices of goods and services. While this system avoids the costs of competition, it ignores consumer preferences and is difficult to implement fully.
2.2 Capitalist Undirected Economy
Here, the state plays a minimal role, primarily maintaining order and allowing private initiative to address social and economic needs. This market-driven system grants freedom to producers and consumers in economic decision-making.
There is freedom in the production of goods and factors of production. Profit motivates production. Consumers choose their expenditures, and employers hire factors of production based on remuneration. Private property of the means of production characterizes the legal structure.
2.3 Microeconomic Theory
Microeconomics studies the flow of goods and services from firms to households. This exchange between production and consumption units generates the national product. The circular flow of money between firms and households constitutes the circular flow of income.
2.4 Macroeconomic Theory
Macroeconomics examines economic activity at the aggregate level, including total product, national income, total employment, and the general price level. It also studies national income distribution, aggregate demand, and total production (national product).
3.1 The Company
A company, a coordinated set of production factors under the employer’s direction, control, and responsibility, primarily aims to produce and maximize profit. Its key characteristics are:
- Existence of private wealth.
- Employer responsibility for the unit.
- Profit as the primary goal.
- Operation in a free market.
Production enhances the usefulness of economic goods. Companies, the economic units of production, create tangible goods (e.g., manufactured products) and intangible goods (e.g., services).
3.2 Company Methodology
This methodology focuses on operations, with typical applications including:
- Existence Problems: Determining acquisition quantities based on demand or purchase frequency when availability is limited.
- Assignment Problems: Allocating resources to jobs when resources are insufficient for optimal completion of each job.
- Queue Problems: Determining the number of services needed or scheduling tasks to minimize losses.
- Sequence Problems: Determining the order of tasks.
- Routing Problems: Finding the shortest path through a network.
- Replenishment Problems: Determining when to replace equipment or facilities.
3.3 Principles of Business
3.3.1 Productivity
Productivity (Output/Input) is the relationship between output and resources used. Output is the work done per unit of time. Labor efficiency is the ratio of output to employees. Key inputs include human labor, technical equipment, and manufacturing processes.
3.3.2 Economy
A company operates economically when it achieves a given production level with minimal resource use. This involves selecting and optimally combining factors of production. Substitution among factors is often possible (e.g., machine labor for manual labor).
Economy can be expressed as the ratio of the most favorable cost situation to the actual cost incurred (Anticipated Expenses / Actual Costs).
3.3.3 Profitability
Profitability is the relationship between profit and capital. Profit is the difference between income and expenses. A positive difference indicates a profit, while a negative difference represents a loss. Expenses are the value of consumed goods.
Return on capital is the ratio of profit to average capital available. Capital types include:
- Nominal Value: Initial stock price.
- Actual Value: Nominal value plus distributed profit per share.
- Total Capital: Equity capital plus other capital.
Profitability = Profit / Capital
4.1 Fixed Assets
Fixed assets (fixed capital) are the equipment and facilities necessary for a company’s operations. They influence productivity and comprise fixed costs, variable costs, and total costs.
4.2 Working Capital
Working capital, or circulating capital, enables business operations, such as purchasing raw materials and paying workers. The manufacturing process transforms these inputs into a product sold in the market to recover the investment and generate profit.
The speed of capital turnover is crucial. Assets generate profit, so more cycles lead to higher profits.