Topic Two. Economy 1. What Is Economy? Economy Is A

TOPIC TWO. ECONOMY 1. What is economy? Economy is a science. It deals with the ways individuals and societies choose and decide the use of scarce resources, that is, resources for which there is more demand than supply. It also deals with how the goods and services produced are distributed amongst individuals and social groups in order to satisfy their present and future needs. Economy has evolved quite a lot throughout history. The first economic activities of mankind were limited to hunting and gathering of wild fruits. As time passed by, people in the Near East—what more or less is now Syria, Iraq and Palestine —learnt to farm plants and tamed certain animals such as sheep or horses. Agriculture and cattle raising became by then the main economic activities. But such activities brought about some consequences. The first was that production of food was enough as to free some people from the task of having to produce it by themselves. Instead of this, they could do another kind of work: that of the craftsmen, who make things useful for people such as pottery or tools, while they were fed with vegetables, grain and meat others raised. The second important consequence, derived from the first, was that there had to be an exchange of goods, since nobody produced all they needed. This is the origin of trade. The first form of trade was barter, the exchange of some products for others. When trade increased, it was necessary to have a unit to express the value of the goods and, in this way, make exchanges easier. This is how money was created. Over time, people as well as regions or countries tended to produce what they could best do (i.e., at lower prices and best quality), widening commercial networks. Long before the age of Greeks and Romans, goods from distant places could be found anywhere in the by then known world. Since then, this is a trend that has strengthened until reaching the worldwide markets of our times. Make a glossary with the words in bold, looking for their meaning and translating them into Spanish.

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2. What is the importance of economy? If you pay some attention to daily news you will realize that economy is one of the topics most frequently dealt with. This fact may give you an idea of how important economy is. But what makes of economy such an important issue? One could answer this question arguing that economy influences almost everything. Decisions taken in the realm of economy by economic agents such as governments, banks or multinational companies will often have a bearing in our behaviour as consumers. An example of this could be the decision of the government to increase or to lower taxes we pay to the State. This may induce us to spend more money in goods and services or to limit our expenses to bare essentials, which, in turn, may contribute to keep the level of employment or cause the dismissal of workers from their jobs, making unemployment grow. This example is related to one of the most important laws in economics, that of supply and demand. In order to understand it, suppose that, as is happening right now, there is a great deal of stored and unsold cars. We would say that there is an excess of supply in the market of cars. Car manufacturers will then need to sell these cars to pay for the costs of making them—inputs needed such as manpower, steel, tyres, paint, etc. They will have to lower the price of cars as much as needed to find people ready to pay for them. In other words, if cars were cheap enough more and more people would be ready to buy them. As cars are being sold, we approach the opposite case, in which there is an excess of demand (or its equivalent, a shortage of supply). Then, car prices will rise again until they are too expensive, starting the process all over again. The previous example leads us to the concept of market. The usual meaning of the word makes us think of a place where goods are sold and bought. But in a broader sense, market refers to the real and possible customers for a good or a service. Thus, markets can be very wide, comprising almost all the population—for instance, the cellular phones market, for which we are all potential customers, or very narrow—for instance, the diamonds market, since not many people can or want to buy diamonds. One can say that there is a market for each and every goods and services that the economy offers. Read carefully the above paragraph and try to write a definition for supply and demand.

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Write two markets for which you consider yourself a potential customer and two for which you do not. Now understand

you the

can basic

mechanism that makes the economy work. The process begins with the needs households have. These needs cause a demand, which firms are ready to satisfy making goods or providing services in exchange for an economic profit. However, what we buy from firms is not free—i.e., it causes spending. How do we get the money we need? Selling to the firms our ability to work (labour) in exchange for a salary. Sometimes a firm cannot sell enough quantities of the goods or services it offers, because they are too expensive, its quality is too low compared to that of other manufacturers, or any other reason. As a consequence, the firm makes no profit and begins to lose money. To avoid bankruptcy, it will have to improve its productivity, producing more at lower costs, or the quality of its products. In the first case, the result is often the dismissal of workers and an increase of unemployment. If this process affects more and more firms, then a deep economic crisis develops in a vicious circle, since the more unemployed people there are, the less demand on goods and services offered by the firms, damaging even more the whole economy. It is for these reasons that sometimes firms have tried to reduce competition. This has been done by means of agreements on minimum prices to goods and services or by putting the competition out of business. In the latter case, a situation of monopoly —when a single firm controls the market—or oligopoly—when only a few firms control the market—takes place. Both practices are at present considered illegal. 3. How are economic activities classified? Economic activities are usually classified into three sectors:

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Primary: This includes the activities linked to production of goods and resources from the environment. Agricultural production and cattle raising are included in them, but also mining, fishing and forestry. These activities are predominant in less developed countries (LEDCs), where more than 50% of the population work in them. Secondary. The secondary sector is the industrial sector. This implies the transformation of raw materials into elaborated goods. The building industry is also included in it. Often it takes place in urban areas to take advantage of the proximity of consumers. In LEDCs the percentage of people employed in this sector is usually below 10%. In the most economically developed countries (MEDCs) frequently is not much over 30%. Tertiary. The tertiary sector is devoted to provide services such as medical assistance, education, transport, tourism and communications. For this reason it is also named services sector. Services are supplied throughout the countries, they are preferably concentrated in urban areas. It is the sector with the most manpower employment in developed countries, with an average of 60% of the active population (that is, population that has a job or is looking for one), while in the LEDCs it is quite variable, ranging from 10 to 40% Quaternary. A quaternary sector has been recently included to comprise all the sorts of jobs which require a high qualification and specialization level. This includes management, scientific research or consultancy. It is mainly an economic activity carried out in the most populated cities, where multinational companies have their headquarters or important delegations. In MECDs the percentage of population included in this sector is small, but growing. Apart from its classification by sectors, there is another essential fact related to economies: the way we measure their size. How do we do it? The basic indicator for this purpose is Gross Domestic Product (GDP). The GDP measures the value of all the goods and services generated by a country in a given period of time. With this indicator we can compare the size of different economies. However, this figure can be misleading, for it says nothing about how many inhabitants have contributed to it. For instance, the GDP of China was in 2008 nearly 8 billion U.S. dollars (long scale), while that of Belgium was slightly above 3 thousand million U.S. dollars (long scale). Something like twenty times smaller. However, as a

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whole, Belgians are very much richer than Chinese, because they have to divide the GDP only among 10 million, instead of 1300 million, as Chinese do. At this point we have reached a new concept, that of per capita income. It results from dividing the GDP among the population of a country. In the example above, per capita income of Belgians is 37400 U.S. dollars, while that of the Chinese is 6000 U.S. dollars. This allows us to have an idea of the differences of wealth among countries, no matter of the size of their economies.

Each economic sector contributes to the wealth of countries in different proportions depending of its structure. Contribution of each economic sector to the GDP of France and Burundi. Explain which sector produces the major part of employment and wealth in each case. Which economic differences between both economies can we deduct from the graphs?

Prim ary

Prim ary

Secondary

Secondary

Tertiary

Tertiary

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4. Who takes part in economic activities? Economic agents are all those who takes part in the economy, as producers, distributors or consumers. From this point of view, everyone is an economic agent, even though at small scale. There is an important difference that we must make between private and public economic agents. The former are individuals and companies, and the latter is the state as well as public international agencies such as the International Monetary Fund or the World Bank. Agents

Functions - Act as consumers - Provide manpower - Their savings can be used as capital - Supply goods and services - Consume the goods and services of other companies - Look for profits - Operate on a national, international or multinational basis - Can be owned by one or multiple owners - Their property is often represented by shares (property titles), sold and bought in the stock market - Makes laws to set markets in order - Collects taxes - Act as a great consumer of goods and services - Pays subsidies - Offers services such as health and education - Creates companies - Give advice - Give credits - Make economic plans - Organize trade

Individuals

Private Companies

State Public International economic organizations What are the economic agents? 5. What is needed to produce?

In order to produce the goods necessary to consumers (material things that we can buy) and provide them with the services they need (non material things that others 6

do for us in exchange of money) it is necessary to combine what are called production factors. The first production factor needed in the production process are natural resources—in other cases they are referred to as land. They include not only land but also water, air, animals, plants, energy sources and minerals. Some of these are renewable—that is, they can be regenerated, but others are not: once they are spent, they have to be entirely replaced. What natural resources of the aforementioned do you think are renewable? Labour force is the second production factor. It refers to physical as well as intellectual ability for work aimed at producing goods and services. One must establish a difference between those who work for themselves—i.e., self-employed people, businessmen, and those who work for a salary—employees, whose working conditions are set in a work contract. In Economics and Geography people are classified according to their position with respect to work. Active population comprises the people that have a job or are searching one. In the first case, they are part of the employed population; in the second case they are unemployed. Inactive population comprises the rest: minors, retired people, students and household workers. Trade Unions are important economic agents. Their task consists mainly in improving the working conditions and the salaries of employees. On the other hand, employers are also associated in organizations aimed at promoting the best possible conditions for business. How many Spanish trade unions do you know in Spain? Do you think they are influential? Technology or machinery is the third production factor. As a whole, it comprises of not only all the hardware needed to manufacture goods, but also the processes devised to transform raw materials into finished goods or to render a service. Capital is the fourth production factor. Usually, capital is wrongly identified with money, but it is quite more than that. It can be defined as the resources needed to produce goods and services. In a sense, capital comprises the rest of the production factors. Thus we talk about human capital, referring to trained people able to perform certain tasks of more or less difficulty; physical capital, in reference to the tools and raw materials needed to produce something; and financial capital, the money invested in making all the productive process work. 7

In the latter case, the source of the money can be a single person, but more often it is a number of anonymous investors who buy shares of a given company, becoming owners of a part of it. As long as the company obtains benefits, share owners are rewarded accordingly to the number of shares they have, and these shares increase their price in the stock exchange market, where they are sold and bought. But if the company does not obtain benefits, the company loses money and the price of the shares descends. When the price of shares is extremely low or nil, the company goes bankrupt and the investors lose all the money put into the company. Do you agree with the idea that the risk investors take putting their money in companies should be rewarded in any case? These production factors are essential to explain the difference of wealth among countries. On the first hand, natural resources help to make a country wealthy, but it is not all that is needed. Skilled labour force, scientific and technical research, markets and infrastructures are also needed. Some countries are underdeveloped in spite of having vast natural resources. This is the case of many countries in Africa and South America. The explanation of this fact rests mainly on the lack of some or all the other production factors. Other countries do not have important natural resources, but their skilled labour force, combined with scientific and technical research, capitals, worldwide markets and infrastructures make up for the lack of them. Japan and Switzerland are two examples of this. Finally, one can single out the United States as the country with all the production factors needed for being the biggest economy of the world. Historical reasons and the structure of international trade strengthen this pattern of international distribution of wealth.

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