Economics is a study of production, distribution, and consumption of final products and services. Economics explains the process of wealth creation and how its distributed in a society and how scarce resources are allocated in an economy with the aim of satisfying human needs (Eichhorn & Voeller, 2012). This report discusses the various economic principles and circular flow model and how they influence the flow of money and final products in an economy.
Economists are both scientists and policymakers because they are able to develop principles and theories that can be examined using data. There are often times when economists are asked to describe current world events, such as recommending policies to improve economic outcomes, this is where they are titled a scientist, and when they work to help improve those economic outcomes, they are titled policymakers (Bernanke et al., 2015). The average economist spends a significant amount of time doing work closely related to a scientist as they collect and analyse data in an attempt to support their hypotheses.
First of all, we will focus on what principles society uses in the allocation of its scarce resources. Scarcity is an economic problem of having unlimited human wants in relations to having limited resources to meet those unlimited wants. It also has to do with society having insufficient productive resources to meet all of the humanities wants and needs. Scarcity requires people to make economic decisions so that they can manage the availability of resources they require to meet their needs. An example of scarce resources includes; water, food, and forests. Oil and natural gas are now starting to encroach into the scarce recourses list as well (Frank et al., 2007).
Economists use the first four principles out of the ten principles of economics. The four principles of individual decision making are valuable in the allocation of scarce resources. The First one being, Trade-off, this technic is used by giving up something that society likes. Making decisions demands trading-off ones goals against another. The cost of something is what you give up, is the second principle, one must compare the costs and advantages of alternative actions and options. Economists often have to sacrifice the cost or value of something to obtain an item that is more within their limit of resources (Mankiw, 2014). The third principle; Rationalization, assuming that people are rational and their systematic efforts are in their best interest to achieve the objective.
Lastly, the fourth principle is that people respond to incentives. This is put into perspective because it induces people to act such as a prospect of punishment or reward. Other principles include government printing of excess money leads to a price increase, market outcomes can sometimes be improved by the government, markets are normally a right means to organize business activities, Trade can make everyone better off, an economys standards of living depends on its capacity to manufacture commodities and services, society is faced with a short-run trade-off between unemployment and price increase in the form of inflation,
The economy works in many aspects and to better understand how the economy operates one must show a model to demonstrate how the economy is designed whereby society in an economy interacts with each other. This report looks at a circular flow model to identify the flow of money and goods in an Economy (Bernanke et al., 2015). A circular flow diagram illustrates how money flows through markets among households and firms. As illustrated in the diagram below;
The circular flow diagram above illustrates interdependence between the firms and the households its shows how firms compensate households for their labour in the form of compensations such as wages, dividends, capital and in turn this compensation is used to purchase the final goods and services that the firms produce which is represented by the diagram above.
The economy coordinates societys independent economic players by applying the price system. The price system is a coordination of all major economic actors in the society. The price system facilitates the purchase of products from producers they do not know. The system also helps agents to have a specific price system to meet all wants from others. Another factor that influences economic coordination is the production of goods. For a firm to produce efficiently, it requires to use and follow certain fundamental rules that maximize profits and minimize costs (Eichhorn & Voeller, 2012). Distribution of goods and services plays a vital role. In this case, the economy ensures that products are easily accessible to every household.
Gross Domestic Product is defined as the as the total value of everything produced in an economy in a given period. Its job is to determine how well an economy is doing by looking at the total income that everyone in the economy is making. To do this, GDP measures the cumulative income for all citizens in an economy and the total expenditure on the economys output. It can range from food, land, cars, and clothing. What GDP does not measure is anything illegal such as illegal drugs. It also excludes any homemade products that never made it to the market. For instance, if you purchased vegetables at a grocery store it is part of GDP, but if you grew them in your own garden, it is not part of the economys GDP (Frank et al., 2007). This means that the value is left out of the market. Another example would be goods and services being purchased in other countries which are also not part of GDP. The GDP is illustrated in the formula below;
GDP = Consumption + Investment + Government Spending + Net Exports
The consumer price index (CPI) is the general price level of goods and services in a country. CPI shows the value of commodities and services relative to the cost of similar commodities and services in the base year. By measuring consumer price index, economists can determine the rate of inflation. CPI is obtained by measuring the fluctuations of the price level of a market basket of goods and services used by households. (Miller et al., 2015). CPI overstates annual inflation by about one percent point, this because; people often change towards products that have become less expensive, the introduction to new goods, and the unmeasured quality of changes in goods and services and because of those reasons CPI is an imperfect measure of the cost of living and these imperfect measurements can overstate the annual inflation of an economy.
In conclusion, we can now better understand and are familiar with current economic principles and macro-economic data and how they influence the flow of money and final products in an economy.
References.
Bernanke, B., Antonovics, K., & Frank, R. (2015). Principles of macroeconomics. McGraw-Hill Higher Education.
Eichhorn, W., & Voeller, J. (2012). Theory of the Price Index: Fishers Test Approach and Generalizations (Vol. 140). Springer Science & Business Media.
Frank, R. H., Bernanke, B., & Johnston, L. D. (2007). Principles of economics (pp. 2-3). New York: McGraw-Hill/Irwin
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.Miller, T., Kim, A. B., & Holmes, K. (2015). 2015 Index of economic Freedom. Washington
DC: The Heritage Foundation.
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