Fascinating economy

Be Rational

There is no rule that says you have to use cost-benefit analysis, but players who want to maximize benefits and minimize costs use it all the time. It is one of the properties of the game of economics.

You do not always have to list the pros and cons to do cost-benefit analyses. In fact, such an analysis happens frequently, and almost automatically. Any time you accept a cost, you are looking for a benefit. You have probably done a cost-benefit analysis of your own, even if you did not sit down to make a list of pros and cons.

Money Is not Everything

Money is one common way of calculating cost. You see price tags all over the place. It is normal to think of cost and price as the same thing, but the cost of a decision cannot be measured in money alone.

When you buy something with money, there are always additional costs. For instance, the time and effort involved in shopping are costs. And whatever you must give up by buying one thing instead of another is also a cost.

Imagine that you received $200 in birthday money. That is quite a benefit, but spending it involves costs. Maybe you decide to buy a new game console with the money. The price of the console is only one factor. There are hidden costs, too, such as gas for the car or bus fare to get to the store. The time you spend is another cost. So, while it may seem that you are getting something for free – a console bought with someone else’s money – buying it brings certain costs. And maybe you wanted a new backpack and a pair of shoes, too. You are sacrificing those purchases for the game console.

That is Your Opinion

Cost goes beyond money. No price tag reveals the full cost of something. Everyone’s feelings about cost are very personal. The way you calculate the cost of a decision depends very much on your tastes and your situation.

Whenever you buy something, there is a cost in time and effort beyond the price of the purchase. The time and effort spent on a task may be a high cost for one person and a low cost for another. An hour spent shopping probably seems like a low cost for someone who loves to shop – it may even seem like a benefit. But an hour spent shopping may be a very high cost for someone who does not like to shop. Time and effort are non-monetary costs of shopping.

Even monetary costs can vary depending on a person’s situation. If you are a millionaire, paying $10 for a movie is not a big deal. If your job pays $7 an hour, however, that $10 may seem like a lot of money.

Everyone calculates costs and benefits differently. That makes these calculations subjective. In other words, they depend on a lot of factors that vary from one person to another. Because people’s opinions and tastes differ, it affects how they see the costs and benefits of decisions.

Something’s Missing

Unfortunately, not all rational decisions work out the way you might hope. Sometimes you ignore a cost, or overestimate the benefits. This does not mean you are irrational. You simply could not think of everything.

Often, it is impossible to predict what is going to happen. Unexpected costs arise. Benefits turn out to be less than you thought. That is normal, because no one can predict the future. That does not mean a cost-benefit analysis is useless, though.

Economic Reasoning

Cost-benefit analysis is sometimes called economic reasoning. In many ways, economic reasoning is just like any other kind of reasoning – it is a matter of weighing pros and cons.

Some might call this logic, others common sense. Whether you call it economic reasoning, logic, or common sense, it is all the same thing. It is how people play the game of economics. They make rational decisions hoping for benefits that outweigh costs.

There is no such thing as a free lunch, even when someone else is buying.

The economy is not just a collection of people. It is like a game, except that instead of playing on a board or a field, the players move within the greater economic system. They follow rules and make decisions, and these decisions result in outcomes.

Definition of the Economy

The economy is the total of all the outcomes that result from people participating in the economic system.

Economists measure and discuss the strength and performance of the economy. When they use words such as health, vitality, and even stamina, it sounds much like a doctor talking about a patient. This is not far from the truth.

Economic Indicators

Economists measure the health of the economy by comparing and analyzing economic outcomes that result from various activities. Economists use these instruments to measure economic activity. These instruments, called economic indicators, include

• Gross domestic product.

• Growth rates.

• Unemployment rates.

• Inflation rates.

Doctors use measurements to judge the condition of their patients. Economists measure the health of the economy.

Gross Domestic Product

Some indicators are used quite often to measure the health and vitality of the economy. For example, gross domestic product (GDP) is a very helpful, and widely used, tool.

The GDP measures the overall size of a country’s economy. It is the monetary value of all goods and services produced in a country during a given time, usually one year. The GDP provides a good overall picture of how much economic activity there is within a country.

Understanding GDP

Gross domestic product is the sum total of private consumption, government spending, investment, and the net value of exports. The net value of exports, sometimes called the trade balance, is the value of the goods exported minus the goods imported.

The equation can be put more concisely as follows:

GDP = private consumption + government spending + investment + exports – imports

A common mathematical formula for measuring GDP looks like this:

GDP = C + G + I + Ex – Im

Private consumption includes all the goods and service purchased or consumed by individuals. Government spending includes all the costs incurred by the government, such as salaries of government employees, military spending, funding for education, and so on. Investment is limited to business investments in capital, and it does not include financial investments such as savings accounts or bonds. Exports are those goods that are produced inside one country and sold in another country. Imports are the reverse – goods made outside the country and purchased within the country. Imports are subtracted from the GDP because they are purchased from other countries before they are sold within the United States. These funds contribute to another country’s GDP.

The GDP is a very weighty number for every country in the world.

World GDP

GDP is an important economic indicator. The bigger the GDP, the more activity there is in a country’s economy. For large countries, the GDP numbers are likewise usually very large. Sometimes a country’s GDP is so large that it is hard to comprehend. So what does a GDP number really tell us?

There are a couple of ways to make the GDP more meaningful. One is to make comparisons. For example, in 2011, the GDP for the entire world was just under $70 trillion. The same year, the GDP of the United States was about $15 trillion. That means that roughly one-fifth of all economic activity in the world took place in the United States. That is a lot of economic activity for one country.

The United States has the largest GDP in the world, as evidenced by our many shopping malls.

Annual GDP

You can also compare the GDP from one year to the next, which gives an indication of economic growth on an annual basis, or year by year. For instance, if a country’s GDP grows by 10 percent from one year to the next, the economy is growing rapidly. If its GDP goes down, the economy is weakening. If the GDP stays about the same, the economy is stagnating.

Another way of making the GDP useful is to look at per capita GDP. To do this, you divide a country’s GDP by its population. This tells you the average amount of economic activity contributed by each person in that country.

Growing Up

There are measurements for almost every type of economic activity. These measurements are usually reported as growth rates. Growth rates show how much economic activity there is in specific parts of the economy.

There are additional indicators that show how fast the economy is growing (or shrinking) in particular areas. There are also dozens of other government statistics that measure economic activity, all of which tell us how well businesses and consumers are doing.

Additional growth indicators include

• Corporate profits.

• Farm income.

• Industrial production.

• New housing construction.

• Personal income.

• Retail sales.

Growth is important for an economy.

Help Wanted

GDP and other growth indicators measure the amount of activity taking place in an economy. Another way to measure activity is to look at inactivity.

One important measure of inactivity is the unemployment rate. This indicator tells us the percentage of workers who are out of work. This is a good way to measure the health of an economy. When only 5 percent of people are out of work, the economy is much healthier than when the unemployment rate is 10 percent.

As with GDP, comparisons across time provide a more useful perspective. If the unemployment rate is declining, that means more people are working. The economy is getting stronger. If the unemployment rate is rising, then the opposite is true.

Did You Know?

A country’s unemployment rate might actually be higher than what is officially listed. This is because many people who are out of work do not report this fact to the government, so they do not get recorded as part of the total percentage of unemployed citizens.

When a lot of people are out of work, the economy is not healthy.

The Rising Cost of Living

People from an older generation remember when a penny or a nickel was worth much more than today. There is a reason your grandparents could buy candy for a penny, while you have to spend close to a dollar. It is called inflation.

Inflation is a feature of economic systems that demonstrates that as time passes, things get more expensive. This might seem unfair if incomes always stayed the same. But usually incomes go up as prices rise. This helps offset increases in the cost of living.

Still, not every good or service increases in price over time. In fact, some prices actually decrease over the years. When a technology is very new, it is often quite expensive. As technology advances and new ways are discovered to produce something more efficiently, the price of an item might actually decrease. Examples of items that have decreased in price after first being introduced are radios, televisions, and personal computers.

The average price for a gallon of gas rose during a relatively short period of time. Think about possible reasons why the price continues to rise today.

The Increasing Price of Gas

1977: $0.55

1980: $1.00

1990: $1.25

2000: $1.55

2006: $3.00

2014: $3.56

The Inflation Rate

The U.S. government measures inflation with something called the Consumer Price Index, or CPI. The CPI is the average price of a group of goods and services such as food, transportation, and medical care. As the CPI rises, economists can get an overall picture of how fast prices are rising. This lets them determine what the inflation rate is.

The inflation rate is an important economic indicator. It lets people know how fast they should expect prices to rise.

The inflation rate can also be used to adjust for the effects of inflation. Doing this shows how much something in the past would cost today. For example, by calculating the inflation-adjusted price, you would find out that something you paid $5 for in 1990 would cost $8.90 in 2013.

It is easy to see the effect of inflation – did you ever see gas selling so cheaply?

What Your Money Can Buy

Prices are always going up, but not all prices rise at the same rate. Some prices go up faster than the inflation rate, while others go up more slowly.

If the actual price and the inflation-adjusted price are about the same, then the price has not really gone up, even though the number on the price tag is bigger.

For example, when gas went from 55 cents per gallon in 1977 to $1.55 in 2000, that was about equal to the inflation rate. So, gas cost about the same. But inflation would have made that $1.55 in 2000 into only $1.82 by 2006. When gas went up to $3, it rose faster than inflation.

Often, when prices go up faster than the inflation rate, it is a result of high demand. For instance, football is a more popular sport today than it was in 1975. So prices for tickets to the Super Bowl have increased more than three times as fast as the inflation rate. Other areas where prices have outpaced inflation include medical care and college education.

If prices rise at 4% and your income does the same, you are not harmed in the short run. But you might be harmed in the long run as you try to save for college or retirement if your savings cannot keep up with rising costs over a long period of time.

As time goes by, a dollar buys less and less.

Knowledge Is Power

Decision making is an important part of the game of economics. Making good decisions requires knowledge, skill, and information.

The indicators give economists and others a fairly good picture of how the economy is doing.

Economic indicators have an influence on the decision-making process. For instance, the inflation rate is useful for making smart decisions. Imagine that you want to buy an expensive new TV. If the inflation rate is high, it might make sense to buy the TV now before it gets much more expensive. On the other hand, it might make more sense to save the money because your rent and food bills are going to go up, too. Economic indicators are like signposts guiding you along an economic path. If read correctly, they can help an economic player arrive at safely at a destination.

People who try to make money in the stock market use all kinds of information to make predictions.

Doctoring the Economy

Economists are like doctors who try to determine the health of the economy. They use different measures, such as gross domestic product, growth rates, the unemployment rate, and the inflation rate. These indicators provide useful information when it comes to making good decisions.

Unfortunately, unlike doctors, economists cannot cure economic sickness. They can diagnose the problems, but they leave it to us to make our own economic choices.

Economists examine the health of the economy.

Someone born in 1950 lived without computers for some 30 years, and then witnessed the evolution of laptops and the Internet. Later, he or she witnessed the invention of the cell phone and then the development of smart phones.

All this technology has drastically changed the way people live. Changes in technology affect the economy on a large scale, which in turn affects how people play the game of economics.

What could be coming next? We do not know exactly, but we do know there is something coming. And it will probably be amazing.

Humans are always striving to do things better. Developing technology is one way to do this. The advancement of technology leads to greater speed, higher production, and increased efficiency.

Many people think of technology as electronic devices such as computers, cell phones, and other wireless tools. These kinds of devices can certainly improve results in many areas.

Computers help people work faster by making it easier to find, organize and reorganize information. Cell phones make it easier to get in touch with others. Some devices can include a calendar, address book, computer, camera, and phone all in one.

But technology includes more than just smaller, faster, more powerful electronic devices. Technology is any new advancement in or application of science that improves results.

The Power of Machines

For thousands of years, humans have been inventing things to make their work easier, faster, and more efficient. Many of the things people have invented are machines that use power to replace human or animal effort.

You can get from one place to another in a horse-drawn carriage. But the car, once known as the «horseless carriage,» gets you there much faster. The car improves the ride.

The horse-drawn carriage was a technological development a long time ago. It provided an alternative to walking for those who could afford it. With a horse-drawn carriage, people could get to places much faster and with less effort.

The car increased that speed and reduced that effort even more.

Build a Better Mousetrap

New technologies are invented every day. In most cases, today’s devices are not made to replace human or animal effort. Instead, they are designed to replace older, less powerful machines with newer versions.

For example, the telephone replaced the telegram. While the telegram was the fastest way of getting messages from one place to another in its time, the telephone further increased the speed of communications.

More recently, cell phones are quickly replacing home phones and other so-called «land lines.» Home phones make calls fine, but their area of use is limited. Cell phones can go anywhere. This development makes an already powerful technology even more effective.

A Method to Their Madness

There is more to technology than just machines. Smaller, faster, more powerful machines lead to improved results. Better results can also be produced by organizing time or energy in new and different ways. Technological improvement can come from introducing a new method.

Methods are all over the place, even if you do not realize it. Nearly everything you do follows a method of some sort. How many fingers do you use to type, two or 10? That is your method. Do you brush your teeth with a side-to-side or swirling motion? Whichever you use is your method.

Some methods can be improved by changing them. These improvements are also technological developments. They improve results and make people’s lives better by increasing speed, efficiency, power, and so on.

Productivity Is Up

Producers like to improve efficiency. If they can make goods more easily, more quickly, and with less money, they can increase their profits. Producers are always looking for technological improvements to increase productivity. Machines can help do this.

Power tools tighten bolts more quickly than regular wrenches. Electric sewing machines enable faster production of clothing than a needle and thread. Backhoes haul much larger loads of dirt than shovels.

These are just a few examples. Machines are used in almost all types of production to make things easier and faster for workers. Sometimes, machines even replace workers entirely, eliminating human effort from the production process.

New methods can also increase productivity. One of the most powerful production methods is the assembly line.

The assembly line is a simple concept. Instead of having workers move from one production task to another, workers line up and each performs just one task as the product moves down the line. Each worker performs a different task very quickly as products move along. Also, each task uses just one tool, so no one has to put tools down or move to a different position. This eliminates extra extra motion and increases the speed of production.

The assembly-line method can be used to do anything that requires several steps, which is just about everything.

Prices Are Down

Improving productivity has major effects on the overall economy. For one thing, increased productivity usually leads to lower prices.

According to the law of supply and demand, when supply increases, prices drop. When technology makes production more efficient, there is usually more supply. That brings down the price of those goods. When the price of a good drops, more people can afford to buy the good, so producers make more sales and more profits.

The increased demand because of lower prices would normally raise prices again. But greater productivity helps producers meet rising demand with even more supply, so they can keep prices low.

Greater productivity brings cheaper goods to more people and wealth to the producer. Producers use some of this wealth to develop even better technologies, further increasing productivity.

Increased productivity makes more goods available more cheaply.

The Ripple Effect

Technology increases productivity by making it easier and cheaper to produce goods and services. This lowers prices and brings more goods and services to more people. There is also a ripple effect that occurs when goods and services are widely available. When more people have access to something, it changes how they behave.

Think of the cell phone. When very few people had a cell phone, its usefulness was limited. You could usually only reach people at home because few other people had cell phones.

However, as cell phones became less expensive, more and more people could buy them. Eventually, cell phone owners could reach more people in more places. That increased the number of calls. Today, most people can be reached no matter where they are.

Prices came down, more people got cell phones, and the number of conversations went up. That is the ripple effect in action.

Although Ransom E. Olds of Oldsmobile invented the original assembly line, Henry Ford introduced conveyor belts to the design, which greatly sped up production.

By 1914, the Ford factory was turning out a new Model-T every 93 minutes. Because of the speed of production, the Model-T could be made and sold very cheaply. Cars were no longer a luxury. Suddenly, millions of people could afford cars, and it did not take long for most families to have a car.

This had a ripple effect on the way people lived. Now that cars were so common, people could live farther from where they worked. This led to the development of suburbs. Instead of living in crowded cities or distant farms, people had both space and access to the city.

Ford’s assembly line changed the place – and the way – many people lived.

Because of the development of suburbs, more highways were needed for people to get back and forth to work. Soon there were highways connecting different cities all across the country. These highways made it easier to go long distances, and that meant that people could take vacations to far away places by driving there.

The tourism industry became much larger once most Americans had cars. With increases in tourism came more motels and amusement parks and restaurants.

The Model-T changed America into a car society, and this affected other parts of the American economy. Increases in productivity often have this kind of ripple effect.

Make It Fast

Distribution is another area that benefits from technological improvements. If productivity is improved, prices go down and more goods are available to consumers. And if goods can be moved around more quickly and inexpensively, the same thing happens.

Technology has been helping improve the distribution of goods since the first horse-drawn cart was piled full of goods to be transported elsewhere. In the past 50 years, there have been drastic improvements in distribution technology.

FedEx changed the package delivery industry by introducing a new type of system called the hub-and-spoke model.

Strange as it may sound, FedEx sent all of its packages to a central facility in Memphis before shipping them to their final destination. Even if you were sending a package from New York to Boston, it went to Memphis first. This is called the hub-and-spoke-model of distribution.

Here’s how Fred Smith, the founder of FedEx, explained the advantage of this method:

If you take any individual transaction, that kind of system seems absurd – it means making at least one extra stop. But if you look at the network as a whole, it is an efficient way to create an enormous number of connections. If, for instance, you want to connect 100 markets with one another and if you do it all with direct point-to-point deliveries, it will take 100 times 99—or 9,900—direct deliveries. But if you go through a single clearing system, it will take at most 100 deliveries. So you are looking at a system that is about 100 times more efficient.

FedEx not only used this new method of shipping packages. They employed new technological devices to make sorting and delivery easier. FedEx used bar codes to sort and track packages, and it put computers in delivery vans to map the driver’s route and continue tracking packages.

Both the hub-and-spoke model and electronic devices led to faster deliveries. Soon other delivery companies were imitating Federal Express. Today, fast, and reliable delivery is a regular part of life, thanks to FedEx and the technological advancements they developed and used.

Simplicity

Technologies do not have to be complicated or powerful to have a major impact on productivity and distribution. Sometimes it is enough just to make things simpler, like FedEx did, or to standardize methods.

One of the most influential technological advancements in the past century did both of these things. The cargo container is just a simple rectangular box, but it changed the world of shipping and distribution by standardizing and simplifying.

The cargo container is partly responsible for rapid increases in global trade.

The Revolutionary Box

Cargo containers are simple metal boxes with a wooden floor, 8 1/2 ft high and either 20 or 40 ft long. Because of their simplicity, the cargo container has increased the efficiency of cargo transportation, making the distribution of goods both faster and less expensive. This has increased the amount of international trade and made it possible for consumers to purchase goods more cheaply. There are nearly 15 million of these boxes currently roaming the Earth, and in 2005, nearly 8 million containers entered the United States. Their cargo was worth almost $800 billion.

Before containers, cargo was loaded and unloaded by dockworkers known as longshoremen. Longshoremen could sometimes use cranes and forklifts, but much of the cargo was contained in bags, boxes, and barrels that had to be moved piece by piece, sometimes by hand. This took a very long time and was tiring and dangerous. A normal ship could take a week or more to unload, with 20 longshoremen working around the clock. The cost of paying these dockworkers was enormous. Labor costs were at least half of the total cost of shipping goods.

With the use of cargo containers, freight can be loaded and unloaded much more quickly and easily. Special cranes called straddle carriers pick up and drop off containers. The straddle carriers grab containers, wheel them from ship to dock or vice versa, and drop them again, transporting a large amount of cargo in a matter of minutes. It now takes less than 10 hours to unload the same amount of cargo it once took a week to unload, and the process requires fewer workers and is less likely to involve accidents or breakage.

The cargo container also makes it much easier to transport goods from the dock to warehouses, distribution centers, and stores. The containers can be put onto flatbed train cars just as easily as they are loaded and unloaded from ships. Or they can be placed on wheels for transport by truck. Goods can go nearly the entire length of their journey from factory to store in the same container. This eliminates all of the wasted time of loading and unloading freight into different carriers.

The increase in speed and reduction in labor costs have made distribution much less expensive, and this makes the prices that consumers pay much lower. Before the cargo container, shipping costs accounted for about one-eighth of the price of goods. The cut that goes to shipping is now less than 1 percent. For example, it costs only 34 cents to ship a pair of shoes from an Asian factory to an American store that can sell the shoes for $45. The shipping costs once would have been $6 or $7. With such high shipping costs, it made more sense to simply make the shoes in America, where they were going to be sold. But many goods can be made more cheaply in other countries, and now that it is inexpensive to ship them to America, they cost much less at the store. This simple technology – the rectangular box – has revolutionized shipping and helped transform the global economy and the American consumer experience.

The Economic Effects of Technology

There is so much technology available today.

Technology can improve production and distribution. The improvements affect the price and availability of goods and services. They also influence how people live their lives.

Technology gives us different options and affects our decisions. When we are looking at the overall economy, we cannot ignore the effects of technology.

Think of all the things you do on the Internet, whether you use a desktop computer, a laptop, a tablet, or a handheld device. You can stay in touch with friends, catch up on the news, watch your favorite shows, or just check the weather forecast.

But the Internet is not just about getting information or having fun with friends. The Internet is also a key technology that has affected the overall economy. In fact, the Internet is the world’s largest marketplace.

The Communication Explosion

Different technologies have made it easier and easier to communicate. The invention of the printing press made it easier to print a large number of books. The invention of the radio made it possible to broadcast stories to large audiences.

With the Internet and smart phones, information of all kinds can be shared very efficiently with nearly everyone on Earth. We can send and receive documents, pictures, videos, and audio files over the Internet and over our phones, and we can do it almost instantly.

The ease of sharing information has led to a huge increase in the amount of communication taking place. People are sharing information far more than they ever have. Think about all the e-mails you write, and the texts you send. Would you ever write that many letters?