Economics 101 and 102

It is time to share some basic information on economic theory that most people have never heard let alone understand. You may be surprised to learn how the economy actually works. It is very different from what your media stars claim, or our elected officials.

First, there are two ways to view the economy. The first is micro economics. This is the economy of the individual or family or small business.

The second is macro economics. This is the economy on a national basis. It refers to a nation which makes its own decisions and sets its own economic policies, including printing money, managing currency, operating the national banking system, and much more. Think of it as a closed system. All individuals, families, and companies participate in the economic system but do not directly control it. Neither do states nor national regions exercise control over the system.

An important point needs to be made here. Most European nations operate within the European Union. This means that monetary and currency policies are shared among their nations and no one of them can act unilaterally without damaging the system. Witness Greece. Their fiscal policies destroyed their credibility in the minds of the rest of the European Union. Hence the other nations are in the position of bailing out Greece to maintain currency value of the Euro. Portugal and Spain pose a similar threat but of lesser severity. I mention the Common Market countries because they gave up some of their sovereignty to share unified trading markets and currency. The US retains entire control over its currency and economic policies.

Micro Economics describes how we earn income, pay living costs, save and invest. It teaches us how interest rates affect our choices and each other’s decisions as a result. The concept of market enters the picture which explains how relative values are developed for goods and services traded in the marketplace. The elements of compounded interest and investment gains are covered. The cost of debt and how it affects other financial components of the individual’s balance sheet is explained.

Explaining the economics of the ‘firm’ is usually based on a proprietorship or small company, not a large corporation. The latter has influence well beyond its walls which affect national economics and that is the province of ‘macro economics.’

Macro Economics is based on a large scale. Think of all income from all individuals taken together within the nation; also their tax payments to governments; their living costs taken en masse, the accumulative effect of millions of decisions made by individuals, what effects these have on overall pricing of goods, services, labor rates, interest rates and the supply and demand for goods overall throughout the economy. The purpose of Macro Economics is to study and understand what decisions can be made at the national level (government and the Federal Reserve Bank) that will have desired effects on economic outcomes.

If the unemployment rate is low, how is the economy supported to remain that way? If labor costs are too high and inflation seems likely, how can labor costs be pushed down and inflation tamed before it starts? How much inflation is bad, and how much is good? At what level is unemployment too low, or too high? Are interest rates too low or too high? Is there enough investment activity occurring in the economy that creates new jobs, new products, new technologies, all of which will keep the economy functioning smoothly? Is our monetary supply adequate to meet the needs of exchange among the consumers and producers? Are prices stable? Or are they inflationary; perhaps deflationary? Which is desirable at this specific time? What are the prevailing conditions we are encouraging or discouraging. These are constant concerns with oversight by the Council of Economic Advisors, the Federal Reserve System (banking authority) and various Congressional committees.

There are a myriad of economic control levers that can be operated to produce a smoothly operating economy. However, these same levers can be manipulated by those charged with the oversight authority. That’s when political and ideological skirmishing enters the picture. I’ll leave this discussion for another time. For now just know this is the point of political intrigue and trouble making!

A final thought before closing today’s blog: International Economics and Trade is a separate arena of economic science. It is where national economies meet and do business with each other. Their national economies heavily dictate the terms of trade based on how well their respective economies are functioning. Pricing, currency values and balance of trade issues enter the picture here. Global interest rates and commodity pricing central to international trade grows large in their effects on the economic well-being of other nations. So, each country is not alone. How well we do at home affects how well we do across borders. More on this another day!

October 26, 2011