English Economics

Money in an Economic System Money facilitates market activities and is necessary for complex market systems. With money, people can avoid the problems associated with coincidence of wants. Among, these problems is the pricing of commodities. Prices stated in terms of all possible trading goods makes it difficult to determine what anything costs. In barter economies hours are spent in negotiating for even simple transactions, these hours are resources that could have been spent on other activities (therefore the hours of negotiations are the opportunity cost of a money economy). The functions of money include; (1) medium of exchange, (2) store9 of value, and (3) a measure of worth, because money is acceptable as a form of payment for all commodities, barter is no longer needed. Money can be easily stored in a tin can or bank account, so commodities need not be stored and can be purchased when needed. Because money is acceptable in virtually all transactions, prices can be stated in terms of dollars or yen thereby simplifying transactions substantially. In other words, money is the grease that lubricates any complex economic system. Fiat money is what is common in modern economic systems. Fiat money is moneythat is defined as legal tender by either a government or some organization with the authority to define legal tender. In the United States, the Federal Reserve System issues Federal Reserve Notes, which serve as the legal tender for the United States. The currency used here is backed by nothing except the faith of the general public that this money will be acceptable by everyone else with whom you could have an economic transaction. President Nixon in 1971 took the United States off of the gold standard. Up to that point of time the value of the dollar was expressed in some fixed ratio to the Commodity – gold. The end result was the dollar had become seriously over-valued, Land something had to be done so that American exports could resume to our trading partners. When the U.S. abandoned the gold standard gold went from less than forty dollars an ounce, to over $1000 an ounce in a matter of weeks, thus illustrating the folly of pegging one’s currency to the value of some commodity. Fiat money is not a new idea. Some European historians identify the first use of fiat money in Europe resulting from gold and silver smiths issuing their customers receipts for gold or silver left in their care. The receipts were commands over that gold and silver and began to trade as easily as the commodity itself, to the extent that the parties to the transaction knew of the smith and the note bearer. This trade in receipts dates back to the mid-fifteenth century. Hence, in this case the value of money is based on some mutual trust between the principles to these transactions. The first recorded use of fiat money, however, dates to three hundred years earlier in Asia. Because of the shortage of gold and silver to run the Mongol Empire, Genghis Kahn began to issue orders, in writing, that the written order was to be given deference as a specific amount of gold or silver. Genghis was known to be a nonsense sort of guy, and the violation of his decrees were clearly unhealthy acts. Therefore these orders were the first fiat money recorded in history, and not backed by anything save the martialmight of the Mongol Army. Perhaps, in retrospect, it is better that currency be acceptable on economic grounds than under threat of violence from a government.

Introduction to Economics Economists have developedthe terminology to describe economic issues.This terminology is important because if you are going to talk about the state of the economy, you need the terminology to do it. Shareholder, GDP, GNP, capital, supply and demand, costs, benefits, exchange rate are just a few of the terms the meaning of which any educated person in modern society needs to know. Two terms to be introduced to you immediately are the economy and economics. The economy is the institutional structure through which individuals in a society coordinate their diverse wants or desires. Economics is the study of the economy. That is, economics is the study of how human beings in a society coordinate their wants and desires. An economic institution is a physical or mental structure that significantly influences economic decisions. Corporations, governments, and cultural norms are all economic institutions. Many economic institutions have social, political, and religious dimensions. For example, your job often influences your social standing. In addition, many social institutions, such as family, have economic functions. If any institution significantly affects economic decisions, it can be considered as an economic institution. Even cultural norms can affect economies. A cultural norm is a standard people use when they determine whether a particular activity or behavior is acceptable. Learning economic reasoning means learning how to think as an economist. People trained in economics think in a certain way. They analyze everything critically. Having put their emotions aside, they compare the costs and the benefits of every issue and make decisions.

Markets A market is nothing more or less than the locus of exchange it is not necessarily a place, but simply buyers and sellers coming together for transactions. Transactions occur because consumers and suppliers are able to purchase and sell at a price that is determined through the free interaction of demand and supply. Adam Smith, in the Wealth of Nations, described markets as almost mystical things. He wrote that the interaction of supply and demand "as though moved by an invisible hand" would determine the price and the quantity of a good exchanged. In fact, there is nothing mystical about markets. If competitive, a market will always satisfy those consumers willing and able to pay the market price and provide suppliers with the opportunity to sell their wares at the market price. To understand the market, one need only understand the ideas of supply and demand and how they interact. Demand. The law of demand is a principle of economics because it has been consistently observed and predicts1 consumers’ behavior accurately. The law of demand states that as price increases (decreases) consumers will purchase less (more) of the specific commodity, ceteris paribus. In other words, there is an inverse relationship between the quantity demanded and the price of a particular commodity. This law of demand is a general rule. Most people behave this way, they buy more the lower the price. However, everyone knows of a specific individual who may not behave as predicted by the law of demand, but remember the fallacy of composition because an individual or small groupbehaves contrary to the law of demand does not negate it. The demand schedule (demand curve)reflects the law of demand. The demand curve is a downward sloping function (reflecting the inverse relationship of price to quantity demanded) and is a schedule of the quantity demanded at each and every price. As price falls from P1 to P2 the quantity demanded increases from Q1 to Q2. This is a negative relation between price and quantity, hence the negative slope of the demand schedule; as predicted by the law of demand. Consumers obtain utility from the consumption of commodities. Economists have long recognized that past some point, the consumption of additional units of a commodity bring consumers less and less utility. The change in utility derived from the consumption of one more unit of a commodity is called marginal30 utility. The idea that utility with the amount added to total utility will decline when additional units are consumed past some point has also the status of principle. This principle is called diminishing marginal utility. Because consumers make rational choices, that is they act in their own self interest, there are two effects that follow from their attempts to maximize their well-being when the price of a commodity changes. These two effects are called the; (1) income effect, and (2) the substitution effect.Together these effects guarantee a downward sloping demand curve. The income effect is the fact that as a person's income increases (or the price of item goes down [which effectively increases command over goods] more of everything will be demanded. The income effect suggest that as income goes down (price increases) then less of the commodity will be purchased. The substitution effect is the fact that as the price of a commodity increases, consumers will buy less of it and more of other commodities. In other words, a consumer will attempt to substitute other goods for the commodity that became more expensive. The substitution effect simply reinforces the idea of a downward sloping demand curve. The demand schedule can be expressed as a table of price and quantity data, a series of equations, or in a downward sloping graph.To this point, our discussion has focused on individuals and their behavior. Assuming that at least a significant majority ofconsumers are rational, it is a simple matter to obtain a market demand curve. One needs only to sum all of the quantities demanded by individuals at each price to obtain the market demand curve. Changes in the price of a commodity causes movements along the demand curve; such movements are called changes in the quantity demanded. If price decreases, then we move down and to the right along the demand curve; this is an increase in the quantity demanded. If price increases, then we move upward and to left along the demand curve, this is a decrease in the quantity demanded. Remember, (it is important) such changes are called changes in the quantity demanded because the demand curve is a schedule of the quantities demanded at each price. Movements of the demand curve itself, either to the left or right are called changes in demand. A change in demand is caused by a change in one or more of the nonprice determinants of demand. A shift to the right of the demand curve is called an increase in demand; and ashift to the left of the demand curve is called a decrease in demand. The nonprice determinants of demand are; (1) tastes and preferences of consumers, (2) the of consumers, (3) the money incomes of consumers, (4) the prices of related goods, and (5) consumers' expectations concerning future availability or prices of the commodity If the tastes and preferences of consumers change they will shift the demand curve. If consumers find a commodity more desirable, ceteris paribus, then an increase in demand will be observed. If consumer tastes wane for a particular product then there will be a shift to the left of the demand (a decrease in demand). An increase in the number of consumers or their money income will result in a shift to the right of the demand curve (an increase in demand). A decrease in the number of consumers or their income will result in a shift of the demand curve toward the origin (a decrease in demand). Consumers will also react to expectations concerning future prices and availability. If consumers expect future prices to increase, their present demand curve will shift to the right; if consumers expect prices to fall then we will observe a decrease in current demand.