Understanding Basic Economics

The role of economics in business, finance and life in general is profound, and until you look into the basic concepts underpinning economies on a micro and macro scale, it can be hard to appreciate the extent to which everyday activities are interlinked.

For example, an interest rate rise in China could impact on inflation in the UK. Likewise, rising unemployment in the north of England could lead to a reduction in government capital spending on projects in Scotland – financial systems are intrinsically linked by virtue of economics in a very real and practical sense, and understanding the basics of how economics works gives a good insight into market behaviour which could help more readily identify winning trades.

Scarcity, Supply and Demand

At its core, economics is all about the movement of scarce resources. Anything that has a price and can be sold does so because it is scarce – that is to say, so long as there are more consumers for those goods than there is availability, there will be value in acquiring those goods. Some things are abundant – for example, oxygen, water and light. It would be hard (although notably not impossible) to create a value proposition for these kinds of commodities – indeed, even bottled water is scarce because it is bottled – not because of its raw contents.

Assuming goods are scarce, i.e. limited and by definition not infinite, they will be governed to a greater or lesser extent by supply and demand. A substance that is in plentiful supply will carry less of a premium for the user than a substance which is extremely rare, thus the price points will tend to vary accordingly. More supply tends to equate to a lower market rate, whereas higher demand/less supply will drive prices upwards with more consumers vying to acquire less abundant resources.

The implications of this for futures trading can be best identified in the respect of commodities. If soya is regarded as an undesirable product for manufacturing purposes, people won’t buy it, and the price will naturally fall on the commodities exchanges. Conversely, if oil is highly sought after and increasingly scarce, prices will rise to reflect the value each barrel will deliver to the consumer – thus prices are flexible, and often defined by external market conditions.

Cause and Effect

Running alongside scarcity and supply/demand as principles of economics is the idea of cause and effect. Everything, economically speaking, is dependent on everything else – sometimes directly, sometimes indirectly, and sometimes in a peculiarly abstract way. Thus, if it transpires that one commodity has risen dramatically in price, you can expect the price consumers pay for products that depend on that commodity will eventually follow suit. This could lead to inflation in the country, and in some cases even lead to macroeconomic difficulties, such as rising unemployment. It might seem tenuous, but these links are very real, and put a whole new perspective on the importance of markets in determining price.

Economics is a vast area of interest, and one that people the world over dedicate their lives to studying. At its heart is the mechanics of the systems that govern our world, and its role on the markets and your trading performance shouldn’t be underestimated. Learning more about the fundamentals of economics is not only advisable from a trading perspective, but also from the point of view of better understanding the world, and reading into the subject further comes thoroughly recommended for traders of all stages. Not only will economics broaden the trading mind and point to more obvious opportunities for profit over time, but it will also add considerably to the trader’s understanding of business, finance and politics more generally.

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