Important Concepts in the Study of Economics

Important Concepts in the Study of Economics

Introduction

Economics as a social science entails studying daily activities associated with the production, distribution, and consumption of commodities within a specified geographic location (Murphy,2020). Effective economic activities in any given community depend on effective decisions and the establishment of economic systems. Economic systems are simple descriptions of reality based on economic behaviors. Economic systems help to solve economic problems such as the type and quantities of goods to be produced, how commodities are supposed to be produced, how outputs are circulated, and at what time commodities should be produced. In addition, economic systems explain how various institutions and agencies are linked to each other, how data and information are exchanged between them, and how they socially relate.

In today’s world, economics has diversified from single to multiple sources of income due to growth in various sectors of the economy and markets. Economic diversification has led to an exchange of experiences that have resulted in overall economic growth. To further understand how the economy works, the following concepts have to be understood.

Absolute and Comparative Advantage

A country is said to have an absolute advantage over other countries if it can produce more and better products and services than other countries producing similar goods and services. Comparative advantage occurs when a country produces goods and services at a slightly lower cost than other countries that produce similar commodities (Machado, Trigg, 2021). A country with a comparative advantage is assumed to have access to inputs compared to a country with an absolute advantage. With comparative advantage, it is a guarantee that trade has to occur even though the other country has an absolute advantage.

Benefits of Comparative Advantage in the International Market

Comparative advantage is among the fundamental principles of international trade. Comparative advantage enables countries to specialize in producing products that cost less. For instance, Portugal and England have benefited through specialization trading based on comparative advantages. In this case, Portugal makes wine at a low cost because of surplus wheat, whereas England cheaply manufactures cotton clothes because of surplus cotton (Machado, Trigg, 2021). Market prices for the two countries are low, giving them a wide market both locally and internationally.

A country with a comparative advantage enjoys the benefit of free trade. With specialization, countries are allowed to export their commodities because of favorable commodity prices that do not exploit other country’s customers. Comparative advantage has also made protectionism unsuccessful, as countries that are internationally trading always find partners that have comparative advantages. For instance, China and the USA. China produces goods using cheap labor, while the USA produces sophisticated goods through capital-intensive labor (Machado, Trigg, 2021). Finally, the two countries trade along the same lines.

Benefits of Absolute Advantage in the International Market

When a country produces more commodities compared to other countries, it can be relied upon to meet high market demand in international markets. Producing more of a commodity to a readily available market increases a country’s revenue, leading to overall economic growth and development (Machado, Trigg, 2021). Countries with absolute advantage can dispose of goods compared to countries without absolute advantage.

“Invisible hand”

“Invisible hands” are forces that cannot be seen or identified, but they are capable of moving market economies (Liu,2018). These invisible forces are based on a country’s self-interest with freedom of production and consumption while assuming that the interest of other countries is also fulfilled. With an indivisible hand, free-market exchange exists, but valuable goods and services are not easily availed in the market. Markets with indivisible hands do not have market regulations; hence the market reaches equilibrium without government interventions.

How Indivisible Hand Affects Decision-Making in Economic Systems

Good economic systems are those regulated by the government. With an indivisible hand, where markets are free without government interventions, decision-making becomes difficult. For markets to reach equilibrium, decisions have to be made by bodies that regulate international markets. In the case of free markets, consumers are likely to be exploited by individuals pursuing self-interest to maximize their social well-being (Liu,2018). There is a possibility of low-quality products in a free market because there is no government intervention to regulate production decisions.

On the other hand, if consumers have choices on what to buy and how much to pay, producers are free to choose what to produce and which prices to charge; this becomes beneficial in the economic system as every individual can make favorable decisions. Producers can use cheap production methods to maximize profits (Liu,2018). consumers can also buy low-priced products. Business people would also venture into investments that maximize profits.

Circular Flow Diagram

The circular flow is a model used to explain how the economy works. It shows how incomes, goods, and services circulate in the economy with government regulations (Reisman, 2018). The model has two main characters; households, firms, and the government, as shown in the diagram below.

References

Boldrin, M., & Scheinkman, J. A. (2018). Learning-by-doing, international trade, and growth: A note. In the Economy as a complex evolving system (pp. 285-300). CRC Press. https://www.taylorfrancis.com/chapters/edit/10.1201/9780429492846-20/learning-international-trade-growth-note-michele-boldrin-jos%C3%A9-scheinkman

Kaplan, G., & Violante, G. L. (2018). Microeconomic heterogeneity and macroeconomic shocks. Journal of Economic Perspectives, 32(3), 167-194. https://www.aeaweb.org/articles?id=10.1257/jep.32.3.167

Liu, G. M. (2018). Inventing the Invisible Hand: Adam Smith in American Thought and Politics, 1776–Present. Stanford University. https://www.proquest.com/openview/601a11f607d130521a8345d08559fb63/1?pq-origsite=gscholar&cbl=18750&diss=y

Machado, P. S., & Trigg, A. B. (2021). On absolute and comparative advantage in international trade: A Pasinetti pure labor approach. Structural Change and Economic Dynamics, 59, 375-383. https://link.springer.com

Murphy, R. H. (2020). Economics is whatever the comparative advantage of economists is: a comment on Leeson (2020). Journal of Institutional Economics, 16(4), 553-556. https://www.cambridge.org/core/journals/journal-of-institutional-economics

Reisman, D. (2018). The Circular Flow. In Thomas Robert Malthus (pp. 159-183). Palgrave Macmillan, Cham. https://link.springer.com/chapter/10.1007/978-3-030-01956-3_8

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Important Concepts in the Study of Economics

Your son is graduating from high school and is about to enter the workforce. He has developed a strong curiosity about our economic system and how it works. Because you have a good understanding of basic economics, he has asked you to explain several concepts that are essential to an understanding of how the economy works. Your son has asked you to explain the following concepts and ideas:

Absolute and comparative advantage: Explain how these concepts describe the benefits and costs of international trade.
“Invisible hand”: What is it, and how does it affect the decision-making process in our economic system?
Circular flow diagram: Include the government sector in your explanation, a description of the roles that each participant plays in the economy, and how the different sectors interact in the markets.
The Production Possibilities model: Provide an example and include a summary of what the model is illustrating and the economic implications for the economy.
Microeconomics and macroeconomics: Explain the differences between the two and why economics is divided into these two subdivisions.