What makes an economy change? The reasons why the direction of markets change, countries prosper or fall behind, and businesses find success can all be explained by understanding the rules of economics. A paper focusing on the entire scope of economic reasoning would be a frightening read, however, in this paper, I will describe principles of economics and how it relates to macroeconomics. These principles will encompass reasoning on how economists are both scientists and policymakers. We will also address what principles society uses to allocate scarce resources. This paper will also address the circular flow model along with, explain the flow of money and goods in an economy. I will address how the economy organizes society’s independent economic players. And finally, we will look at how a countries’ GDP is defined and calculated, along with what is included in the calculation of the consumer price index.
How economists are both scientists and policymakers
Economists can fill the role of both Scientists and Policymakers. An economist dedicates a substantial amount of time working in a way that closely relates to the work of a scientist. They both apply the scientific method in collecting and analyzing data along with verifying assumed economic concepts (Chetty, 2013). An economist can test their subject by implementing the same scientific methods that a scientist would employ, use theories and data then analyzing the information collected to verify. When economists are called upon to explain current world events and reasoning behind the status of markets, here we see that economists are fulfilling the role of a scientist. When the economist is asked to develop strategies to improve the economic outcomes of a marketplace, they are conducting themselves as policymakers.
The circular flow model, how the flow of money and goods move in an economy.
The economy depends on the population of its market to earn an income that can be exchanged for products or services that are offered by from people, businesses, an institution. The circular flow chart illustrates the transfer of money from individual households into the economy for the acquisition of goods and services from the market (Beggs, 2016). The flow chart first depicts income earned by the household that was received from work. Households then spend this money and redistribute it into the market when they go to the department store and buy clothing for the dwellers of the household. The money received by the department store does not stay stationary, the store then takes the money to payback the suppliers of the items sold, pay the overhead of operation such as rent, utilities, or for the use of paying employee wages. Once the department store reallocates the money by placing it back into the market, the business is able to continue operation and provide jobs that deliver income to their employees. This cycle continues in the same applicable order.
How the economy coordinates society’s independent economic actors
Economists use the price system to manage society’s independent economic players. The price system creates economic stimulation by coordinating the actions of consumers and producers, of the goods and services provided. Suppliers in a market who have previous communication with one and other are led by the price system to deliver on each other’s requests. In today’s economy, a consumer is able to purchase goods that they have never previously bought because of the price system, or because they were produced by an agent that the consumer was unaware of. The price system coordinates all of the main economic actors in the within the market. Economies have three major participants households, firms, and governments. In economics, households are important because they generate the need for goods and services from the market, and provide resources, labor, and land into the resource markets (Baumol, 2011). Each household is a single decision maker, economists assume that these decision makers will always attempt to exploit their utility. Thus, to effectively achieve maximum utility households use their resources such as capital and labor. Firms are economic actors that comprise of investors and entrepreneurs who deploy resources to manufacture goods or provide services in order to sell for money within the market. A firm must follow practices that lead maximum profit at a minimum cost to produce a good most efficiently. Distribution of goods is a major function of organizations that determine the efficiency of the product.
The Governments role is to implement policies that influence these actors. The government will analyze the economy and implement policies that are either targeted to be equal or most efficient. The differences between efficiency and equality are that to provide an equal benefit it should aim to distribute evenly amongst the target group, being efficient would utilize scarce resources be used to provide maximum benefit to the target group as a whole.
A country’s gross domestic product (GDP) and how it is defined and calculated
When analyzing the health of an economy in entirety the GDP is a common tool used. Gross domestic product measures an economy by adding the total value of all goods and services produced by the entire population of that country and organizations operating within the country. Regardless if producers are internationally owned, if work is being conducted within the borders of the country, their production is counted into the overall GDP of the country where work is being done. According to Mankiw “GDP measures two things at once: the total income of everyone in the economy and the total expenditure on the economy’s output of goods and services. GDP can perform the trick of the measuring both total income and total expenditure because the two things are the same” (Mankiw, 2015). The GDP formula is set up like this: GDP= private consumption + gross investment + government investment + government spending + (exports-imports). This calculation is done for a to specify specific periods, such annually or quarterly, and provides the most accurate depiction of the health of the economy.
The consumer price index an imperfect measurement of the cost of living.
The consumer price index is also another important calculation used when analyzing the economy. The CPI accounts for the total amount of money that is expended on goods and services purchased by the standard consumer in that economy. The CPI is frequently calculated and is often discussed in media outlets, an example would be the cost of gasoline. The CPI calculates price changes from year to year on items to show the inflation rate. To calculate the CPI, one would put together a standard market basket and determine the cost of that basket over several years. You would take the cost of that basket in a given year and divide that by the cost of the basket from a year determined to be the base, then multiply the result by 100. This result of this calculation gives you the CPI. The CPI is constructed by comparing the difference of price of a fixed basket of goods in an economy between different time periods, the basket can consist of goods such as groceries. The CPI is not a perfect measurement of the cost of living, it is susceptible to unmeasured quality changes, substitution bias, and the introduction of new goods. The CPI was a cost of goods index, however, over time, the U.S. Congress embraced the view that the CPI should reflect changes in the cost to maintain a constant standard of living (Kaifosh, 2016).
Economists are both scientists and policymakers on matters regarding economic factors, and they dedicate ample in researching factors that affect the economy. The constant cycle and rate of the economy are kept up by the continuity of households buying goods and services and allowing firms to pay employee wages and produce products which in turn places that money back in the hands of the household. Economists use measurable results to view the changes in an economy such as GDP and measurable with the CPI.