Chapter 3: Economic Principles

Introduction to Economics

• Economics is about understanding choices made by individuals, companies, and governments.
• Market economy includes all activities related to producing and consuming goods and services.
• Scarcity limits our ability to acquire certain goods and services.
• Prices are determined by the interaction of supply and demand.

Demand and Supply

• Interaction between market participants determines prices for goods, services, shares, etc.
• Key principle:
  • If demand is high but supply is low, prices go up.
  • If demand is low but supply is high, prices go down.

Microeconomics vs. Macroeconomics

Microeconomics

• Focuses on behavior of individual consumers, households, and producers.
• Analyzes supply, demand, and prices of specific markets.
• Example Questions:
  • How does a minimum wage affect labor supply and company profits?
  • How do tariffs impact industries?
  • How does capital gains tax influence investment decisions?

Macroeconomics

• Looks at the economy as a whole.
• Major topics include unemployment, inflation, national debt, government spending, etc.
• Example Questions:
  • Why did GDP shrink?
  • How does interest rate affect economic growth?
  • How can a nation improve its standard of living?

Economic Decision Makers

1. Consumers
   • Aim to maximize satisfaction with limited resources.
2. Businesses
   • Profit-driven entities that benefit shareholders.
3. Governments
   • Provide infrastructure and services like defense, education, and health care.

Market Equilibrium

• Price of goods is determined by demand and supply interaction.
• Law of Demand: Higher prices lead to lower quantity demanded.
• Law of Supply: Higher prices lead to higher quantity supplied.

Measuring the National Economy

• Gross Domestic Product (GDP):
  • Market value of all goods and services produced in a year.
  • Expenditure Approach: Measures total spending on goods/services.
  • Income Approach: Measures total income earned by producers.
• Nominal GDP vs. Real GDP:
  • Nominal GDP does not account for inflation.
  • Real GDP adjusts for inflation, reflecting actual growth.

Economic Growth Determinants

• Factors contributing to GDP growth:
  • Increase in population.
  • Increase in capital stock (machinery, processes).
  • Improvement in technology.
• Economic cycles: expansion, peak, recession, recovery.

Economic Indicators

• Leading Indicators:
  • Predict economic changes (e.g., housing stats, stock market).
• Coincident Indicators:
  • Reflect current economic conditions (e.g., GDP, personal income).
• Lagging Indicators:
  • Change after economic shifts occur (e.g., unemployment rates).

Recessions

• Defined as two consecutive quarters of declining GDP.
• Key factors for judging a recession: depth, duration, and impact on the economy.

Labor Market Indicators

• Participation Rate: Share of working-age population in labor force.
• Unemployment Rate: Share of employed individuals actively seeking work.
• Types of Unemployment:
  • Cyclical: Tied to economic fluctuations.
  • Frictional: Normal job turnover.
  • Structural: Mismatch of skills and jobs.
  • Seasonal: Jobs tied to specific seasons.

Interest Rates

• Link between current and future economic activity.
• Affects borrowing costs and consumer spending.
• Factors influencing interest rates: demand and supply of capital, risk assessment, foreign interest rates, and central bank credibility.

Money and Inflation

• Money serves as a medium of exchange, unit of account, and store of value.
• Inflation: Sustained increase in prices.
• Measured by Consumer Price Index (CPI).
• Inflation impacts:
  • Erodes purchasing power, especially for fixed-income individuals.
  • Distorts investment value and economic decisions.

Causes and Types of Inflation

• Demand-Pull Inflation: Higher demand increases prices.
• Cost-Push Inflation: Rising production costs lead to higher prices.
• Disinflation: Slower rate of price increase.
• Deflation: Sustained decline in prices.

Monetary Policy

• Conducted by central banks (e.g., Bank of Canada).
• Goals: Sustain economic growth and control inflation.
• Types:
  • Expansionary: Increase money supply.
  • Contractionary: Reduce money supply.

Fiscal Policy

• Conducted by government to influence the economy through taxation and spending.
• Expansionary fiscal policy increases spending and decreases taxes.
• Contractionary fiscal policy reduces spending and raises taxes.

International Economics

• Canada's economic interaction globally, especially trade balances.
• Balance of Payments:
  • Current Account: Trade transactions.
  • Capital Account: Investment transactions.
• Dependence on exports is crucial for Canada's economy.