Economics

Economics is the social science that studies economic activity to gain an understanding of the
processes that govern the production, distribution and consumption of goods and services in an
economy.
Economics is a science which studies human behaviour as a relationship between ends and
scarce means which have alternative uses.
The term economics comes from the Ancient Greek from (oikos, "house") and
(nomos, "custom" or "law"), hence "rules of the house (hold for good management)".
'Political economy' was the earlier name for the subject, but economists in the late 19th century
suggested "economics" as a shorter term for "economic science" to establish itself as a separate
discipline outside of political science and other social sciences.
Economics focuses on the behavior and interactions of economic agents and how economies
work. Consistent with this focus, primary textbooks often distinguish between microeconomics
and macroeconomics. Microeconomics examines the behavior of basic elements in the economy,
including individual agents and markets, their interactions, and the outcomes of interactions.
Individual agents may include, for example, households, firms, buyers, and sellers.
Macroeconomics analyzes the entire economy (meaning aggregated production, consumption,
savings, and investment) and issues affecting it, including unemployment of resources (labor,
capital, and land), inflation, economic growth, and the public policies that address these issues
(monetary, fiscal, and other policies).
Microeconomics

Microeconomics (from Greek prefix mikro- meaning "small" and economics) is a branch of
economics that studies the behavior of individuals and small impacting organizations in making
decisions on the allocation of limited resources (see scarcity). Typically, it applies to markets
where goods or services are bought and sold. Microeconomics examines how these decisions and
behaviors affect the supply and demand for goods and services, which determines prices, and
how prices, in turn, determine the quantity supplied and quantity demanded of goods and
services.
This is in contrast to macroeconomics, which involves the "sum total of economic activity,
dealing with the issues of growth, inflation, and unemployment." Microeconomics also deals
with the effects of national economic policies (such as changing taxation levels) on the
aforementioned aspects of the economy.

One of the goals of microeconomics is to analyze market mechanisms that establish relative
prices amongst goods and services and allocation of limited resources amongst many alternative
uses. Microeconomics analyzes market failure, where markets fail to produce efficient results,
and describes the theoretical conditions needed for perfect competition. Significant fields of
study in microeconomics include general equilibrium, markets under asymmetric information,
choice under uncertainty and economic applications of game theory. Also considered is the
elasticity of products within the market system.

Microeconomic topics
The study of microeconomics involves several "key" areas:
Demand, supply, and equilibrium

Supply and demand is an economic model of price determination in a market. It concludes that in
a competitive market, the unit price for a particular good will vary until it settles at a point where
the quantity demanded by consumers will equal the quantity supplied by producers resulting in
an economic equilibrium for price and quantity.
Supply and demand

The supply and demand model describes how prices vary as a result of a balance
between product availability and demand. The graph depicts an increase (that is,
right-shift) in demand from D1 to D2 along with the consequent increase in price and
quantity required to reach a new equilibrium point on the supply curve (S).

Prices and quantities have been described as the most directly observable attributes of goods
produced and exchanged in a market economy.[35] The theory of supply and demand is an
organizing principle for explaining how prices coordinate the amounts produced and consumed.
In microeconomics, it applies to price and output determination for a market with perfect
competition, which includes the condition of no buyers or sellers large enough to have pricesetting power.
For a given market of a commodity, demand is the relation of the quantity that all buyers would
be prepared to purchase at each unit price of the good. Demand is often represented by a table or
a graph showing price and quantity demanded (as in the figure). Demand theory describes
individual consumers as rationally choosing the most preferred quantity of each good, given
income, prices, tastes, etc.
The law of demand states that, in general, price and quantity demanded in a given market are
inversely related. That is, the higher the price of a product, the less of it people would be
prepared to buy of it (other things unchanged). As the price of a commodity falls, consumers
move toward it from relatively more expensive goods (the substitution effect). In addition,
purchasing power from the price decline increases ability to buy (the income effect). Other
factors can change demand; for example an increase in income will shift the demand curve for a
normal good outward relative to the origin, as in the figure. All determinants are predominantly
taken as constant factors of demand and supply.
Supply is the relation between the price of a good and the quantity available for sale at that price.
It may be represented as a table or graph relating price and quantity supplied. Producers, for
example business firms, are attempt to produce and supply the amount of goods that will bring
them the highest profit. Supply is typically represented as a directly proportional relation
between price and quantity supplied (other things unchanged).
That is, the higher the price at which the good can be sold, the more of it producers will supply,
as in the figure. The higher price makes it profitable to increase production. Just as on the
demand side, the position of the supply can shift, say from a change in the price of a productive
input or a technical improvement. The "Law of Supply" states that, in general, a rise in price
leads to an expansion in supply and a fall in price leads to a contraction in supply. Here as well,
the determinants of supply, such as price of substitutes, cost of production, technology applied
and various factors inputs of production are all taken to be constant for a specific time period of
evaluation of supply.
Market equilibrium occurs where quantity supplied equals quantity demanded, the intersection of
the supply and demand curves in the figure above. At a price below equilibrium, there is a
shortage of quantity supplied compared to quantity demanded. This pushes the price up. At a
price above equilibrium, there is a surplus of quantity supplied compared to quantity demanded.

This pushes the price down. The model of supply and demand predicts that for given supply and
demand curves, price and quantity will stabilize at the price that makes quantity supplied equal to
quantity demanded. Similarly, demand-and-supply theory predicts a new price-quantity
combination from a shift in demand (as to the figure), or in supply.
Other applications of demand and supply include the distribution of income among the factors of
production, including labour and capital, through factor markets. In a competitive labour market
for example the quantity of labour employed and the price of labour (the wage rate) depends on
the demand for labour (from employers for production) and supply of labour (from potential
workers). Labour economics examines the interaction of workers and employers through such
markets to explain patterns and changes of wages and other labour income, labour mobility, and
(un)employment, productivity through human capital, and related public-policy issues.
Theory of production

Production theory is the study of production, or the economic process of converting inputs into
outputs. In microeconomics, production is the conversion of inputs into outputs. It is an
economic process that uses inputs to create a commodity or a service for exchange or direct use.
Production is a flow and thus a rate of output per period of time. Production uses resources to
create a good or service that is suitable for use, gift-giving in a gift economy, or exchange in a
market economy. This can include manufacturing, storing, shipping, and packaging. Some
economists define production broadly as all economic activity other than consumption. They see
every commercial activity other than the final purchase as some form of production.
Costs of production

The cost-of-production theory of value is the price of an object or condition is determined by the
sum of the cost of the resources that went into making it. The cost can comprise any of the
factors of production: labour, capital, land. Technology can be viewed either as a form of fixed
capital (ex:plant) or circulating capital (ex:intermediate goods).
Inputs used in the production process include such primary factors of production as labour
services, capital (durable produced goods used in production, such as an existing factory), and
land (including natural resources). Other inputs may include intermediate goods used in
production of final goods, such as the steel in a new car.
Economic efficiency describes how well a system generates desired output with a given set of
inputs and available technology. Efficiency is improved if more output is generated without
changing inputs, or in other words, the amount of "waste" is reduced. A widely accepted general
standard is Pareto efficiency, which is reached when no further change can make someone better
off without making someone else worse off.

Perfect competition

Perfect competition describes markets such that no participants are large enough to have the
market power to set the price of a homogeneous product. An example is Ebay.
Perfect monopoly

A monopoly (from Greek monos (alone or single) + polein (to sell)) exists when a
single company is the only supplier of a particular commodity.
Oligopoly

An oligopoly is a market form in which a market or industry is dominated by a small number of

sellers (oligopolists). Oligopolies can result from various forms of collusion which reduce
competition and lead to higher costs for consumers.[5]
Market structure

The market structure can have several types of interacting market systems. Different forms of
markets is a feature of capitalism and advocates of socialism often criticize markets and aim to
substitute markets with economic planning to varying degrees. Competition is the regulatory
mechanism of the market system.

Monopolistic competition, also called competitive market, where there is a

large number of firms, each having a small proportion of the market share
and slightly differentiated products.

Oligopoly, in which a market is run by a small number of firms that together

control the majority of the market share.

Duopoly, a special case of an oligopoly with two firms.

Monopsony, when there is only one buyer in a market.

Oligopsony, a market where many sellers can be present but meet only a few
buyers.

Monopoly, where there is only one provider of a product or service.

Natural monopoly, a monopoly in which economies of scale cause efficiency

to increase continuously with the size of the firm. A firm is a natural
monopoly if it is able to serve the entire market demand at a lower cost than
any combination of two or more smaller, more specialized firms.

Perfect competition, a theoretical market structure that features no barriers

to entry, an unlimited number of producers and consumers, and a perfectly
elastic demand curve.

Examples of markets include but are not limited to: commodity markets, insurance markets,
bond markets, energy markets, flea markets, debt markets, stock markets, online auctions, media
exchange markets, real estate market.

Opportunity cost
Opportunity cost of an activity (or goods) is equal to the best next alternative uses/foregone.
Although opportunity cost can be hard to quantify, the effect of opportunity cost is universal and
very real on the individual level. In fact, this principle applies to all decisions, not just economic
ones.
Opportunity cost is one way to measure the cost of something. Rather than merely identifying
and adding the costs of a project, one may also identify the next best alternative way to spend the
same amount of money. The forgone profit of this next best alternative is the opportunity cost of
the original choice. A common example is a farmer that chooses to farm their land rather than
rent it to neighbors, wherein the opportunity cost is the forgone profit from renting. In this case,
the farmer may expect to generate more profit alone. This kind of reasoning is a very important
part of the calculation of discount rates in discounted cash flow investment valuation
methodologies. Similarly, the opportunity cost of attending university is the lost wages a student
could have earned in the workforce, rather than the cost of tuition, books, and other requisite
items (whose sum makes up the total cost of attendance).
Note that opportunity cost is not the sum of the available alternatives, but rather the benefit of the
single, best alternative. Possible opportunity costs of a city's decision to build a hospital on its
vacant land are the loss of the land for a sporting center, or the inability to use the land for a
parking lot, or the money that could have been made from selling the land, or the loss of any of
the various other possible uses but not all of these in aggregate. The true opportunity cost
would be the forgone profit of the most lucrative of those listed.
It is imperative to understand that no decision on allocating time is free. No matter what one
chooses to do, they are always giving something up in return. An example of opportunity cost is
deciding between going to a concert and doing homework. If one decides to go the concert, then
they are giving up valuable time to study, but if they choose to do homework then the cost is
giving up the concert. Any decision in allocating capital is likewise: there is an opportunity cost
of capital, or a hurdle rate, defined as the expected rate one could get by investing in similar
projects on the open market. Opportunity cost is vital in understanding microeconomics and
decisions that are made.
Macroeconomics

Macroeconomics (from the Greek prefix makro- meaning "large" and economics) is a branch of
economics dealing with the performance, structure, behavior, and decision-making of an

economy as a whole, rather than individual markets. This includes national, regional, and global
economies.[1][2] With microeconomics, macroeconomics is one of the two most general fields in
economics.
Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price
indexes to understand how the whole economy functions. Macroeconomists develop models that
explain the relationship between such factors as national income, output, consumption,
unemployment, inflation, savings, investment, international trade and international finance. In
contrast, microeconomics is primarily focused on the actions of individual agents, such as firms
and consumers, and how their behavior determines prices and quantities in specific markets.
While macroeconomics is a broad field of study, there are two areas of research that are
emblematic of the discipline: the attempt to understand the causes and consequences of short-run
fluctuations in national income (the business cycle), and the attempt to understand the
determinants of long-run economic growth (increases in national income). Macroeconomic
models and their forecasts are used by governments to assist in the development and evaluation
of economic policy.

Basic macroeconomic concepts

Macroeconomics encompasses a variety of concepts and variables, but there are three central
topics for macroeconomic research.[3] Macroeconomic theories usually relate the phenomena of
output, unemployment, and inflation. Outside of macroeconomic theory, these topics are also
important to all economic agents including workers, consumers, and producers.
Output and income

National output is the lowest amount of everything a country produces in a given time period.
Everything that is produced and sold generates income. Therefore, output and income are usually
considered equivalent and the two terms are often used interchangeably. Output can be measured
as total income, or, it can be viewed from the production side and measured as the total value of
final goods and services or the sum of all value added in the economy.[4]
Macroeconomic output is usually measured by Gross Domestic Product (GDP) or one of the
other national accounts. Economists interested in long-run increases in output study economic
growth. Advances in technology, accumulation of machinery and other capital, and better
education and human capital all lead to increased economic output over time. However, output
does not always increase consistently. Business cycles can cause short-term drops in output
called recessions. Economists look for macroeconomic policies that prevent economies from
slipping into recessions and that lead to faster long-term growth.

Unemployment

The amount of unemployment in an economy is measured by the unemployment rate, the

percentage of workers without jobs in the labor force. The labor force only includes workers
actively looking for jobs. People who are retired, pursuing education, or discouraged from
seeking work by a lack of job prospects are excluded from the labor force.
Unemployment can be generally broken down into several types that are related to different
causes.

Classical unemployment occurs when wages are too high for employers to be
willing to hire more workers.

Consistent with classical unemployment, frictional unemployment occurs

when appropriate job vacancies exist for a worker, but the length of time
needed to search for and find the job leads to a period of unemployment. [5]

Structural unemployment covers a variety of possible causes of

unemployment including a mismatch between workers' skills and the skills
required for open jobs.[6] Large amounts of structural unemployment can
occur when an economy is transitioning industries and workers find their
previous set of skills are no longer in demand. Structural unemployment is
similar to frictional unemployment since both reflect the problem of matching
workers with job vacancies, but structural unemployment covers the time
needed to acquire new skills not just the short term search process. [7]

While some types of unemployment may occur regardless of the condition of

the economy, cyclical unemployment occurs when growth stagnates. Okun's
law represents the empirical relationship between unemployment and
economic growth.[8] The original version of Okun's law states that a 3%
increase in output would lead to a 1% decrease in unemployment. [9]

Inflation and deflation

A general price increase across the entire economy is called inflation. When prices decrease,
there is deflation. Economists measure these changes in prices with price indexes. Inflation can
occur when an economy becomes overheated and grows too quickly. Similarly, a declining
economy can lead to deflation.
Central bankers, who control a country's money supply, try to avoid changes in price level by
using monetary policy. Raising interest rates or reducing the supply of money in an economy
will reduce inflation. Inflation can lead to increased uncertainty and other negative
consequences. Deflation can lower economic output. Central bankers try to stabilize prices to
protect economies from the negative consequences of price changes.
Changes in price level may be result of several factors. The quantity theory of money holds that
changes in price level are directly related to changes in the money supply. Most economists

believe that this relationship explains long-run changes in the price level. [10] Short-run
fluctuations may also be related to monetary factors, but changes in aggregate demand and
aggregate supply can also influence price level. For example, a decrease in demand because of a
recession can lead to lower price levels and deflation. A negative supply shock, like an oil crisis,
lowers aggregate supply and can cause inflation.

Macroeconomic policy
Macroeconomic policy is usually implemented through two sets of tools: fiscal and monetary
policy. Both forms of policy are used to stabilize the economy, which usually means boosting the
economy to the level of GDP consistent with full employment.[22]
Monetary policy

Central banks implement monetary policy by controlling the money supply through several
mechanisms. Typically, central banks take action by issuing money to buy bonds (or other
assets), which boosts the supply of money and lowers interest rates, or, in the case of
contractionary monetary policy, banks sell bonds and takes money out of circulation. Usually
policy is not implemented by directly targeting the supply of money.
Banks continuously shift the money supply to maintain a fixed interest rate target. Some banks
allow the interest rate to fluctuate and focus on targeting inflation rates instead. Central banks
generally try to achieve high output without letting loose monetary policy create large amounts
of inflation.
Conventional monetary policy can be ineffective in situations such as a liquidity trap. When
interest rates and inflation are near zero, the central bank cannot loosen monetary policy through
conventional means. Central banks can use unconventional monetary policy such as quantitative
easing to help increase output. Instead of buying government bonds, central banks implement
quantitative easing by buying other assets such as corporate bonds, stocks, and other securities.
This allows lowers interest rates for broader class of assets beyond government bonds. In another
example of unconventional monetary policy, the United States Federal Reserve recently made an
attempt at such as policy with Operation Twist. Unable to lower current interest rates, the Federal
Reserve lowered long-term interest rates by buying long-term bonds and selling short-term bonds
to create a flat yield curve.
Fiscal policy

Fiscal policy is the use of government's revenue and expenditure as instruments to influence the
economy. Examples of such tools are expenditure, taxes, debt.
For example, if the economy is producing less than potential output, government spending can be
used to employ idle resources and boost output. Government spending does not have to make up

for the entire output gap. There is a multiplier effect that boosts the impact of government
spending. For example, when the government pays for a bridge, the project not only adds the
value of the bridge to output, it also allows the bridge workers to increase their consumption and
investment, which also help close the output gap.
The effects of fiscal policy can be limited by crowding out. When government takes on spending
projects, it limits the amount of resources available for the private sector to use. Crowding out
occurs when government spending simply replaces private sector output instead of adding
additional output to the economy. Crowding out also occurs when government spending raises
interest rates which limits investment. Defenders of fiscal stimulus argue that crowding out is not
a concern when the economy is depressed, plenty of resources are left idle, and interest rates are
low.
Fiscal policy can be implemented through automatic stabilizers. Automatic stabilizers do not
suffer from the policy lags of discretionary fiscal policy. Automatic stabilizers use conventional
fiscal mechanisms but take effect as soon as the economy takes a downturn: spending on
unemployment benefits automatically increases when unemployment rises and, in a progressive
income tax system, the effective tax rate automatically falls when incomes decline.
Comparison

Economists usually favor monetary over fiscal policy because it has two major advantages. First,
monetary policy is generally implemented by independent central banks instead of the political
institutions that control fiscal policy. Independent central banks are less likely to make decisions
based on political motives.[22] Second, monetary policy suffers shorter inside lags and outside
lags than fiscal policy. Central banks can quickly make and implement decisions while
discretionary fiscal policy may take time to pass and even longer to carry out.