The basic principles of economics

With so much going on right now, the economy is in turmoil. Some people are trying to figure out what’s going on, how to protect their savings and stock market investments, and whether it’s time to buy or sell real estate.

So here’s a short summary of the mechanisms of economics, and also a little dictionary of economic terms to help you make decisions with a better understanding.

Principles of economics: the mechanisms

• The law of supply and demand : the higher the demand for a product or service, the higher the price. The price will be set at the point of equilibrium between supply and demand.
• Rarity: everything that’s rare is expensive.
• The interest rate : the interest rate is influenced by the central bank, which sets the key rate at which other banks can borrow from it. The higher the rate, the less consumers will borrow to buy, and the fewer purchases there will be, the more prices will fall. When there’s a risk of inflation, the central bank raises interest rates. When the economy slows down too much, it lowers rates to facilitate borrowing and therefore purchases.
• The state budget : a complementary means to interest rates for controlling the economy. A deficit budget will give consumers money to buy, thus boosting the economy, but with the risk of pushing up prices. Any money spent isn’t lost, it goes into someone else’s pocket. A government budget deficit is financed by debt or by printing money. A conservative policy prefers a balanced, profitable budget, as one would do in a family, so as not to postpone a debt. Others, on the contrary, believe that a state can run a deficit and that it will take a long time to pay it back.
• Government debt is the result of deficits. One school of thought advocates paying off debt as quickly as possible to avoid paying interest and mortgaging the future. The other school advocates paying it off as late as possible, because despite the interest rate, the economy will grow faster than the debt, and the latter will see its relative weight diminish over the years.
• The balance of payments represents all sales of goods and services abroad. If it’s highly profitable, it can build up substantial currency reserves, but it can also contribute to domestic inflation, since most production is consumed abroad.
• Monetary reserves are linked to a country’s balance of payments surplus. High currency reserves indicate a country that exports a lot of goods or raw materials, but they can also point to a country that, like Russia in September 2022, is having difficulty buying what it wants from abroad because of economic sanctions.
• The stock market rises in times of certainty and falls in times of uncertainty. Many neophytes are surprised to see it fall following the announcement of good news, the reason being that the markets have anticipated this news and some fund holders are starting to sell when they believe the market is at its peak.
• Gold is a safe-haven asset that generally rises when the stock market falls, and vice versa.
• Crises are inevitable and cyclical. If you want to be well protected, you shouldn’t put all your eggs in one basket: equities for the good times, gold for protection, real estate because in the long term it always goes up, and cash to take advantage of buying opportunities during the crisis.
• The secret? all the specialists will tell you: buy when it’s cheap and sell when it’s expensive!

Structural solutions for the economy

A state can, of course, play on the various monetary and budgetary mechanisms described above, but the safest course is to build a solid economy by optimizing business efficiency.

• Market domination strategies are divided into three categories
  • China’s current strategy is cost domination, which enables it to offer very low, competitive prices, thanks to a very cheap labor force and virtually no social protection.
  • Quality dominance through quality improvement and problem-solving programs, as in Germany and Japan in the automotive and electronics sectors.
  • Dominance through marketing, as the Americans know so well how to do throughout the world
• There are many ways of implementing these strategies, but it’s all down to people, their skills and their training. Countries like Germany, Japan and the United States invest heavily in employee training to make a difference.

Economic dictionary

• Actions
  • Securities representing a portion of a company’s capital that can be bought or sold, and which entitle the holder to a vote at a shareholders’ meeting. Owning shares allows you to earn a share of the company’s profits, but also to pay for any losses.
• Amortization
  • Assessment of the loss in value of an asset over a period of time.
• Self-financing
  • Self-financing for an individual, a company or an association, without having to ask for money from a bank or outside parties. Self-financing means not depending on other entities
• Comparative advantage
  • Each country has its own advantages when it comes to producing certain products, demonstrating that international trade is good for everyone.
• Competitive advantage
  • It’s the difference that enables companies to increase their sales thanks to the advantages they offer over the competition.
• Balance of trade
  • This is the difference between imports and exports. When we export more than we import, the balance is in surplus; when we don’t, it’s in deficit.
• Balance of payments
  • This is the balance of trade, but also of goods and services. If the balance is largely in surplus over several years, countries will build up monetary reserves; otherwise, they will go into debt.
• Bank
  • A company that trades in money and is controlled by the central bank and legislation to ensure that customers are not harmed, as has been the case in the past.
• Central bank
  • The state bank controls the other banks, organizes refinancing between banks and sets interest rates.
• Profit
  • It’s the money a company earns after deducting expenses, otherwise it’s a loss.
• Stock exchange
  • The place where buyers and sellers exchange goods, shares and services. Supply and demand determine the price.
• Budget
  • A country’s budget is the sum total of its expenditure and revenue. When revenue exceeds expenditure, the country has a surplus; when it doesn’t, it has a deficit.
• Speculative bubble
  • Sharp rise in the price of shares or certain goods and services linked to strong demand and not to the real value of these goods. There’s a limit to everything: when the rise stops, some start selling, others follow, the bubble bursts and prices collapse.
• Unemployment
  • The unemployment rate is the percentage of the working population not in employment. Unemployment that’s too high (above 7%) is bad, because part of the population is working to pay the unemployment benefits of others. Unemployment that’s too low is also bad, because companies find it hard to hire. The incompressible unemployment rate is 3 or 4%, due to illness and job changes.
• Cartel
  • A limited number of companies agree to artificially raise prices. Most countries ban them.
• Sales figures
  • A company’s sales are its total sales of goods and services, less taxes. A company generally tries to increase its sales and thus its profits.
• Competition
  • In a market economy, companies compete to sell their goods and services, which helps to improve quality and lower prices. This is the opposite of monopolies or trusts, where a few companies collude to artificially raise prices. Liberal economies fight against trusts and monopolies that are unfavorable to consumers.
• Pure and perfect competition
  • Pure and perfect competition only occurs when products are absolutely identical and sold under the same conditions. This is rare, but it can happen with raw materials such as oil, minerals and certain food products.
• Consumption
  • Consumption of goods and services by households and businesses is the engine of growth. This consumption is linked to confidence in the future, which is often measured by consumer and business surveys.
• Economic crisis
  • An economic crisis can be seen in a number of ways, all of which can be combined: halted growth, inflation, lack of confidence in the future, halted investment, rising interest rates.
• Growth
  • A country’s growth is measured by the increase in the Gross Domestic Product of goods and services. Growth is driven by increased consumption, investment in production assets and modernization.
• Budget deficit
  • A budget deficit occurs when the state spends more than it earns. The deficit is financed by borrowing to create new money.
• Deflation
  • Prices are falling because demand is falling, which is a short-term benefit for consumers, but the incomes of producers and retailers are also falling, which is negative and causes consumers to lose confidence.
• Sustainable development
  • Development that respects resources and people, present and future generations. But the notion is limited: what is sustainable?
• Request
  • Corresponds to overall demand for products and services. Confronted with supply, it will give the equilibrium price.
• Public debt
  • All state debt
• Dow Jones
  • Index of the thirty largest stocks on the New York Stock Exchange. We prefer the S&P 500 (top 500 companies)
• Market economy
  • An economy based on the laws of exchange both within the country and internationally, as opposed to the now outmoded communist economy.
• Savings
  • The part of income not used for consumption. A minimum cushion of savings is necessary to get through the ups and downs of life, but saving too much without consuming is not good for the economy.
• Welfare state
  • Is a state that collects taxes to pay out to citizens in the form of social aid, unemployment insurance and a minimum income for all. A state that redistributes nothing doesn’t help individuals in times of hardship, but a state that redistributes too much to everyone doesn’t encourage people to work.
• Exports
  • Sales of products and services outside the country. They demonstrate the attractiveness of the country’s products to the outside world. There are 3 ways to increase sales abroad: price (e.g. China), quality (e.g. Germany) and marketing (e.g. USA).
• Human Development Index (HDI)
  • Created by the United Nations to provide a finer measure of people’s well-being, it incorporates not only GDP, but also life expectancy and literacy rates.
• Inflation
  • This is the rate of price increase, calculated using an index covering a number of consumer goods.
• Investment
  • The money we spend to create the means that will provide us with income: means of production, apartments, land, etc. Investment drives growth.
• Economic liberalism
  • An economy based on the laws of the market, with as little interference as possible from the state. The state often has laudable objectives in intervening, but in the long term this only makes things worse. For example, the state invests in the creation of social housing, but that’s not its role and a company would do it better. The state must therefore play a minimum economic role, looking after the police, the army and providing a minimum social safety net.
• Free trade
  • Market without customs or regulatory barriers between countries, allowing free competition. Free-trade zones are generally created, which are preferable to the overall development of the zone’s economy, but do not allow certain countries to protect certain economic sectors, unless there are exceptions.
• Money supply
  • This is the mass of money in circulation in its various guises: currency, banknotes, deposits, accounts and foreign exchange.
• Households
  • The number of people per family is currently declining, but the number of households is increasing in most countries. The household unit is ideal for economic studies.
• Capital loss
  • This is when there’s a negative difference between the purchase price and the selling price, so you’ve sold at a loss.
• Globalization
  • Most goods are now traded internationally, whereas in the past they were limited to a single village or country. In Roman and Greek times, international trade already existed, but now it’s much easier thanks to new means of communication.
• Monopoly.
  • When an organization is the only one selling a product or service. This is the opposite of a competitive situation, and contributes to higher prices for the consumer.
• Tax niche
  • A limited economic sector in which there has been an oversight in the law that allows an individual or company to reduce or not pay taxes at all.
• Obligation
  • This is a loan, usually medium- or long-term, whose value does not fluctuate positively or negatively like equities.
• Offer
  • All the products and services offered in a country. When demand is lower, prices tend to fall; when demand is higher, prices rise.
• Oligopole
  • Few companies sell identical products to the general public. There is no cartel, but the lack of competition contributes to higher prices.
• Added value
  • This is the positive difference between the purchase price and the selling price. The capital gain is only realized after the sale, otherwise it is potential.
• Workforce
  • Population working or of working age, between 15 and 64
• Productivity
  • Production efficiency is measured by comparing the value of goods produced with the value of the means of production.
• Gross domestic product (GDP)
  • The total value of all goods and services produced in a country by companies, foreign companies located in the country and government agencies. It does not take into account the well-being of the population, undeclared work or prohibited trafficking. GDP is a measure of economic growth.
• GNP
  • Sum of all values produced in the country, excluding those produced by foreign subsidiaries in the country, and including those produced by foreign-based companies in the country concerned. It is used extensively by the USA, which has many foreign subsidiaries, and is relevant because subsidiaries contribute to the wealth of the USA.
• Profit
  • This is the positive difference between a company’s income and all its expenses and taxes. Profit is used to remunerate capital
• Protectionism
  • A state’s policy of protecting its industries through tariff and regulatory barriers.
• Recession
  • It’s the opposite of growth: the economy is shrinking. Recession is measured by GDP.
• Stagflation
  • The economy is flat and in recession, but still experiencing inflation.
• Savings rate
  • This is the ratio of total household savings to the country’s total income.
• Inflation rate
  • An increase in the price of goods and services over a given period, it is calculated on the basis of an index covering a number of basic countries. There are often discussions about which products and services should be included.
• Interest rates
  • Measures the cost of borrowed capital, thus remunerating the capital lent. The higher it is, the more expensive it will be to borrow, and the greater the drag on growth.
• Growth rates.
  • It measures the growth of a country’s economy by means of GDP, which is evaluated in volume terms to exclude inflation.
• Added value
  • This is value creation, calculated as the difference between the total value of a company’s production minus the value of the intermediate products required for this production.

These definitions will give you a better understanding of financial information and economic principles.

Jean-Pierre Mercier