Economic Theories and Money | Econo&Me

Econo& Me Series : To inspire normal citizen like you and me to understand a little bit of economy and how does this relates to us :)

Since the birth of modern economic thought, people have tried to work out how the quantity of money in an economy affects prices and the behaviour of consumers and businesses.

HOW IT WORKS:
Early 16th century — scholars note that the abundance of silver coming into Spain from the New World led to increased prices.

18th century — Classical School believed that the market would correct for such events, reaching an equilibrium price by itself.

Early 20th century — some economists believed that intervention by the government was necessary to maintain a balanced economy, arguing that government spending could boost employment by increasing overall demand.

1935 — John Maynard Keynes [ General Theory ]

Brief bio about Keynes — British economist, his ideas fundamentally changed the theory of practice of macroeconomics and the economic policies of governments.

He argued that government spending and taxation levels affect prices more than the quantity of money in the economy.

He proposed that in times of recession, a government should increase spending to encourage employment, and reduce taxes to stimulate the economy.

Government:
When output is shrinking and unemployment is rising, a government must decide how to react.

Investment and Spending:
As demand falls, firms reduce production, which raises unemployment and lowers demand.

Stimulating Demand:
The government increases its spending, for example on infrastructure. This reduces unemployment.
Building: houses, schools, hospitals
Welfare: Healthcare, Education, Policing
Defence
Transport Infrastructure

Production Increase:
With more people in employment, consumer spending rises. Increased demand leads to increased production.

Business Spend more:
With demand rising, firms invest more, opening more factories and providing more employment.

Economy in Balance:
With levels of investment and production high, and employment and wages rising, the stimulation of extra government spending is no longer needed.

Fisher’s quantity theory of money
American economist
Irvine Fisher’s theory argued that there is a direct link between the amount of money in the economy and price level, with more money in circulation increasing prices.

Low money supply = demand for money rises = high demand increases value = money buys more goods.

High money supply = demand for money reduces = low demand decreases value = money buys fewer goods

Marx’s labour theory of value:
The German economist Karl Marx argued that the real price (or economic value) of goods should be determined not by the demand for those goods, but by the value of the labour that went into producing them.

1 pair of shoes = 2 hours’ labours at 10 Euro / hour = 20 euro

1 dress = 10 hours’ labour at 10 euro = 100 euro

Hayek’s business cycle
Austrian Economist Friedrich Hayek noted a cycle in the economy, in which interest rates fall during a recession.

This leads to an over-expansion of credit, necessitating a rise in interest rates to counter excess demand.

Friedman’s Monetarism
American economist Milton Friedman

Argued that governments could change interest rates to affect the money supply.

Cuts would stimulate consumer spending ; Rises would restrict it and reduce the money supply

LOW interest : employee paid 100 euro → spends 100 euro → supermarket pays supplier 100 euro → supplier pays employees 100 euro

HIGH interest : employee paid 100 euro → saves 50 and spends 50 → supermarket pays supplier 50 → suppliers pays employee 50 euro.

Learning summary from the visualised book [How Money Works] by DK Publisher.

Econo&Me Learning Insights:
I have always been wondering how the economy works and these few key theories have somehow help me understand the relation of money in the economy system.

I always remembered this ceteris paribus while i was learning economics during my high school. We answer a question and we will put this at the end of the answer.

Ceteris paribus :
with other conditions remaining the same; other things being equal.

— all these theories only applicable in real world — ceteris paribus — if only the system could be that simple and direct so we can regulate and ensure everyone in the system propers.

Understanding how the economy works, how the quantity of money works in the economy system — my question always would be why do we need to know all these right? I think we can get to be more literate in economics so that:

1. We can grasp a deeper level of thinking and understanding how the money supply in the market indicating the upcoming rate of consumer spending and prices of goods. Then, we are able to somehow understand the market in overall, and we are able to critically think about whether is our government doing the right move or not so wise move. so that we are able to gauge a little bit.
2. As it relates to our livelihoods and quality of living. If we understand scarcity and the allocation and management of available resources, we can better understand labour, production, income, wages and more. Yes, it’s all big big words but we all play a role in this system, the more we are aware of daily issues such as taxation, inflation, interest rates and wealth.
3. So that we know WHEN is the right timing to do buying or selling. We then can make informed decision. Since we are all going to be run by the system, so why not understand how the system works and we can be creatively taking advantage of the system so that we can be more aware on how this going to affect our future generation.

Penny L.