Understanding Economics: Key Concepts and Variables
Definition of Economics
Economics is the study of how society decides what to produce, how to produce it, and for whom to produce it, given the scarcity of available resources.
It is the science that deals with the management of scarce resources to produce goods and services and distribute them for consumption among members of society.
Microeconomics
Microeconomics studies the economic behavior of individual elements within an economy, such as the price of a good, its demand, the supply of a particular good, and consumer preferences.
Macroeconomics
Macroeconomics analyzes the economy as a whole, focusing on a country’s total output, money supply, level of imports and exports, unemployment and inflation rates, and government budget revenues and expenditures.
Economic Variables
Examples: price, quantity demanded of a good
Exogenous Variables
These are variables whose values are determined outside the model and then inserted into the model.
Example: drought in a market of goods, wars
Stock Variables
These variables relate to a specific point in time, with the reference to time serving as a historical fact.
Example: population, wealth
Flow Variables
These variables are meaningful and useful when referred to over a period of time.
Example: income and investment, a salary of $150,000 per month
Nominal Variables
Nominal variables are widely used in economics and are fundamental to understanding the impact of inflation. They are expressed in current monetary units, i.e., in the monetary units of the year in which they apply.
Real Variables
Real variables take into account changes in the general price level and are expressed in constant currencies for a base year.
Example: real wage vs. nominal wage.
The Economic Problem
Every society must solve three basic problems:
- What goods and services should be produced and in what quantities?
- How should these goods and services be produced?
- For whom should these goods and services be produced?
These three questions are universal because human needs and wants are almost unlimited, while all societies have limited resources to produce goods and services.
Different social arrangements attempt to answer these basic questions.
Pure Communism (Centralized Economy)
- Loss of freedom for the sake of common good.
- Production facilities are owned by the State.
- Rejects the concept of private property.
Pure Capitalism (Decentralized Economy)
- The individual drives society.
- The state plays a subsidiary role.
- The state intervenes only when necessary.
Production Decisions
What amount of goods and services are to be produced, including the quality and quantity of consumer goods and capital goods?
How to Produce
This refers to determining how to produce goods, also known as the technical problem. It involves choosing the method of production, technology, and resources used to develop the production process. The goal is to avoid waste and achieve the most efficient way to produce output at a minimum cost.
Distribution
Once production is determined, the problem of how to distribute goods and services among members of society must be solved. From the State’s perspective, this involves deciding how to divide the national product within the country.