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Why The Markets Reflect The Economy Part 3
We started the series by discussing how individuals make decisions, and we then looked at how people interact with one another. All of these decisions and interactions together make up the many variables of "the economy." As we explore the final part in our three part series we discuss how the last three principles examine the workings of the economy as a whole.
Principle 8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services
The differences in living standards around the world are staggering. In 2007, the average American had an income of about $37,500. In the same year, the average Mexican earned $8,950, and the average Nigerian earned $900. Not surprisingly, this large variation in average income is reflected in the quality of life. Citizens of high-income countries have more TV sets, more cars, better nutrition, better healthcare, and a longer life expectancy than citizens of low-income countries.
What explains these large differences in living standards among countries and over time? The answer is surprisingly simple. Almost all variation in living standards is attributable to differences in countries' productivity the amount of goods and services produced from an employee's time. In nations where workers can produce a large quantity of goods and services per unit of time, most people enjoy a high standard of living. Similarly, the growth rate of a nation's productivity determines the growth rate of its average income.
Principle 9: Prices Rise When the Government Prints Too Much Money
In Germany in January 1921, a daily newspaper cost 0.30 marks. Less than 2 years later, in November 1922, the same newspaper cost 70,000,000 marks. All other prices in the economy rose by similar amounts. This instance is one of history's most stunning examples of inflation.
What causes inflation? In almost all cases of large or persistent inflation, the culprit is growth in the quantity of money. When a government creates large quantities of the nation's money, the value of the money falls. In Germany in the early 1920s, when prices were on average tripling every month, the quantity of money was also tripling every month. Although less dramatic, the economic history of the United States points to a similar conclusion: The high inflation of the1970s was associated with rapid growth in the quantity of money, and the low inflation of the 1990s was associated with slow growth in the quantity of money.
Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
Although a higher level of prices is, in the long run, the primary effect of increasing the quantity of money, the short-run story is more complex and more controversial. Most economists describe the short-run effects of monetary injections as follows:
Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services.
Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to increase the quantity of goods and services they produce and to hire more workers to produce those goods and services.
More hiring means lower unemployment.
This line of reasoning leads to one final economy wide trade-off: a short-run trade-off between inflation and unemployment. Although some economists still question these ideas, most accept that society faces a short-run trade-off between inflation and unemployment. This simply means that, over a period of a year or two, many economic policies push inflation and unemployment in opposite directions. This short-run trade-off plays a key role in the analysis of the business cyclethe irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.
The series is Part 1 of a three part series titled how the "How the Markets reflect the economy ." If you would like to read the entire series then please visit our website. http://www.apexinvestmentservices.net
