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Tag: econ help

  • What are the Fed’s new monetary policy tools?

    Today we’re going to talk about a really important topic: what are the main tools that the Federal Reserve uses to influence the economy and how does it do it?

    We will also learn the tools that the Fed uses in its new monetary policy and how they are different from their old way. Don’t worry if you’re not familiar with economics, because I am going to break it down step by step.

    So, first things first, what is the Federal Reserve? Well, it’s the central bank of the United States and to put it simply, The Federal Reserve (the Fed) is like a bank for the U.S. government.


    If you look at the Federal Reserve website, it says “One of the most important functions of the Fed is to promote economic stability using monetary policy. The Fed’s goals for monetary policy, as defined by Congress, are to promote maximum employment and price stability.” This means the highest level of employment that the US economy can sustain while maintaining a stable inflation rate of around 2%.

    So how does the Fed control the economy?

    The Fed has some tools to control the economy, these are monetary policy tools. Imagine the economy is like a car. If it’s going too fast and might crash, then the Fed can step on the brakes. If it’s too slow, they can press the gas pedal.

    The FOMC is the money boss

    So let’s understand how the Fed works, The Federal Open Market Committee, or the FOMC is like the money boss of the Federal Reserve. They meet in Washington, D.C., eight times a year to talk about the economy. They look at economic data and statistics, talk to economists, and decide how much interest banks should charge each other.

    This interest is called the federal funds rate. Fed funds rate is the banks’ overnight lending and borrowing rate from each other. This rate matters because it affects how much regular people pay for things like houses and cars. If it’s high, things are a bit more expensive. If it’s low, things are more affordable.

    Let’s understand it step by step, Banks have a place where they put some of their money, called the Federal Reserve. They earn interest on it. Sometimes, one bank has extra money and another needs some to do their everyday stuff. So, the bank with extra money can lend it to the one that needs it. The important part is that the interest rate for this lending is not decided by the big boss or the Fed but by the banks themselves. They agree on a fair rate and it is thus market-determined.

    So how does the Fed steer this key interest rate in the target range set up by FOMC?

    The Fed uses its two administered rates – the first is the interest on reserve balance and the second is the rate on reverse purchase agreement. These are their main monetary tools to control the Federal funds rate in the current times.

    According to the Fed’s chair, Jeremy Powell, “The Federal Reserve sets two overnight interest rates: the interest rate paid on banks’ reserve balances and the rate on our reverse repurchase agreements. We use these two administered rates to keep a market-determined rate, the federal funds rate, within a target range set by the FOMC.”

    When the FOMC wants the fed funds rate to go up, the Fed moves the interest on the reserve balance up. This rate sets the lowest interest rate banks are willing to accept when lending out their money to anyone else. Since banks can also earn this interest by depositing their money at the Federal Reserve and keeping money with the Fed is a safe way to earn money, banks prefer to do this rather than lend it at a lower rate to another bank.

    This acts as a floor for the Federal funds rate, which means the banks will not accept any lower interest rate than this to lend money to one another for a short term.

    Another important concept to understand here is called “arbitrage,” which is like making a profit by buying low and selling high. So let’s say the federal funds rate is 5.5%, and the Fed pays 6% for deposits to be kept at Fed, banks can borrow at 5.5% from other banks and then deposit at 6% to make a profit.

    This pushes the federal funds rate up until it’s close to the interest on reserve balances rate (6%). Similar to the interest on reserve balance which is mainly for commercial banks, the Fed also has other tools, like the “Overnight Reverse Repurchase Agreement Facility,” which is the interest other broader financial institutions can earn by keeping money at the Fed. Thus, it serves the same purpose as the interest on reserve balance and sets a floor for the federal funds rate, which means the federal funds rate won’t go below this.

    The other tool the Fed uses is the Discount Window. Because banks will not likely borrow at a higher rate than they can borrow from the Fed, this acts as a ceiling. It is set higher than the interest on reserve balances rate and the overnight reverse repurchase agreement rate.

    So these are two tools that the Fed is now using in the ample reserves case.

    The Fed’s tools before the 2008 crisis

    The Fed used to use this tool called Open Market Operations as its primary tool, where it bought treasury securities to pump money into the economy. However, after the 2008 financial crisis, it has ample reserves that it only buys government securities to make sure the reserves remain ample in the banking system. So, it uses open market operations only as a supplement tool.

    So how does the FOMC decide on the target interest rate?

    Economic data on inflation and unemployment helps the FOMC decide its target interest rate. Over the years, FOMC has been changing this Federal funds rate target range up and down to help the economy. Think of it like a volume knob on your music player.

    When the economy was in trouble after the 2008 financial crisis, the Fed turned the volume to almost zero to help it get better in 2015.

    Then, when the COVID-19 pandemic happened, they quickly turned the volume back down to almost zero to help the economy during that tough time.

    Most recently, since last June 2022, the Fed has been raising the interest rate to control inflation. As of today, the target range for the Federal funds rate is between 5.25 to 5.50%.

    So, you can think of the Fed as a DJ for the economy, adjusting the volume to keep things running smoothly.

  • How government intervention is needed for social benefit?

    Today, we’re diving into the fascinating world of economics to discuss a crucial concept that often goes unnoticed but has a profound impact on our daily lives – externalities.

    What are externalities?

    Before we delve into examples, let’s define what externalities are. In economics, externalities refer to the unintended consequences of economic activities that affect individuals or entities not directly involved in the transaction. These external effects can be positive or negative, and they often lead to a divergence between private and social costs or benefits.

    Some Examples of Positive Externalities

    1. Education

    To better understand positive externalities, let’s take the example of education. When an individual pursues education, they gain knowledge and skills that benefit them personally. However, education also has positive externalities that extend beyond the individual. When educated people enter the workforce, they contribute to the economy’s productivity, innovation, and overall growth.

    2. Vaccination

    Another example is when the Government provides Vaccination. In the most recent case of the COVID-19 pandemic, people who got vaccines were less likely to get extremely sick or spread the virus to others.

    Similarly, any vaccination for other infectious illnesses provides health benefits not just to the person receiving the vaccine but also to the entire community of people he or she comes in contact with.

    Negative Externality

    Now, let’s shift our focus to negative externalities, using the example of pollution.

    When a factory produces goods, it incurs private costs like labor and raw materials. However, it may also release harmful pollutants into the air or water, causing damage to the environment and people nearby.

    Impact of Externalities

    Externalities can significantly impact market efficiency. When externalities are present, markets may fail to achieve an optimal allocation of resources, leading to overproduction or underproduction of goods and services.

    How can government intervention solve the problem?

    Governments can step in to correct the market failure caused by positive externalities. For example, they may provide subsidies to educational institutions or offer tax breaks to individuals pursuing education. This encourages more people to invest in education, leading to a better-educated workforce and more prosperous society.

    Similarly, to address negative externalities like pollution, governments may impose regulations, taxes, or fines on polluting industries. By internalizing the external costs into the production process, these measures encourage businesses to adopt cleaner and more environmentally friendly practices.

    Conclusion

    Externalities are all around us, influencing our decisions and shaping our economy in both positive and negative ways.

  • The rice export ban by India will have a major impact on the World

    Hi all, today, I am going to dive into some breaking news that’s sending ripples across the world’s food markets.

    There’s a rice ban in play by the Indian government, and it’s set to have some major consequences.

    Brace yourselves because this ban is no small deal. It’s projected to reduce the world’s rice shipments by almost half, leaving many wondering what this means for inflation and food prices worldwide.

    What is causing the ban?

    So, you might be asking, “Why the ban in the first place?” Well, here’s the deal –

    Last week, the Indian government put a ban on the export of non-Basmati rice varieties.

    Retail prices for white rice have been on the rise in India, and it’s got the Indian government on high alert.

    In just one month, white rice prices shot up by 3%; over the past year, they increased by a whopping 11.5%. Ouch!

    But here’s the kicker: Devastating monsoons, on which Indian agriculture relies heavily, are the main reason affecting this price surge.

    The unpredictable weather has wreaked havoc on rice production in India, creating concerns about food supplies in India and beyond.

    And that’s why the Indian government had to make some tough decisions.

    Key points showing the impact

    Now Let’s break down some key points to get a clearer picture of the impact:

    1. A rice ban of this magnitude will affect about half of the world’s rice exports – that’s a huge chunk!
    1. India is a major player in the global rice market, accounting for a whopping 40% of all rice exports. So, when India makes a move, the world will notice.
    1. Here’s a staggering statistic: rice is a staple food for over 3 billion people worldwide. Yes, you heard that right, 3 billion! That’s roughly 40% of the entire world’s population relying on rice as a dietary staple.

    NRI community in the US is hoarding rice further increasing the price and shortage

    In the US, the ban on non-Basmati rice exports from India is causing quite a stir. This is especially among the Telugu community living here. People are rushing to stock up on rice, fearing a potential shortage and higher prices.

    Indian grocery stores in major cities like Texas, LA, Michigan, and New Jersey are seeing long queues and a surge in demand for rice.

    Why all the fuss over rice? Well, a 9kg bag of rice is being sold at a massive PRICE OF 27 dollars due to the export ban, which is contributing to the worries.

    These grocery stores have even implemented restrictions, allowing only one rice bag per customer to manage the situation.

    Why is this panic buying happening?

    The panic buying might be twofold:

    First, there’s concern about the scarcity of fine variety rice like Sona Mahsuri, which is much sought-after.

    And secondly, with the ban in place, there’s a possibility of rice prices skyrocketing.

    According to a leading economic news source in India, Economictimes, several countries, including Benin, Nepal, Bangladesh, China, Cote D’Ivoire, and others, heavily rely on non-basmati rice imports from India. With this recent ban, it’s projected that world rice shipments will be cut almost in half, raising fears of global inflation in food markets.

    So, guys, this rice ban is causing quite a stir in the world’s food markets  With half of the world’s rice shipments set to be impacted and India being a significant player in the global rice trade, we can’t underestimate the potential consequences.

  • The economics behind overbooking done by the Airlines

    Picture this: you’ve arrived at the airport, excited about your upcoming trip, only to hear those dreaded words at the gate, “We regret to inform you that this flight has been overbooked.” Frustrating, isn’t it? But have you ever wondered why airlines resort to overbooking flights? Let’s find out.

    Today, we’re delving into a question that has puzzled many passengers: Why do airlines overbook flights?

    What is overbooking?

    But first things first, what exactly is overbooking? Put simply, it’s when an airline sells more tickets for a flight than the available seats on the aircraft. Seems counterintuitive, right? Well, airlines engage in this practice based on historical data and statistical analysis.

    Reason 1: No-show Passengers: Airlines overbook flights because they expect a certain number of passengers to not show up. This happens more often than you might think. Passengers may miss their flights due to various reasons, such as traffic delays, personal emergencies, or even connecting flight issues.

    So, why do airlines take the risk of overbooking flights?

    Overbooking allows airlines to maximize their revenue and efficiently utilize their available resources. It’s a balancing act, predicting the number of no-show passengers to ensure a full flight without causing excessive inconvenience to passengers.

    Overbooking helps airlines maintain high load factors, which means filling as many seats as possible on each flight. This leads to optimal fuel usage, better cost management, and a higher chance of profitability. Moreover, a full flight reduces the need for rescheduling or canceling flights, which can disrupt passengers’ travel plans.

    Reason 3: Compensation Options

    When an airline realizes that a flight is overbooked and there are not enough volunteers to give up their seats, they might have to involuntarily deny boarding to some passengers. In such cases, the passengers are entitled to compensation, which can vary depending on local regulations. This compensation usually includes options like rebooking on a later flight, accommodations, meal vouchers, and sometimes monetary compensation.

    Now It’s clear that airlines have their reasons for overbooking, but it’s important to address passengers’ concerns as well. Let’s talk about that.

    So how do airlines handle the frustration and inconvenience caused by overbooking?

    Airlines understand that overbooking can be frustrating for passengers, and they strive to minimize the impact. They typically use sophisticated algorithms and predictive models to estimate the number of no-shows accurately. If a flight is overbooked, airlines prioritize finding volunteers willing to give up their seats in exchange for compensation before resorting to involuntary denial of boarding.

    Conclusion

    Thus, airlines overbook flights to optimize their operations, maximize revenue, and account for the possibility of no-show passengers.

  • Understanding Credit Scores

    A credit score is a three-digit number that represents your creditworthiness, that is, how likely you are to repay a debt. Credit scores range from 300 to 850, with higher scores indicating better creditworthiness. A credit score is calculated based on various factors, such as your payment history, credit utilization, length of credit history, types of credit used, and new credit accounts.

    How are credit scores calculated?

    Let’s take a closer look at how credit scores are calculated. Payment history is the most important factor, accounting for 35% of your credit score. It refers to how you’ve paid your debts in the past and whether you’ve made payments on time. Late payments, defaults, or collections can significantly lower your credit score.

    The second factor is credit utilization, which makes up 30% of your credit score. It’s the amount of credit you’re using compared to your credit limit. Keeping your credit utilization below 30% is considered good, and exceeding it can negatively impact your credit score.

    The length of your credit history makes up 15% of your credit score. The longer your credit history, the better, as it indicates a more stable financial track record.

    The types of credit you use also matter, accounting for 10% of your credit score. Having a mix of different types of credit, such as credit cards, car loans, and mortgages, is considered good, as it shows you can handle different types of debt.

    Finally, the last factor is new credit accounts, which make up 10% of your credit score. Opening too many new credit accounts in a short period can negatively impact your credit score.

    Why are credit scores important?

    Now that we know how credit scores are calculated, why are they important? Your credit score can affect your ability to get approved for credit cards, loans, or mortgages. A higher credit score can lead to lower interest rates, saving you money in the long run. Additionally, employers and landlords may also check your credit score to evaluate your financial responsibility and trustworthiness.

    Now, let’s look at some examples of credit scores and how they’re typically categorized:

    • A credit score of 750 or above is generally considered very good or excellent. This indicates a strong credit history and may qualify you for the best interest rates and terms on loans and credit products.
    • A credit score between 700 and 749 is typically considered good. This shows that you have a solid credit history, but there may be some room for improvement in certain areas.
    • A credit score between 650 and 699 is generally considered fair or average. This means you may have some negative items on your credit report or a shorter credit history, but you may still be able to qualify for credit products.
    • A credit score between 600 and 649 is typically considered poor. This indicates a higher risk to lenders and may result in higher interest rates or less favorable terms on loans and credit products.
    • A credit score below 600 is generally considered very poor. This indicates a significant risk to lenders and may make it difficult to qualify for credit products or result in very high-interest rates.

    It’s important to keep in mind that credit score ranges and categories can vary depending on the scoring model used and the lender’s specific criteria. However, in general, a higher credit score is typically viewed more positively than a lower score.

    CONCLUSION

    In conclusion, understanding credit scores is crucial for your financial health. It’s a three-digit number that represents your creditworthiness, calculated based on various factors such as payment history, credit utilization, length of credit history, types of credit used, and new credit accounts. A higher credit score can lead to better financial opportunities, while a lower score can limit your options. So, be sure to monitor your credit score regularly, pay your debts on time, and keep your credit utilization in check.

  • The jobs market in the US is still going strong

    Two days ago, President Joe Biden proudly posted that the unemployment rate in the US was 3.5% in July. This matched the lowest rate in the last 50 years. He also said that since he started, 10 million jobs have been created in the US economy.

    Praising the fastest-growing job market, Biden mentioned that 528,000 jobs were added in the US in July itself. “Today, we also matched the lowest unemployment rate in America in the last 50 years: 3.5%,” he said.

    The Bureau of Labor Statistics (BLS) in the US publishes data for the unemployment and labor force statistics every month. These are based on the data collected from household surveys and establishment surveys on sample-based estimates of employment.

    I got this Civilian unemployment rate graph from the BLS. You can see that the US unemployment rate is now at its lowest level at 3.5%. This had happened three times before in Sep 2019, Jan 2020, and Feb 2020, when it hit 3.5%.

    But have you ever wondered what is the unemployment rate anyway?

    Well, the unemployment rate is the percentage of people who don’t have a job but can work and have actively looked for a job in the past 4 weeks. This is relative to people in the labor force.

    According to the BLS, The labor force is the sum of employed and unemployed people ages 16 and older at a given period.

    Their recent report about July’s unemployment rate was contrary to what many people would have expected. People were expecting a somewhat slowdown in the job market, but clearly, this hasn’t happened yet. The Fed has been raising interest rates to control inflation. The Fed’s policy aims to cool the overheated economy by reducing overall spending by individuals and businesses.

    So what does a low unemployment rate mean for you?

    If you are looking for work or want a change of job, right now could still be a good time for that. There’s a huge likelihood of you finding it sooner than later and as per your terms. With many employers paying higher salaries, it is a good time to ask for a raise if you think you deserve it.

    When the effects of tightening monetary policy start showing up and we see a reduction in jobs created, it might be a little late to negotiate.

    As always, if you enjoyed reading my post and learned something, please feel free to write your views in the comment section below. Thank you, till we meet again next time!

  • What does a vaccine, a park and a factory have in common?

    These are all examples of externalities. Sorry, if this sounds too complicated at the beginning, it will all make sense as you read along. Externalities can happen when the after-effects of certain actions can spill over to other people not directly involved in it. These could be either positive or negative spillovers.

    Externalities can arise between producers, between consumers or between consumers and producers. Externalities can be negative when the action of one party imposes costs on another, or positive when the action of one party benefits another.

    Let’s look at an example of a positive externality. Vaccination for any infectious disease would be a positive externality because vaccination will reduce the overall severity, symptoms, and thus the possibility of spread of infection of that particular disease. This will also benefit people who are not vaccinated through positive spill overs by others who are. People who didn’t receive the vaccine are less likely to get an infection if more and more people around them are vaccinated. Vaccination also reduces the burden on a country’s healthcare and benefits society. Most recent example of this is the Covid 19 vaccine, which was provided mainly by the government in many countries to stop the spread of infection.

    In both positive or negative externalities, government intervention is required to make sure the businesses that create externalities get the benefits for positive externalities or pay the price for negative externalities.

    If a factory is producing toys but at the same time polluting the environment, people are bearing the cost of pollution. This is a negative externality. From an economic perspective, the business is transferring some of its cost of production to society. Without any tax on pollution, that business factory’s actual cost of production is less than what it should be, so it can charge lower prices from the people for the toys it produces. This reduced price creates more demand for toys, making the business produce more and more toys and thus polluting the air more.

    In our first example above, the factory will find ways to reduce its chimney smoke from polluting air if it has to pay the price for its pollution. Government can impose taxes in these cases. Tax will also increase the overall cost of production for the business. The business will be forced to charge higher prices from the consumers, which will, in turn, reduce the demand for it and the over-pollution problem will be solved to some extent. Similarly, water pollution that is caused by industrial effluents can harm ocean life, other plants, animals, and humans. The government imposing a tax on factories creating water pollution can limit it to some extent. In economics, the use of tax to limit negative spillovers is known as internalizing the externality.

    Another type of negative externality is caused by smoking. The government wants to discourage smoking and thus impose heavy duties and taxes on cigarette manufacturers because active or passive smoking both are harmful to society. Thus, cigarettes sell at a fairly expensive price. People who can’t afford to buy can refrain from consuming it. Also, smoking is banned in public places and to minors, these are all attempts to reduce the consumption of smoke.

    Similarly, to encourage businesses with positive externalities, government can provide subsidies to those producers. When producers get subsidy it lowers their cost of production and it encourages them to produce more. Also, the subsidy is a government expenditure, which government meets through taxation on general public. This taxation on general public is either form of direct tax (like income tax) or indirect taxes (like those paid on goods and services when we buy them.) Thus, the society who is reaping the fruits of a positive externalities ultimately ends up paying the price of subsidy.

    One example of this is public (government funded) education, when the government subsidizes public education, a greater quantity of education (more schools and colleges) is made and the society as a whole reaps the spillover benefits of more educated people. Also, parks, the police force, and public hospitals provided by the government provide benefits to any person who lives in the neighborhood. These are called public goods with positive externalities that are nonexcludable and benefit the larger public who indirectly pay for them through taxation.

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  • What role do models and graphs play in economics?

    Our economies are complex, but by making some simple assumptions, we can focus on what is most relevant in explaining something. For this reason, economists use models to give us logical and precise reasoning behind many questions that come to our minds. Sorry, if you thought of this model as the one who walks on the ramp or does an ad on TV. Unfortunately, here we are talking about a little bit boring, economic models. Unlike attractive human models, these models generally consist of a set of mathematical equations, which are a simplified depiction of the real world. So, even if they are not pretty looking, they serve a very important role in economics. They try to precisely (like theories in science) describe how and why, we, as economic agents, act and are likely to act in future.

    One of the most important models in economics is the demand and supply model, together they explain how the price of anything gets determined.

    Economists use models for a variety of reasons, some of these include:

    • To assist in academic research that supports a proposed economic theory
    • To make economic forecasts so that we can understand the conclusions based on the assumptions made
    • To influence policy making relating to larger economic activities or at macro level
    • To explain and influence company strategies for businesses
    • To explain the growth pattern among countries
    • To understand banking, investment and saving behavior
    • To explain decision making at household level

    And many more…

    Even though, no economic model is a perfect description of reality, the process of making, testing, and revising these models forces economists and policymakers to think logically when trying to propose something. With the help of these mathematical models, they try to accurately depict how the economy works, and what drives economic behavior in people at large. This in turn helps them answer what they should or should not do when proposing a particular policy.

    These economic models use a lot of mathematics, as one of the key contribution of economics to mankind is how to think on the margin. That means calculating the additional benefit, and the additional cost of any particular action. Knowledge of calculus comes in handy in finding these solutions. So, if you or someone you know are planning to study economics in college, make sure they are good at calculus and algebra.

    Economists also use a lot of graphs, as these are a good visual representation of these economic models. The charts and graphs are relatively easier for people to understand as compared to mathematical models. So for my blogs, I will stick to graphs only. 🙂

  • How price of anything is set?

    The answer to this complex question is simpler than you might think.

    Do you think a business can charge whatever price it wants, to get the highest possible profit? But consumers who demand those products would like to buy them at the cheapest price, so how do they come to a consensus? In markets that are highly competitive (see footnote)*, meaning there are many producers and consumers of a specific good or service, the price of that product or service gets determined by the interaction of supply and demand forces. These forces work together in the same manner as the blades of the scissors cutting the paper.

    Wait, but what are these supply and demand forces?

    First, let’s understand them individually, and later we will see how they interact to set the “right” price.

    Demand

    In economics, we assume that people buy more of something when its price is lower. This negative or inverse relationship between price and quantity demanded is called the law of demand. This means the higher the price, the lower the demand is, and the lower the price, the higher the demand is for any normal good or service. Undeniably, a change in people’s tastes, income, and preferences can affect the demand for something, but we will assume that these other factors don’t change, so we can only focus on the relationship between price and quantity demanded.

    Let me explain this with a simple example of the demand for bread. The prices are shown on the Y-axis and the quantity that people are demanding is on the X-axis. You can see this inverse relationship in the graph below that slopes downward.

    If the price of one loaf of bread is $10 there is going to be very less demand for it, let’s say only 10 loaves of bread will be demanded. Once the price is lowered to $6, a few more people will be willing to buy it, so the quantity demanded increases to 20. And if the price is further lowered to $2, more people would be willing to buy it, as more can afford it, so the quantity demanded now is 40.

    Supply

    Now let’s look at the supply pattern. For a producer, if he gets a higher price for bread, he will be willing to make more bread and supply more of it. A higher price or reward encourages producers to supply more, and you can see this positive relation in the graph below as an upward-sloping supply curve. So, the law of supply states that there is a positive relationship between the price of a good and quantity supplied. This means the higher the price, the more businesses or producers are willing to supply, and the lower the price, the less they would like to supply. In the graph below, we can see at $2, producers are only willing to supply 10 loaves of bread, at $4, 20 loaves, and at $10, 40 loaves of bread will be supplied.

    Now when we plot both of them together in one graph, we will see there is one price, where both these curves meet. In economics, we call it an equilibrium point, where the price is just right for the producer/seller and the consumers. In the graph below, this happens at point A, where demand and supply meet or cross each other. The price is set at $4 and the quantity demanded and supplied is 25 loaves of bread. Thus, we saw no one individually impacted the price, but producers’ supply and consumers’ demand worked together to set the price that makes everybody happy.

    You understood how prices can influence how much people want to buy and produce. Now, let’s understand also, how it works the other way round, meaning how much people demand and businesses supply can influence the prices as well.

    If there’s more demand than supply for something (such as point B above), this will send a signal to the producers to increase the price from $2 to $6, because they understand that people are prepared to pay more to receive that good or service. In this case, there is an incentive for the producers to increase the price. If the price goes up to $6, some consumers will drop out as they won’t be able to afford bread at price $6.

    On the other hand, if there is more supply than demand (shown as point C above), this is a signal to the producers to lower the price from $6 to $2, because the price at $6 was too high and there is a very limited number of people who are willing to buy it. Now some producers, might drop out and can’t lower the price to $2, because they can’t cover their cost of production.

    Over time the price will keep moving upwards or downwards until it reaches a point where demand is equal to the supply, at point A ($4).

    Today, you learned two fundamental concepts in economics: the law of demand and the law of supply.

    If you are wondering about whether it is possible to plot these demand and supply curves in real life, the answer is, yes? In economics, a graph is just a simple representation of economic principles or behavior observed. Economists survey people and collect data and plot that data using easy-to-understand graphs. In the demand and supply curves we looked at today, the slope could be steeper or flatter. In order to learn what decides how steep or flat (demand or supply) curve will be, we will have to look into another important principle in economics called elasticity. More on that will be in my future posts. For now, if you just want to know why economists use models and graphs to solve real-world economic problems, please read my post here.

    *In non-competitive markets, like monopolies, where one company controls the market, it gets more control in setting the price. The demand and supply forces don’t work very well here. Producers want to get the maximum profits by setting the price higher and can do that as well. In the absence of other competing businesses, consumers who want to buy their product or use their service, don’t get other options. Hence, they end up paying a higher price than they would have paid if more companies were in the market for that product or service. Usually, to prevent businesses from exploiting consumers, some government intervention is required so these monopolies don’t create artificial barriers to entry.  

    It is worth noting that, some monopolies can happen naturally and not all monopolies are bad. We will look at this more in detail with real-world examples in another post.

  • We hear this word so much in news, but what exactly is an economy?

    Has it ever happened to you while listening to the news that there is some big scary vague thing called the economy that’s just out there? You might think you have no control over it, as most of it is based on business and government decisions. You are wrong here!

    You are also a very important player in the economic game. The economy is just all of us together, acting in our own individual best interests, deciding how to use the limited resources we have, to get the maximum happiness. By pursuing our selfish interests, we indirectly contribute to the growth of society, by the magic of some invisible hand.

    We all are in the economy as everyday people, who are going about everyday tasks and decisions. The main point is that we’re all actors in the economy rather than spectators. So, we are not passively looking at this thing called economy but taking an active part in the economy all the time.

    In other words, an economy is a large set of interconnected production, consumption, and trade of goods and services that help in determining how scarce resources are allocated. I know in economics some fancy words are often used, such as “scarce”. By scarce we mean limited, something that we don’t have an infinite amount of.

    It is true that in the news, macroeconomic indicators are discussed more often, like inflation, GDP, unemployment, etc.  But believe it or not, a lot of times, the decision-makers behind these big indicators are millions of small entities like you and me. In microeconomics, we look at how people can make the best decision they can to make their lives better by making good choices.

    We apply an essential economic tool called “thinking on the margin” in our daily lives. It essentially means evaluating the benefit of one extra unit of something vs. the cost of one extra unit of the same thing.

    For example, should I spend one more hour studying? Should I eat one more pizza slice? Small decisions like that are also economic decisions. Households, businesses, and governments all think about tradeoffs and marginal cost vs marginal benefit analysis while taking many decisions in life.

    For an individual, it is a personal decision like should I spend a few additional minutes reading this article or should I switch to some other activity that may give me more marginal benefit? Similarly, firms must decide whether to hire additional labor to increase production and by how much? Will the extra revenue generated from hiring that extra labor to be enough to cover his cost of wages?

    Lastly, on a macro (aggregate) level, governments make the monetary and fiscal policies to make more significant decisions by doing the same marginal analysis. Should they build an extra park or use the money on healthcare? We need to remember that the principles of economics can provide guidance across all sectors, be it at the micro-level or macro level.