Back to: ECONOMIC ANALYSIS & MONETARY POLICY
Economics is a social science that involves three elements including production, distribution and consumption of products and services. It analyzes the way individuals, government authorities, organizations, and countries choose to allocate resources so as to gain maximum satisfaction of their needs and wants. Also, they strive to identify methods for knowing how such communities should manage and instill their efforts for arriving at a stage of the highest output levels.
Economic analysis usually develops through deductive procedures such as mathematical logic that takes into consideration the effects of particular activities in a specific ‘means-ends’ framework.
Economics consists of two core areas: microeconomics and macroeconomics. While microeconomics focuses on small-scale operations like individual consumers, macroeconomics focuses on how the aggregate economy behaves or operates.
Key points to remember
- Economics refers to the analysis of the way people make an optimum utilization of given resources for achieving individual and aggregate purpose of production, distribution, and consumption.
- Microeconomics considers how individuals and organizations respond or operate. Macroeconomics considers the aggregate values of the state-based, national or international levels.
- Economics specifically studies how efficient the processes of production and exchange are. It uses several approaches, assumptions, and theories for forming the best incentives and procedures for achieving the maximum levels of efficiency.
- Economists use many economic indicators in order to study the economic condition. Also, such indicators help investors predicting the market movements which further enable them to make profitable investments.
A Little More on What is Economics
In the 8th-century BC, a Greek-based farmer/poet named Hesiod stated that there has to an efficient allocation of resources including labor, time, and materials for coping up with scarcity. However, the origin of contemporary Western economics happened quite later that was acknowledged in Adam Smith’s book ‘An Inquiry Into The Nature and Causes of the Wealth of Nations’ in 1776.
Economics revolves around the principle that there is no limit on the wants of individuals, and there are limited resources to satiate those needs. Because of this, economists highly emphasize on the terms ‘efficiency’ and ‘productivity’. They say that people use resources efficiently, and there is an increase in productivity levels, it will ultimately create a better standard of living for people.
In 1849, a Scotland based economist Thomas Carlyle referred to economics as the dismal science. He criticized how liberal the perspectives were towards race followed by social equality of modern researchers such as John Stuart Mill. However, there were some sources that proposed that Carlyle was giving information on poor estimates offered by Thomas Robert Malthus that the rate at which population grows will always be more than the food supply.
Types of Economics
Economics is generally divided into two groups:
- Microeconomics: Microeconomics lays emphasis on the factors that influence producers and consumers in taking decisions. This can be one individual, a household, an organization, or a public entity. It considers the way people exchange goods and services with one another, and how market forces ascertain the prices of products and services. Besides, it also studies the extent of efficiency and costs involved in the manufacturing of goods and services, the allocation and division of labor force, risk, uncertainty, and game theory.
- Macroeconomics: Macroeconomics observes the functioning of the whole economy which covers a different location, a continent, or maybe the entire world. It covers several topics including monetary policy, fiscal policy, rates of unemployment, gross domestic product related changes, and economic cycles that generate the following stages: expansion, boom, recession, and depression.
The most commonly known schools of economic thought are Keynesian and Monetarist. As per the Monetarist school, proper allocation of resources takes place in free markets. It further argues that the economy is best managed when a consistent monetary policy is followed. On the other side, the Keynesian school of economics that markets themselves cannot allocate or distribute resources, and considers using fiscal policy for controlling unsound market fluctuations and the periods of recession.
There are some fields of economics that focus on empiricism or experimentation instead of following a logical thought- especially macroeconomics that seeks to consider the natural science-based planned approaches and experiments that are capable of being tested or verified. As economics is not the area where the formulation of real experiments takes place, empirical researchers depend on creating simple assumptions as well as the retroactive analysis of information. However, there are a few economists who argue that economics and empirical testing don’t go hand in hand, and these approaches also lead to wrong answers lacking inconsistency.
The Economics of Labor and Trade
Labor force and trade are the primary driving forces of economics. As labor force has the ability to serve different sectors, and there are several ways of obtaining resources, it becomes hard to find the most feasible method delivering the maximum output.
For instance, economics states that expertise in particular fields of labor and then involving in trade activities for meeting other requirements or fulfilling their wants, instead of making efforts for meeting their demands and needs by using their own resources. Also, it shows that one can experience the maximum levels of efficiency in trade when there is a specific medium of exchange, or money involved.
Incentives and Subjective value
Economics is based on how individuals act. If we analyze different economic models, we shall observe a common assumption that most of them follow, and that individuals have rational thoughts, and they want to achieve the maximum gain or utility from a product or service. However, it is impossible and beyond anyone’s ability to predict how human beings behave or react. Their behavior is associated with personal attributes which again justifies the reason economic theories are not feasible for empirical testing. This states that not all economic models are implemented in real life scenarios.
Economic models offer information on how financial markets, government entities and economies work, and what influences their decision-making abilities. Economic laws are basic in nature, and are created by analyzing what motivates humans. For instance, profits encouraging the entry of new rivals, or increase in taxes leading to less consumer spending.
Economic indicators are reports that inform about how well the country’s economic performance is in a particular location. Generally, government authorities or private entities publish such reports on a periodic basis, and create a significant impact on the performance of fixed income, stock, and forex markets.
Following are the significant U.S. economy reports and indicators that are considered for fundamental analysis.
Gross Domestic Product (GDP)
The GDP, referred to as the gross domestic product, is the significant measure for knowing the economic performance of a nation. GDP is the aggregate market value of finished products and services that a country produces in a given period of time, usually one year (the Bureau of Economic Analysis also releases a monthly report). There are lots of investors, traders, and financial analysts who consider the two reports namely the advance GDP report and the preliminary report, published a few months before the final report of GDP. This reason behind this preference is that the stats given in the final GDP are more of a lagging indicator, that helps in confirming a trend, but is not good at making predictions for one. In terms of structure, there is a similarity between the GDP report and the income statement issued by a public entity.
The Department of Commerce publishes the retail sales reports at the mid of every month. These reports are strictly monitored, and considers the dollar value or total amounts received by all stores. Retailers from all over the country offer information on sample data based on which retail sales reports are made. The report, thus prepared, gives insights about the total quantum of merchandise sold by retailers. The report also helps in knowing about the spending capacity of customers. As consumer spending levels comprise of at least 2/3rd of GDP, the retail sales report signifies how well the economy is doing. The reports, being made on the previous month’s sales data, ensure timeliness as well. There can be possibility of abnormal volatility in the market due to the content mentioned in the sales report. Also, these figures can be considered for ascertaining inflationary forces that have an impact on Fed rates.
The Federal Reserve issues the industrial production report every month. It focuses on the changes encountered in the production of factories, mines, and utilities located in the United States. The report also considers evaluating the capacity utilization ratio that ascertains the extent of productive capacity that is being effectively utilized in the economy. At high rates, a country’s economy will experience an increase in production values and capacity utilization. If the capacity utilization falls in the brackets of 82-85%, the economic condition is said to be tight that ultimately indicates the chances of rise in price or shortage in supply in the coming periods. However, if the ratio falls below 80%, it represents a slack in the economy, and creating more possibilities of a recession.
Employment data is issued by the Bureau of Labor Statistics in a report known as the non-farm payrolls. This report is issued on the first Friday of every month. If there is a steady increase in employment, it signifies economic growth. Similarly, decrease in employment rates can cause diminishing economic growth. Besides these common trends, it is significant to ascertain the existing position of the economy. For instance, if employment data is good, it could result in currency appreciation, especially if the nation recently experienced economic issues, because the growth could signify better functioning of an economy. On the other hand, increased employment can cause inflation, creating a situation of currency depreciation.
Consumer Price Index (CPI)
The Consumer Price Index, known as the CPI is another indicator released by the Bureau of Labor Statistics. It ascertains the extent of changes in the retail prices, or the costs incurred by customers. It is one of the most significant tools for ascertaining inflation in an economy. The CPI considers using a basket that represents the goods and services of the economy for ascertaining and comparing the changes in price from month to month and year to year. The CPI report is again a significant economic indicator, and its issue can enhance the fluctuations in share, equity, foreign exchange, and fixed income markets. If the price hike is more than the expected rate, it gives a hint of inflation that will consequently lead to depreciation in the underlying currency.