The economy is a dynamic, constantly changing mechanism.
The natural resources, workers, managers that are necessary to produce goods and services are all in some way limited. The needs, which we want to satisfy, seem unlimited.
The fundamental economic problem is scarcity, i.e. the imbalance between our desires and the means of satisfying our desires. It is the result of an inability to satisfy all of everyone's wants. This problem concerns rich as well as poor societies.
The law of scarcity states that goods are scarce because there are not enough resources to produce all the goods that people want.
Everyone faces scarcity. Consumers want more than they can afford. Their income, savings and other resources are limited. Even businesses face scarcity. The people who own and manage businesses cant hire all the workers they would like to have or buy all the equipment they want. Their choices are based on limited profits, savings and borrowing power. Governments, too, are limited by their ability to tax, borrow and print money. So, we all must make choices about using money, time and other resources. Economics is the study of how people make choices to use scarce resources to satisfy their unlimited wants and needs.
Economic analysis is divided into two main branches: microeconomics and macroeconomics. Both are important in dealing with the problem of scarcity.
Microeconomics is the study of individual consumers and business firms; macroeconomics is the study of the economy as a whole.
Microeconomics examines the choices that individuals, families and businesses make. It examines the interaction of producers, buyers, and sellers in markets. Microeconomics also studies the factors that influence individual economic choices, how changes in these factors affect such choices, and how the choices of various decision makers are coordinated by markets.
Macroeconomics examines such questions as: How fast is the level of production in the society changing? How fast are prices rising? How many people are unemployed? It seeks solutions to current problems facing the economy, such as unemployment, poverty, inflation and long-term economic growth.
Thus, whereas microeconomics is the study of the individual pieces of the economic puzzle, macroeconomics puts all the pieces together to focus on the big picture.
FACTORS OF PRODUCTION
Resources are basic elements used to produce goods and services.
Economists call all the resources that go into creating goods and services the factors of production.
The factors are natural, capital, human resources and entrepreneurship. Each factor of production has a place in an economic system, and each has an important function.
Natural Resources or Land. Natural resources are what nature provides to create goods and services. They include minerals, the soil, water, timber, wildlife and air. Economists also use the term land when they speak of natural resources as a factor of production.
The price paid for the use of land is called rent. Rent is income to the owner of the land.
Human Resources or Labour. Physical and mental effort of people in the production of goods and services are called labour or human resources.
The price paid for the use of labour is called wages. Wages are income to workers, who own their labour.
Capital resources represent human creations that are used to produce goods and services. There are two kinds of capital: human and physical. Human capital consists of the individual knowledge, talents and skills that people acquire. Physical capital is something which people create to produce other goods and services. Factories, tools, buildings, equipment, machines, roads, etc. are physical capital resources.
Payment for the use of someone else's money is called interest.
Some economists include management or entrepreneurship on the list of productive resources. Entrepreneurship is the imagination, innovative thinking, management and organization skills which are needed to start and operate a business.
The reward to entrepreneurs for the risks, innovative ideas, and efforts that they have put into the business are profits.
Demand is an important factor in determining prices. Obviously, demand is not only influenced by price, but also by many other factors, such as the incomes of the demanders and the prices of substitutes. When two goods satisfy similar needs, they are described as substitutes. A change in the price of one item will result in a shift in the demand for a substitute.
In economics, the interaction of demand and price is expressed by the Law of Demand. It describes the relationship between prices and the quantity of goods and services that would be purchased at different prices. It says that the demand for an economic product varies inversely with its price. In other words if prices are high the quantity demanded will be low, if prices are low, the quantity demanded will be high. More people can buy an item at a lower price than at a higher price.
Elasticity of demand is a measure of the change in the quantity of a good in response to demand. Demand is particularly elastic for non-essential commodities (holidays, parties, visits to theatres or concerts, chocolates, etc.).
Demand is called inelastic if a change in price has a relatively small effect on the quantity demanded. Demand for essential commodities (food, clothing, shelter, medical expenses, etc.) is usually inelastic.
In the world of business supply means the amount of a commodity or service that producers are willing to sell in the market under various conditions.
In economics the interaction of supply and price is expressed by the Law of Supply. The Law of Supply says that the quantity of an economic product offered for sale varies directly with its price. It describes the interaction between prices and the quantity of goods or services that would be offered for sale at all of the possible prices that might prevail in the market. In other words suppliers will offer greater quantities for sale at a higher price and less at a lower price.
Higher prices lead to an increase in quantity supplied. When quantity supplied exceeds quantity demanded at current price, the price tends to fall and quantity supplied decreases.
Supply of many commodities can generally be adjusted to suit market conditions. This means that changes in prices lead to changes in the quantity supplied that can be increased or decreased rapidly in response to market prices.
Supply is determined and influenced by price. But it is also determined by such factors as the cost of production and the period of time allowed supplying to adjust to a change in prices.
It is very important to know the distinction between supply and the quantity supplied. Supply describes the behaviour of sellers at every price. Demand describes the behaviour of buyers at every price. The term "quantity demanded" makes sense only in relation to a particular price.