Economic Theories That Shape Our World
We live in an economy with complex systems and theories that dictate them. Have you ever wondered why we saw economic prosperity during times of warfare? Or how economists are able to predict a country’s growth? Today, we will be addressing the various economic theories that shape our world as we know it today.
Supply and Demand
One of the most important concepts to grasp in economics is supply and demand. When i say it is fundamental — it is fundamental! As important-sounding as it is, the theory is actually not that complicated, so don’t let it scare you away.
I’m going to use an analogy for this. Think of supply and demand as a hot tap and a cold tap for your bathtub. They’re separate taps that you have to control. But you can’t just magically turn the tap on, you need water. For supply and demand, there are rules, too. Supply can only exist where it has the capacity to do so in terms of resources and labour. Demand can only exist when people want things and can afford them.
So we now have water. Your job is to make the water reach a nice temperature, at an equilibrium where everyone is happy. This equilibrium is hard to reach. You don’t want the water to be too hot. You don’t want the water to be too cold. You don’t want too much supply, which means your price is too high. You don’t want too much demand, your price is too low. You want it to be just right!
There’s ways to artificially affect the supply and demand curves through different government policies, but generally, the market has a tendency to fix itself.
The Business Cycle
One of the fundamental theories that shapes our world, the business cycle was groundwork for many modern economists. The theory is broken down into 4 main phases: expansion, peak, recession, and trough. The cycle repeats itself in an unending loop and is impossible to accurately predict, even though there are economic tools we’ve developed that has enable us to better understand indicators that we shift from one phase to another.
Found in 1946, the business cycle at its core is driven by the basic concept of supply and demand. When there is more supply than demand, producers try their best to catch up. They employ more people, make more things, and are able to sell more things. Their employees are also able to afford things from their payrolls, so they push the demand further. When this happens, we’re in an expansion. These are times of economic prosperity and great innovation. However, there is no real way to keep demand high forever. Think about it this way, if everyone is buying phones, the industry would be booming — but we can’t buy a new phone everyday, can we? When we stop buying phones, demand drops and suddenly we have too much supply. When this happens, producers stop making stuff and start laying people off. This sets us into a recession because there is no economic movement and money is stagnant within the economy.
The business cycle is the terminology you will most often see economists and analysts use when discussing the economy. Generally, it gives the public a good idea of economic activities in the foreseeable future. The business cycle is also a powerful tool for policy makers and government personnel. It assists fiscal policies and helps them visualize the movement of the economy.
Free market vs Command
There are 2 main streams of economic thought: free market and command. They are 2 extremes that we don’t often go to, currently, there are no pure market or command economies. Economic systems we live in are usually a mix economy of the two. However, understanding the extremes of economic systems is extremely helpful when evaluating approach to policies.
Free market (sometimes also known as laissez-faire) economy is just as its name suggests: letting the market make decisions. Public supply and demand is driven by individuals and is a self-regulating system. This was the predominating line of thought in classical economic theories, with many famous economists being strong advocates for it.
On the other end of the economic spectrum, we have command market. These theories suggest it is best to have a centralized decision-making body for the economy. It is believed that the way to achieve economic prosperity is if the market is regulated and directed, optimizing effectivity.
Theory of Comparative Advantage
Ever thought about why Canada hasn’t tried to be self-sufficient in growing oranges? From a technological standpoint, we absolutely can. We can build greenhouses and maximize capacity. But we don’t, because it’s so expensive that there is no point. Instead, we produce lumber and other raw materials that is more compatible with the Canadian climate and buy our oranges from countries that can, as Gen Z calls it, slay it better. This is the cornerstone to global trades.
The concept to trade between countries were first developed by Adam Smith and later by David Ricardo. The theory of comparative advantage states that countries should specialize in producing what they are good at which leads to global efficiency. This theory essentially encourages countries to not be self sufficient in everything, making global trade possible because of the supplies that countries may lack from focusing their efforts in selective industries.
Consolidation
There are many other economic theories, and depending on who you talk to, they may have very different ideas of what fundamental theories are. The above are the theories that allowed me to understand the daily operations of our world. I encourage you to learn more if this article interests you, there’s so much more out there!
