What is Economics?
Economics is a social science that studies the way economic agents make choices on the allocation of resources, with alternate uses, to satisfy their needs and wants in order to maximise their output. Economics is concerned mainly with the production, distribution, and consumption of goods and services.
Economics is commonly split into two parts: microeconomics and macroeconomics. Microeconomics examines the behaviour of single economic agents and the way these agents interact in the marketplace along with the outcomes of their interactions. Macroeconomics examines the behaviour of the economy at an aggregate level.
Where did Economics come from?
Economic notions go as far back as Greek and Roman civilisations. Hesiod, a Greek poet, is considered by many economic historians as the ‘first economist’ due to his writings which introduced the notable economic theme of scarcity. The development of this subject was impacted by two groups the mercantilists and physiocrats.
Mercantilism was prevalent in Europe from the 16thcentury to the mid 18thcentury and its aim was to promote government regulation of a country’s economy in order to enhance state power. Mercantilism assumed that the wealth of a country depended mainly on the possession of gold and silver. Under this regime exporting goods would allow countries to earn gold and silver while importing goods from other countries lead to an outflow of gold and silver to those countries. The goal was to reach a positive trade balance where exports were greater than imports. Adam Smith was very critical of this system.
Physiocrats was developed by French economists in the 18thcentury who believed a country’s wealth was solely determined by agriculture and that a country’s surplus of agricultural production should be over its cost. Some key concepts of physiocracy were individualism and laissez-faire with government intervention being discouraged.
1776 is considered the year where economics was acknowledged as a separate subject, when the foundations of modern Western economics were formed. 1776 was the year Adam Smith, a Scottish philosopher, published his book, An Inquiry into the Nature and Causes of the Wealth of Nations. The book introduced the three factors of production still taught today: land, labour and capital. Smith also focuses on the idea of the division of labour and its benefits (labour productivity and gains from trade).
Karl Marx in the mid-19thcentury developed a theory focusing on the labour theory of value and theory of surplus-value, this came to be known as Marxism. The labour theory of value suggested the economic value of a good originates from the amount of labour input. The theory of surplus-value determined how the capitalist employer exploits their workers, by paying them less than the value their labour has added to the goods, to make a profit.
Neoclassical economics was formed between 1870 – 1910 and popular neoclassical economists such as Alfred Marshall helped promote the term ‘economics.’ Marshall established the demand and supply diagram, he stated that value is determined by individual utility. Neoclassical economics is also termed orthodox economics. Mainstream economics today adds to neoclassical economics with extra modules like game theory, econometrics, imperfect competition and market failure and the neoclassical model of economic growth.
Keynesian economics was established by the economist John Maynard Keynes in the 1930s who wrote the book, The General Theory of Employment, Interest and Money in 1936 to help understand the Great Depression. Keynes focused mainly on macroeconomics including ways to boost aggregate demand through government intervention and policies, generally focusing on the economy in the short run, to help prevent future recessions.
Chicago school of economics was founded in the 1930s by Frank Hyneman Knight, it is well known for its free-market principles of minimal government intervention for optimal resource allocation and monetarist concepts. The most notorious monetarist is Milton Friedman who took his basic ideas from Adam Smith and other classical economists but used more mathematical modelling to test contrasting hypotheses.
Types of Economics - Macroeconomics and Microeconomics
Microeconomics examines the behaviour of single economic agents (firms, households and consumers), and the way these agents interact in the marketplace along with the outcomes of their interactions. In a market economy, the allocation of limited resources is determined by the market where agents trade. In the market, agents trade goods (apples, cars and clothes etc) and services (repair services, haircuts and teaching etc). Microeconomics aims to explain why goods and services are demanded and supplied at their specific price levels and how the single economic agents decide how much is best to trade, this is also known as the supply and demand model. Key subjects included in Microeconomics: the supply and demand model elasticity, opportunity cost, different market structures, market failure and government intervention.
The supply and demand model represents’ the relationship between the quantity of goods and services producers want to sell at the corresponding prices and the quantity the consumers wish to buy at those prices. The interaction of the supply curve and demand curve denotes the goods or service’s price, known as the equilibrium price. The equilibrium price, also known as the market-clearing price, shows the position where there is a state of balance in the market between demand
(consumers) and supply (producers). The market can be in disequilibrium where there is either excess supply or excess demand shown by shifts in either the supply curve or demand curve. For example, the agricultural markets are prone to market disequilibrium’s and random shifts of the supply curve from year to year, caused by climate factors (external factors) making the equilibrium price unaffordable for those who demand it but are unable to afford it.
Initially the demand curve, D, and supply curve, S1, intersect to denote the goods market-clearing price, P1, and the quantity, Q1, demanded at P1.
The model shows a rightward shift of the supply curve from S1 to S2, placing the market in a disequilibrium.
Microeconomics also analyses different market structures:
Perfectly competitive markets – all firms sell a homogenous good, firms are price takers (they have no influence on the price of a good).
Imperfect competition – any market that does not meet one of the conditions of a perfectly competitive market. Monopolies, oligopolies, monopolistic competition, monopsonies and oligopsonies are all imperfect markets where the market power is distributed unequally. These markets can allow firms to be price makers (firms who have enough market power can impact and change the prices of their goods).
Monopoly – only one firm in the market.
Duopoly – a market dominated by two firms.
Oligopoly – a market dominated by a few firms.
Monopolistic competition – a market where there are many firms who sell goods that are differentiated from each other.
Monopsony – a market with one buyer and many sellers.
Oligopsony – a market with a few buyers.
Macroeconomics examines the behaviour of the economy at an aggregate level both nationally and internationally. Macroeconomics focuses on analysing inflation, economic growth, national income, gross domestic product (GDP), and unemployment changes and studies connections between developed and developing countries in the global economy. Key subjects studied in macroeconomics include: macroeconomic objectives, unemployment, international trade, inflation, inequality, exchange rates, globalisation, environmental economics, economic growth (recessions, boom and bust cycles, depressions), balance of payments, fiscal and monetary policies.
Key Macroeconomics Objectives:
Low inflation – price stability (UK target CPI inflation at 2%).
GDP – sustainable growth of real GDP.
Unemployment – falling unemployment / raising employment.
Higher average living standards (national income per capita).
Exports – stable balance of payments on current accounts.
Inequality – an equitable distribution of income and wealth.
In order to meet these key macroeconomic objectives, there are 2 main policy instruments available. Monetary policy involves the manipulation of interest rates, the supply of money and exchange rates to influence the economy. Secondly, fiscal policy involves the government adjusting the level of taxation and government spending.
Economic Systems
An economic system is a mechanism by which societies determine the basic problems of what, how much and for whom to produce. Economic systems can be arranged on a spectrum with capitalist systems and socialist systems at opposing ends and mixed economies in the middle.
Capitalism is an economic system where a country’s trade and industry are dictated by private firms instead of the state. According to the World Population Review Hong Kong, Singapore, New Zealand, Switzerland and Australia are the top 5 most capitalist countries in the world.
Socialism is an economic system where a country’s trade and industry are owned and controlled by the state with no private ownership. A mixed economy is a type of economic system that combines elements of both capitalism and socialism, in reality, the majority of economic systems are mixed economies.
A mixed economy is where the economy is left to the free market but if needed the government are able to intervene. For example, in the UK the government intervene to provide public services such as the NHS and education. Iceland, Sweden, France, UK, US and Hong Kong are all examples of countries with mixed economies.
Some Criticisms of Economics
The subject defends unrealistic and simplified assumptions to help study complex scenarios and simplifies the proofs of the outcomes. Some example of these widely used assumptions includes rational choice, profit maximisation and perfect information. I believe the criticism lies when economists base their theories off these assumptions even if they are not always true. For example, the assumption that consumers always act rational which is, in fact, false in real-life situations. Even though these assumptions can help break down and understand complex scenarios, critics suggest they cannot be applied to complex, real-world settings.
Related subjects
Economics regularly overlaps with many other subjects:
· Cultural economics
· Economic History
· Economics and anthropology
· Economics and biology
· Economics and mathematics
· Economics and philosophy
· Economics and physics
· Economics and politics
· Economics and psychology
· Economics and sociology
· Economic geography
· Energy economics
· Family economics
· Institutional economics
· Law and economics
Empirical Research
Empirical research is research based on empirical evidence (information achieved by observing or experimenting, this information is then analysed).
Economics uses empirical research by testing economic theories mainly through econometrics. Econometrics is essentially statistics for the type of data you come across in economics. To understand the econometric theory, you will require a solid knowledge of statistical theory. A linear regression model is the most elementary model used in econometrics to capture the impact a set of variables have on another. Computer programming is increasingly being used in economics as data sets become less manageable in spreadsheets, the new systems are capable of getting solutions very promptly. An econometric software package like ‘Gretl – Gnu, Regression, Econometrics and Time-series Library’ is a free open-source software package available to anyone globally.
For example, Economists may want to quantify the degree of influences of a certain policy. They would then build a model – either try to stimulate an economy similar to the UK on which they can experiment, or scrutinise and analyse the behaviour of past data, and conduct statistical tests on hypotheses implied by the policy. If the economists modelling/simulating technique is inadequate, or if their statistical tests are inappropriate for the type of data they are dealing with then obviously, the conclusions drawn from such modelling or testing could be misleading.
In economics, data is usually observationally analysed and rarely uses the controlled experiments seen in physical sciences consequently making the results open to interpretation and subject to change. Experimental economics is a rapidly expanding field.
Behavioural economics is a method of economic analysis that applies psychological insight into human behaviour to explain how individuals make choices and decisions. Popular behavioural economists who have received the Nobel prize include Richard Thaler and Daniel Kahneman.
Potential Career Paths
Most universities all around the world now have a department or school where academic degrees are awarded in economics for both undergraduate and postgraduate study.
Potential career paths for economic graduates:
· Accountant
· Actuary
· Forex trader
· Data analyst
· Economic consultant
· Economic researcher
· Economist
· Financial consultant
· Financial Planner
· Financial risk analyst
· Investment analyst
· Public sector roles
Economics for stock market investors
Investors aim to analyse the current market condition, generally focusing on the financial health of companies and consumers, they also make expectations about the future and try estimate prices of stocks today. This contrasts with economists who usually look a past data to provide an assessment of the economy.
Basic economic theories can be used by stock market investors. For example, the supply and demand theory which shows the quantity available and the price people are willing to pay for the product. This theory is very important for a stock investors investment analysis because it highlights whether it is a good idea to buy a stock for example, that has excess supply with very little demand, to me this would be a stock I would choose not to invest my money in.
Market investors have an understanding of different economic indicators and how they are calculated, along with their strengths and limitations. An example of an economic indicator used by investors is the Consumer Price Index (CPI) which helps to identify where the economy is going.
Economics for the foreign exchange market (forex)
The forex market is a global marketplace for the trading of currencies. Forex traders rely heavily on economic statistics and they must ensure to keep a watchful eye for the release of this data. Data such as Gross Domestic Product (GDP) is the easiest to find for each country, GDP shows if an economy is growing or not and by how much. However, it is crucial for traders to note that GDP is a lagging indicator meaning its value is based on past events. Inflation is another indicator used by traders, it signals price increases and decreasing purchasing power.
Traders generally have to research not only these two indicators but many more every week and do the same for multiple countries in order to keep up with the face-paced world of forex. This research can take up to hours even days especially for beginner traders, so here at Logikfx we compute thousands of economic reports, for over 23 economies into a simple score, every week which will save traders hours of research on fundamental macro trading.
The global macro strategy
A global macro strategy is an investment strategy which is based on the analysis of the macroeconomic principles of numerous countries. This strategy stands out from others due to its focus on the systematic risks of markets (risk to the entire market as a whole and not just a particular stock or industry). For example, the global pandemic, Covid-19, has affected most countries and sectors at the same time creating multiple industry shocks, unlike any previous crises such as the 2008 financial crisis.
Fund managers usually use currency strategies, interest rates trading and stock index strategies to trade and invest.
Currency strategies
A currency strategy assesses the relative strength of one currency with another currency, known as a currency pair. Fund managers who use this also consider the short-term interest rates between the countries being compared along with their monetary policies.
The main benefit of the currency strategy is the high leverage that can be utilised, which can lead to higher gains for traders but also leads to very risky trades.
Interest rate trading
The interest rate strategy usually invests in instruments (government debt), that coincide with sovereign global debt figures, and are traded in the cash or derivatives markets. The leverage in this market is quite substantial but less than of the currency strategy was used.
Stock index strategies
Stock index strategies focus on the equity indexes for a particular country, the trader aims to design a portfolio that outperforms when interest rates move lower.
Here is a list of companies and investment banks who are very well known for setting up global macro funds and using this strategy to successfully trade: Morgan Stanley, JPMorgan Chase, Schroders and Logikfx.
Logikfx offers the LITA programme for complete beginners who wish to learn how to trade.
Summary
· Economics is a social science that studies economic agents and the way they allocate finite resource to satisfy their needs and wants.
· Split into two parts, microeconomics and macroeconomics.
· Microeconomics examines the behaviour of single economics agents and how they interact in the marketplace.
· Macroeconomics examines the behaviour of the economy at an aggregate level.
· Capitalism is an economic system where a country’s trade and industry are dictated by private firms instead of the state.
· Socialism is an economic system where a country’s trade and industry are owned and controlled by the state with no private ownership.
· A mixed economy is where the economy is left to the free market but if needed the government are able to intervene.
· A few potential careers – actuary, data analyst, economic consultant, economist, investment analyst.
· The forex market is a global marketplace for the trading of currencies. A global macro strategy is an investment strategy which is based on the analysis of the macroeconomic principles of numerous countries. Fund managers usually use currency strategies, interest rates trading and stock index strategies to trade and invest.
· Companies and investment banks who are very well known for setting up global macro funds and using this strategy to successfully trade: Morgan Stanley, JPMorgan Chase, Schroders and Logikfx.
References
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