Understanding the True Meaning of Economics: Principles and Policies Explained

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Table of Contents

The meaning of economics
The Role of Prices
Price controls
Why businesses fail
Profits and losses

The meaning of economics

The true meaning of economics is not about money but about principles and policies and the way they are applied and implemented. The resources in an economic system are limited with respect to the quantity of people or consumers. Policies and principles have to be designed to close the gap between resources and consumer needs.

When a country is poor, the gap has widened between the abundance in resources and the quantity of consumers. The policies applied are not effective and efficient and the policymakers did not apply good economics. Policies have to change to improve the economy and the business value. How do we conduct effective economics? Or what is good economics? The best economic system allows limited resources to meet and satisfy people’s needs.

When China and India, once the poorest countries in the world, changed economic policies and became successful in their economic endeavor, millions of their people were saved from poverty. In short, they learned the lessons of applying good economics. Apart from the meaning of economics, there are conceptions and misconceptions explained in these initial pages.

When we use economics with ordinary terms, we get the word “economize,” which is dealing with the scarcity of resources for other important uses. This depends on the principles and policies that should be implemented to make use of the resources for the people. The resources of a place or country are not really sufficient to meet the needs of the people, especially when more and more human beings are added to the population every day. Policymakers have to do the best they can – that means, economize, which calls for effective implementation of the policies and principles of economics.

Some countries, meaning their governments and policy makers, are experts in making use of their resources and so they can afford to provide high standard of living for their people. Others are not, even if they have more resources than those with high standards of living. They are constrained by factors like economic and political systems. The result is poor economics that may result into poverty.

The United States makes use of its scarce resources effectively even if the population is growing at a rapid pace. But Americans live more comfortably than those living in Europe or the third world. The explanation is the same – they make use of their scarce resources to the maximum and implement effective policies. This concept is not only applicable with Americans but with other people in other parts of the world. It has also been the case with the rest of humanity in the past. There is always scarcity but people who know how to manage their resources effectively live comfortably and in abundance.

The purpose of economics is to be able to cope with limited resources, and make the output satisfy the people’s needs. How can we make sure that the output meets the needs of the population? If we produce more outputs than what is required, the result is a waste of resources, like what happened in some countries. The former Soviet Union was endowed with natural resources that the country did not have effective policies to make use of them, and the result was a waste of resources that provided a lower standard of living for the people.

The Role of Prices

Human beings are dependent with each other because they cannot alone produce everything they need. They need other people to supply them with the basic necessities in life. How other people are motivated to produce the things other people need is ruled by prices. Economics can explain how a few resources can be used to benefit many people. For an authoritative economy, government leaders would command producers what to produce, but for a market economy products and services are ruled by prices, and manufacturers manufacture products consumers need.

The former Soviet Union had abundant resources but the government controlled the prices of basic necessities and commanded the millions of workers what to produce and what not to produce. Prices were not allowed to freely float the market and so producers did not have the slightest knowledge what products were in demand and what were not.

The Soviet policymakers were politicians who did not have knowledge of economics and the law of supply and demand. While manufactured products were becoming rotten in warehouses, producers continued to produce them. The Soviet experience resulted in a waste of resources which was detrimental to the people’s welfare.

In a free market economy, policymakers only need to monitor the prices. Everything is ruled by prices which are allowed to fluctuate according to the supply and demand. No government personnel or politicians command manufacturers what to produce and what not to produce. Knowledge of profits and losses provide information and data about products in demand.

Profits and losses convey messages to producers and traders as they affect prices of products. Producers will know what to produce more if they attain high profits for certain products, and they will also know what not to produce if they have losses for the other products. If producers create products that are not in demand, it can lead to cheap products and may discourage future production of such products. However, producers always find ways to lower production cost so that they can lower their prices. Because of this, competitors also charge lower prices for the same products.

Millions of people were starving in China when the Communist government dictated the prices of basic commodities. The more than a billion Chinese could not all be fed with the scarce resources, but when the government decided to change economic policies by allowing prices to rule the market, China’s economy started to grow and now, more than ever, food starts to be abundant in the country. Cheap food coming from agriculture-rich countries like the United States and Australia and many parts of the world flows to China. China does not need to find new sources of food or to find new lands for agriculture. Prices do it.

Capitalism or free market allows prices to freely float. Prices are a measuring stick for producers to take a look at the supply chain. Manufacturers and traders and all those involved in the supply chain look at the prevailing prices before they manufacture products. Products with lower prices are easily sold in the market; producers would produce more of this sort of product. When there is abundance of materials to manufacturer certain products, prices for these products will become cheaper, even if the people do not know that there is an abundance of raw materials for those products.

Price controls

Price fluctuations have a role in a market economy and there are repercussions if prices are not allowed to fluctuate. Price controls are used in many countries to deal with situations when the demand exceeds the supply. In agriculture, government intervenes by buying farmers’ products and selling them at prices lower than the market price. Price fluctuation is like cause and effect. If there is a minimum price set by the government, a shortage or surplus might occur. In a free market, prices are allowed to fluctuate to meet the needs of consumers at prices they can afford.

Prices rise when there is “shortage” of the product and fall when there is more of the manufactured product of the same kind, which is termed “surplus”. But “shortage” does not necessarily mean there is less of the product with respect to the number of consumers that demand of the product. For example, at the close of World War II, there was an artificial housing shortage although the number of housing units and people did not change. There were more Americans looking for housing units to live in because housing prices were very much lower than before due to rent control.

The demand was such that Americans had to bribe people to be accommodated. Because of the low prices of apartments, more people were seeking apartments, particularly young adults who wanted to live independently from their parents and also larger families who were looking for larger apartments to live in. The artificial shortage ended as soon as the rent control law was not anymore in effect. Other countries, like Sweden and Australia, which have had rent control felt the same effects of housing shortage.

The purpose of rent control is to keep the prices low but there are repercussions and there are reasons why they are implemented. Politicians use it to gain support so that voters will remember them during election time. But apartments are owned by ordinary people with modest means, like the poor ones who rent their apartments.

In other words, the rent control law is there to prohibit landlords of modest means from introducing high rents to their apartments. But rent control as applied to luxury apartments is not so effective because their tenants are the affluent. This situation occurs when rent control is applied with no exception, be it low-cost or luxurious apartments. Cities which have this kind of law have lower rents even for luxurious apartments. The repercussion is that as the rent control tries to protect the poor tenants, it does so with the rich ones.

Because of price controls, the Soviet Union had either surpluses for some goods which were not important to consumers, or shortages of some other goods which were important to consumers. There was no means for producers to know which goods were in demand – they just kept on producing goods upon the dictates of politicians and at the expense of the people.

Another example of the disadvantage of price control is the U.S. meat-packing industry during the period after World War II. The meat-packing industry was declining as most of the job was done in black markets which resulted into an artificial shortage. When the price control for packed meat was ended, the meat-packing plants became alive again and jobs were restored.

Why businesses fail

There are reasons why some businesses are successful and some are not. For businesses listed in the “Fortune 500,” a number of them are out of business within a year or so. There is no permanent business and business owners should learn their lessons from their losses.

Some of the largest businesses which earned billions of dollars in profits later found they were losing money a year later. Before they could find out what really happened, they were already out of business. Big grocery chains, like A & P, were ruling the competition with much lower prices for their grocery items. In a few months, they were losing to rival companies which were also selling at much lower prices than theirs.

Businesses must be able to detect and analyze the changing environment which is hardly noticeable. For example, parking lots add comfort to customers when they shop. During the period after World War II, customers could afford large purchases because they had their cars that could carry their purchased items. In other words, parking lots for supermarkets were necessary and this was more advantageous than shopping at the stores with limited parking lots.

Customers of A & P switched to other grocery chains because of prices. At the turn of the century, Wal-Mart took over and became the leader in the grocery industry. Other corporations became leaders specializing in quality products like cameras and electronic items. The airline industry had shifting competitors and leaders. News reporting also had to cope with the changing times when newspapers were challenged with the new technology and television news reporting. Newspaper companies had to trim down daily circulations because of the availability of afternoon news over television.

Typewriters became obsolete when desktop and laptop computers entered the scene. Business had to diversify, like Smith-Corona which pioneered in typewriters, had to introduce word processor in their new market in order to regain lost profits. Years later, Smith-Corona had to close shop. The message from all these historical events in business is that change is continuous and that prices rule.

Customers want low prices. Businesses must learn their lesson and the role of profits and losses. Business people must be able to analyze the changing conditions and for those who are quick to spot the changes can lead the market while others must close shop, or find new business. However, it is important to have bright ideas and knowledge about the realities of business and how resources are used intelligently.

The market system is more advantageous than the authoritarian system where the political leaders dictate prices or economic policies. Economists should take charge of economic principles and policies and not political leaders who have not the slightest idea about why prices must fluctuate. The knowledge that America needed was not mainly on science and technology but the simple word of retailing which entirely changed the American way of life.

Americans bought goods at the lowest price they wanted and at the fastest way grocery stores could do. Above all, giant grocery chains must learn their lesson and listen to the insights and opinions of their employees. Insights and knowledge of these “small” employees are valuable and may even save their company in times of trouble. Most of those ordinary employees have become owners themselves of retail giants.

Profits and losses

Firms must consider the inputs and outputs in their business operations. Profits should be weighed down against losses. Profits are regarded by economists as additional cost, but prices have to be reduced during stiff competitions. An effective way is to reduce production cost. When a firm lowers prices, other competitors follow and the public can be benefited. Sometimes companies can reduce costs at the expense of quality. Innovation does not mean reducing the quality as product concepts mean innovations.

Capitalists work for profits. Socialists, on the other hand, have argued that profits are additional expense on products placed by capitalists, and if profits are removed prices can be lowered. This is not what is happening in socialist domains where prices have remained higher. Capitalism is for a free market while socialism is said to be “pro-poor” or “pro-people”. Ideologies are sometimes difficult to explain. When India controlled the market economy, the roads were dominated by the Ambassador cars which were of low quality and had many accidents on record.

When companies were allowed to import cars, consumers enjoyed the comfort of owning quality cars and prices were lower than before. We can fully understand prices and profits if we do not apply them in business, like the way they do it in socialist countries. Capitalist enterprises will find ways to lower cost of production and still provide product quality. The socialist enterprise will stop at innovation because there is the absence of prices and profits.

Competition can make or break even Fortune 500 firms. Losses for those companies registered in billions of dollars. However, these losses should not be mistaken as bad luck as they can bring firms into better position if they know how to regard losses as lessons: what to do and what not to do in the future and the necessary innovations. Losses allow firms to locate problems in the supply chain and in determining the needs of consumers. Losses are economic events that force giant firms to institute drastic change, and with these changes efficiency and profits follow.

A business can be said as a combination of several functions. When a car manufacturer assembles cars, it does not mean it produces all parts of the car – it outsources some parts of the car like tires, lights, chassis, electronic parts, and so on. Moreover, the company also has to contract car dealers to conduct the sales. Middlemen are as important as other functions in the business. In the newspaper industry, newspapers and magazines are sold by newsstands and bookstores. Gasoline has to be retailed to consumers by gas stations and not by oil companies. All these have to be taken into consideration in formulating product prices.

Many business owners have tried different ways to reduce production cost so they can lower prices. Profits are counted against the expenses spent for a particular product. When a store buys a product and resells it by adding a certain amount to cover the cost, the store must consider the various expenses in adding the cost. This is different with profit of investment wherein the investor is after the annual rate for the amount he/she has invested. The corporation will provide the investor details of the total capital and the prices of shares of stocks.

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