Economy - Basics

What is an Economy ?

Economy is defined as wealth and resources of a country or region, esp. in terms of the production and consumption of goods and services.An economy consists of the economic systems of a country or other area - the labor, capital, and land resources; and the manufacturing, production, trade, distribution, and consumption of goods and services of that area.A given economy is the result of a process that involves its technological evolution, history and social organization, as well as its geography, natural resource endowment, and ecology, as a few of the main factors. 

Types of  Economies or Economic Systems 

There are many different kinds of economies around the world, but they all fall into two basic categories. One category is the command economy which is also called central planning. It has strong government control. The other type is the free market economy which is also called capitalistic economy. In this type of economy, there is very little government control. Currently, all real economies combine parts of capitalism with those of central planning. Each country around the world differs from one another in the amount they use the two systems. For example, the United States and Canada have economic systems that use very little government control so they are usually described as capitalistic.

Command economies have strong government control. So if you wanted to start your own business, you would have to get permission from the government. In a command economy, the government owns most of the industries and companies. One type of command economy is communism. True communism is a type of economic system that doesn't allow ownership of private property. Most of the command economies that existed in the world had strong central governments. These governments dictated how much was made and what was made by industry. The communists believed that life is a class struggle between workers and the owners of a industry or factory.In a communistic economy, goods were distributed on an as-needed-basis. In the command economy, the government makes the decisions as to what goods to supply to the people. The Soviet Union was an example of a communistic command economy. Many people think China is still a communist country. But they, and other countries like them, have given control over some of their economic activities back to the people. 

The other basic type of economy is the free market or capitalistic economy. It is an economy that has very little  government control. So if you wanted to start your own business, you would not have to get permission from the government. In a free market economy, the consumer decides what they want to buy. A consumer is a customer. The law of supply and demand is what drives the free market economy. Supply and demand is what sets the prices of goods and services in the free market economy. As supply goes up the prices go down. When the demand goes up the prices go up. Due to low government control, people are free to spend their money the way they want to. People can take the risk of starting their own business and losing money or starting their own business and making lots of money. People like James Ford Bell and Will Kellogg took risks in starting their own breakfast cereal businesses. Some examples of countries with a free market economy are The United States of America, Germany, and England.

 In the world today free market economies have social programs such as the Social Security Systems. Command economies like China are introducing free market economies into their economy. 

The basic and general economic systems are :

Market economy  ("hands off" systems, such as Laissez-faire capitalism)

Mixed economy  (a hybrid that blends some aspects of both market and planned economies)

Planned economy  ("hands on" systems, such as state socialism or state capitalism)

Traditional economy  (a generic term for older economic systems)

Command (Centrally Planned) Economic Systems: (a generic term for older economic systems)

Participatory economics (a system where the production and distribution of goods is guided by public participation)

Gift economy (where an exchange is made without any explicit agreement for immediate or future rewards)

 Barter economy (where goods and services are directly exchanged for other goods or services)

List of Economic Systems - Click Here  

An open economy is an economy in which there are economic activities between domestic community and outside, e.g. people, including businesses, can trade in goods and services with other people and businesses in the international community, and flow of funds as investment across the border. Trade can be in the form of managerial exchange, technology transfers, all kinds of goods and services. Although, there are certain exceptions that cannot be exchanged, like, railway services of a country cannot be traded with another to avail this service, a country has to produce its own. This contrasts with a closed economy in which international trade and finance cannot take place. No economy is totally open or closed in terms of trade restrictions, and all governments have varying degrees of control over movements of capital and labor. Degree of openness of an economy determines a government's freedom to pursue economic policies of its choice, and the susceptibility of the country to international economic cycles. In terms of the percentage of the GDP dependent on foreign trade, the UK is a more open economy than the US.

Closed Economy is an economy in which no activity is conducted with outside economies. A closed economy is self-sufficient, meaning that no imports are brought in and no exports are sent out. The goal is to provide consumers with everything that they need from within the economy's borders. A closed economy is the opposite of an open economy, in which a country will conduct trade with outside regions.

Sectors of Economy : 

A nation’s economy can be divided into various sectors to define the proportion of the population engaged in the activity sector. This categorization is seen as a continuum of distance from the natural environment. The continuum starts with the primary sector, which concerns itself with the utilization of raw materials from the earth such as agriculture and mining. From there, the distance from the raw materials of the earth increases.

Primary Sector

The primary sector of the economy extracts or harvests products from the earth. The primary sector includes the production of raw material and basic foods. Activities associated with the primary sector include agriculture (both subsistence and commercial), mining, forestry, farming, grazing, hunting and gathering, fishing, and quarrying. The packaging and processing of the raw material associated with this sector is also considered to be part of this sector.

In developed and developing countries, a decreasing proportion of workers are involved in the primary sector. About 3% of the U.S. labor force is engaged in primary sector activity today, while more than two-thirds of the labor force were primary sector workers in the mid-nineteenth century.

Secondary Sector

The secondary sector of the economy manufactures finished goods. All of manufacturing, processing, and construction lies within the secondary sector. Activities associated with the secondary sector include metal working and smelting, automobile production, textile production, chemical and engineering industries, aerospace manufacturing, energy utilities, engineering, breweries and bottlers, construction, and shipbuilding.

Tertiary Sector

The tertiary sector of the economy is the service industry. This sector provides services to the general population and to businesses. Activities associated with this sector include retail and wholesale sales, transportation and distribution, entertainment (movies, television, radio, music, theater, etc.), restaurants, clerical services, media, tourism, insurance, banking, health care, and law.

In most developed and developing countries, a growing proportion of workers are devoted to the tertiary sector. In developed countries like the U.S., more than 80% of the labor force are tertiary workers.

Quaternary Sector

The quaternary sector of the economy consists of intellectual activities. Activities associated with this sector include government, culture, libraries, scientific research, education, and information technology.

Quinary Sector

Some consider there to be a branch of the quaternary sector called the quinary sector, which includes the highest levels of decision making in a society or economy. This sector would include the top executives or officials in such fields as government, science, universities, nonprofit, healthcare, culture, and the media.

An Australian source relates that the quinary sector in Australia refers to domestic activities such as those performed by stay-at-home parents or homemakers. These activities are typically not measured by monetary amounts but it is important to recognize these activities in contribution to the economy.

Informal Economy or Informal Sector :

An informal economy is economic activity that is neither taxed nor monitored by a government, contrasted with a formal economy. The informal economy is thus not included in that government's Gross National Product (GNP). Although the informal economy is often associated with developing countries, all economic systems contain an informal economy in some proportion.The terms "under the table" and "off the books" typically refer to this type of economy. The term black market refers to a specific subset of the informal economy. The term "informal sector" was used in many earlier studies, and has been mostly replaced in more recent studies which use the newer term.

The two types of informal sector activities can be described as follows:

1. Coping strategies (survival activities): it includes barter of goods and services, mutual self-help, odd and casual jobs, temporary jobs, unpaid jobs, street trading, and other such direct sale activities,subsistence agriculture, multiple job holding.n less developed countries much of the work done by women is in the informal sector; this includes such activities as petty trading, small-scale agriculture, and crafts.

2. Unofficial earning strategies (illegality in business):
a) Unofficial business activities: tax evasion, avoidance of labor regulation and other government or institutional regulations, no registration of the company;
b) Underground activities: crime, corruption - activities not registered by statistical offices.

Ways to measure Economic Activity :

There are a number of ways to measure economic activity of a nation. These methods of measuring economic activity include:

Consumer spending
Exchange Rate
Gross domestic product
GDP per capita
GNP
Stock Market
Interest Rate
National Debt
Rate of Inflation
Unemployment
Balance of Trade

What is Economic Growth ?

Economic growth is  an increase in the capacity of an economy to produce goods and services, compared from one period of time to another . It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Economic growth can be measured in nominal terms, which include inflation, or in real terms, which are adjusted for inflation. For comparing one country's economic growth to another, GDP or GNP per capita should be used as these take into account population differences between countries.

What is GDP ?

Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time.Gross Domestic Product, is a primary indicator used to assess the strength of a country’s economy representing the total value of all the goods and services produced over a particular time frame. Normally, GDP is articulated as an evaluation to the preceding quarter or fiscal. It helps the foreign investors to assess the safety of their investments, popularly known as FDI – Foreign Direct Investments in overseas countries and may either fix caps in dealing or may safely stay from investing. It has a great bearing on the value of the overseas countries’ currency value vis-à-vis its own currency to determine the value of business likely to be obtained while dealing with other countries.

"Gross" means that GDP measures production regardless of the various uses to which that production can be put. Production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets. "Domestic" means that GDP measures production that takes place within the country's borders.

  GDP can be contrasted with gross national product (GNP) or gross national income (GNI). The difference is that GDP defines its scope according to location, while GNP defines its scope according to ownership.
 
Why Is the GDP Growth Rate Important?

The GDP growth rate is the most important indicator of economic health. If it's growing, so will business, jobs and personal income. If it's slowing down, then businesses will hold off investing in new purchases and hiring new employees, waiting to see if the economy will improve. This, in turn, can easily further depress the economy and consumers have less money to spend on purchases. When the economy is expanding, the GDP growth rate is positive. However, in a recession, the economy contracts. When that happens, the GDP growth rate is negative.

What is the GDP Growth Rate?

The GDP growth rate measures how fast the economy is growing. It does this by comparing one quarter of the country's economic output (Gross Domestic Product) to the last.The GDP growth rate is driven by the four components of GDP. By far, the most important driver of GDP growth is personal consumption, which is 70% of the total economic output. This includes retail sales. GDP growth is also driven by business investment, which includes construction and inventory levels. Government spending is another driver of growth, and is sometimes necessary to jump start the economy after a recession. Last, but not least, are exports and imports. Exports drive growth, but increases in imports have a negative impact.

How is GDP Calculated ?

GDP = private consumption + gross investment + government spending + (exports − imports)

GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net Exports (X – M).

Y = C + I + G + (X − M)

Description of each GDP component:

C (consumption) is normally the largest GDP component in the economy, consisting of private (household final consumption expenditure) in the economy. These personal expenditures fall under one of the following categories: durable goods, non-durable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses but does not include the purchase of new housing.

I (investment) includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Examples include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in Investment. In contrast to its colloquial meaning, 'Investment' in GDP does not mean purchases of financial products. Buying financial products is classed as 'saving', as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds or stocks is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products.

G (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.

X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.

M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.

What is Economic Development ?

Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area. Economic development can also be referred to as the quantitative and qualitative changes in the economy. Such actions can involve multiple areas including development of human capital, critical infrastructure, regional competitiveness, environmental sustainability, social inclusion, health, safety, literacy, and other initiatives.

Difference between Economic Growth and Economic Development :

 Economic development differs from economic growth.Economic development is a policy intervention endeavor with aims of economic and social well-being of people, economic growth is a phenomenon of market productivity and rise in GDP.

Economic Growth and Development

How Economy Works ?

An economy consists of all the wealth and resources of a society. Within this society, individuals and businesses interact daily--buying, selling, working and producing. Understanding how an economy works is a central task of economics, which studies how societies allocate scarce resources to satisfy wants and needs. Economists believe understanding the ways in which different societies allocate scarce resources helps to explain why some nations are prosperous and others are not. To explain how economics and economies work, economists rely on economic models, which represent in mathematical or graphic forms a simplified version of real-life economic activity.

A favourite model among economists for explaining how economies work is a circular flow diagram. This simplifies the overall economy by reducing it to two basic economic actors: consumers and companies. The circular flow depicts an ongoing process of buying and selling among these two classes. Companies use factors of production, or inputs, such as land, labour, and capital (production facilities and machinery, for example) to manufacture goods and services. They offer these products for sale, and consumers buy them. Meanwhile, consumers sell inputs, such as their labour, to companies, for which they receive money, which they then use to purchase the goods and services they want and need.