You Gotta Know These Economic Concepts
- Supply and Demand. Supply and demand embody the general idea that, at any given price, producers are willing to produce a given amount of a good (the quantity supplied) and consumers are willing to buy a different amount (the quantity demanded). As the price rises, firms will be willing to supply more goods, but fewer will be demanded; conversely, as price falls, consumers will demand more goods, but fewer will be supplied. On a graph showing price and quantity on its two axes, this is represented by a downward sloping demand curve and an upward sloping supply curve. Where the two curves intersect, there is an equilibrium; economists predict this equilibrium quantity will be produced (and consumed) in a free market.
- Elasticity. Elasticity is a measure of how much one economic variable changes in response to a change in a different variable, expressed in the form of “Every 1% change in the independent (second) variable leads to an x% change in the value of the first (dependent) variable.” A common example is the price elasticity of demand, which measures the degree to which the quantity demanded changes when the price is altered.
- Monopoly. A monopoly occurs when there is only one firm producing goods for a given market. This allows that firm to set the price higher—and thus the quantity sold lower—than would otherwise occur. An oligopoly is a similar market environment where production is dominated by a few firms, whereas a monopsony is the opposite case: a market with only a single consumer.
- Tariff. A tariff is a tax placed on the import (common) or export (rarer) of a good. Tariffs have various—often controversial—sociopolitical goals, but economists agree that they raise consumer prices relative to equilibrium (resulting in a lower quantity demanded). Tariffs are analyzed similar to quotas, in which a government limits the amount of a good that may be imported.
- Factors of production. There are three classical factors of production: land, labor, and capital (i.e., machinery and tools). Modern economists sometimes add a fourth, entrepreneurship.
- Unemployment. The unemployment rate refers to the percentage of the population that is actively seeking work but cannot find a job. Unemployment can be cyclical (common in seasonal industries like fieldwork), frictional (the natural time between jobs that exists in most labor markets), or structural (when workers’ skills do not match those required by open jobs).
- Gross Domestic Product. Gross domestic product (or GDP), is a commonly used measure of the size of a country’s or state’s economy. GDP is computed by summing consumption, investment, government expenditures, and exports, and then subtracting imports.
- Inflation. The inflation rate is the pace at which prices are rising, usually expressed in the form “2.5% per year.” This is equivalent to the rate at which currency loses its value. Inflation is often measured by the consumer price index, which establishes a standard basket of goods that a family might buy and seeing how its total price changes over a year.
- Interest rate. The interest rate is a “price of money,” inasmuch as it is the amount one must pay to use somebody else’s money (“borrow”) for a given period of time; the term is also used for the payment the lender (e.g., a person with a savings account) receives for loaning out his money. Because inflation lowers the value of currency, economists routinely distinguish between nominal interest rates (the actual amount earned by a lender/saver) and real interest rates (which are corrected for the inflation rate). A savings account earning 5% interest is not acquiring the ability to buy more things if prices are also going up by 5% per year!
- Comparative advantage. Comparative advantage is the idea that every pair of potential trading partners (two firms, two neighbors, two countries, etc.) can benefit by trade if they are producing at least two goods. The counterintuitive aspect is that this result is true for every pair, no matter how unproductive one of the parties might be (in absolute terms). Broadly speaking, each party should specialize in what it does best (relative to the other party) and then trade for everything else. David Ricardo formulated this theory with a famous example involving Britain’s cloth industry and Portugal’s wine industry.
- Invisible hand. The invisible hand is the metaphorical notion that producers and consumers acting in their own narrow interest (e.g., by trying to maximize income from their business) will create an overall benefit to society. This might happen by their rewarding technologies that make production more efficient, rewarding firms who can sell at lower cost, rewarding inventors who discover new processes, and so on. The phrase was introduced by Adam Smith in his 1776 book The Wealth of Nations, but the modern understanding (and broad-based application of the metaphor) is due to later thinkers.
This article was contributed by NAQT editor Kurtis Droge.