Important Economic Terms
- Why Should I Care?
We must agree on basic definitions before we start arguing about how to run the show. In this module we will discuss the terms that most economists use and agree on.
- This Lecture Has 4 Parts
- Products
- Suppliers
- Flows and Stocks
- Resources
- What are Economic Terms?
The economy is a system composed of many different kinds of people and objects. Each one has a role to play that needs to be identified clearly. Economic models are used to simulate changes to the economy and its important to understand the terms used for each variable. This textbook is intended for students who could be studying more advanced economics in the future, so we want to know the jargon used in the discipline.
- Products
What people consume is called a product. A product is the output of the production system. It is the end result of many transformations of raw materials by workers.
Production:
Economic output which is the result of the processing of inputs.
There are two kinds of products: goods and services.
Goods:
physical, or tangible, objects that result from production.
Services:
non-tangible production, such as accounting services, education, or health care.
In a modern economy, most production is measured in terms of currency, because it was the object of a money transaction. However, there are things produced, which no one buys, such as the secondary production of many plants and factories. Secondary production is not a problem unless it pollutes the environment or otherwise decreases a community's well-being. In those cases, secondary production is considered a bad, rather than a good.
Since goods are tangible objects, we notice them more than services. But most of the economy is made of services, at least in its dollar value. Goods make up about a quarter of production, even though they may be very expensive to purchase, such as a home, or a car. Since production is measured in units of currency (dollars), one quickly realizes that we spend more money on services than we do on goods. In many cases, bads are not sold on a market, so their production goes largely unnoticed. If a ‘bad’ is sold as an input, then it’s cost is included in the market value of the final good.
Consumer spending on goods and services depends on many factors, notably their income. Economists generally believe that consumer demand for many goods will rise as people become wealthier. We call these “normal” goods. Think luxury cars, restaurant meals, vacations, fancy clothing, and computers.
Inversely, there are cases when the demand for some goods will actually drop as people become wealthier. We call these “inferior” goods. Think home cooked meals, smaller vehicles, public transit, and stay-cations (instead of vacations). The reason is that as income increases, we are likely to spend less on inexpensive products, and more on expensive products.
- Suppliers
The people who sell products are called suppliers and producers. In an economic model, any organization on the selling side is usually called a 'firm', or a producer. However, there are many steps to production, with different roles for different organizations.
If they did not make the product, they can be called retailers (if they use a store), or distributors (if they use a warehouse).
The word supplier also refers to people who sell inputs such as parts and machines to the organizations that oversee final production stages.
If they did produce the said product, a supplier can also be called a manufacturer, if they produce in a plant or a factory.
Companies with less than 100 employees are usually considered small businesses. Companies with more than 100, and less than 500, employees are considered medium-sized businesses. Companies with more than 500 employees are generally considered large businesses.
An industry is a group of producers who make and sell a similar product. The industry is named by its main product. The Quebec beer industry, for example, is a group of brewing companies. The group is made of Molson Coors Brewing Co., Anheuser-Busch InBev (Labatt), Heineken International BV, Sleeman Breweries Ltd., as well as a few local breweries such as Brasseurs RJ.
Every industry is classified according to large groups, depending on their role in the economy. In Canada, the USA, and Mexico, producers are sorted with the North American Industrial Classification System (NAICS). Economists use three large groupings to distinguish industries. These groupings are called sectors.
Primary Sector:
Industries in agriculture, natural resource extraction such as forestry, mining, fishing.
Secondary Sector:
Industries in construction, manufacturing of goods, transportation and distribution.
Tertiary Sector:
Industries in services, such as civil service, education, health, justice, retail sales, restaurants, and hotels.
- Stocks and Flows
Resources and products are measured in two distinct ways. First, economists will measure how much stuff we have. This is called a stock. This term does not refer to shares of a company, but rather to the accumulation of objects in terms of inventory. Economists use stock measurements to measure patterns such as an economy's capacity to produce, using inventory levels, reserves of mineral resources, and the quantity of available labour. Economists also measure outcomes such as levels of wealth, using assets, and debt. To use a simple example, you could say that the stock of automobiles in Canada is 35.7 million units. The stock can be measured as a unit (automobile), or as a monetary value (dollars). Stock measurements are useful to decide if we have enough of something, or if we need to produce more. Considering the example of automobiles, there are almost as many of them, as humans, in the country, so we might be tempted to say that we have enough cars.
Accountants will measure a company's stock in terms of their balance sheet, which compares assets owned, and liabilities owed (debt). In French you would use the word 'stock' and see these figures in the Bilan financier. When a company fails, creditors will want to be paid back with what's rest of the company's assets, hence the expression 'Déposer le bilan' means to go bankrupt.
Second, economists will measure how much stuff we produce over a period of time. This is called a flow. The quantities sold, or produced, are measured over a year, or a month. Flow measurements are useful for identifying sectors of the economy that are increasing production, or slowing down. In the case of automobiles, instead of saying that there are 35.7 million cars in Canada, you would look at how that number is changing, i.e. cars that are taken out of circulation per year, or cars that are added to circulation. In 2019, Canada added 1.6 million automobiles. That's almost the human population of the City of Montreal. We definitely like to buy new cars!
Accountants will tally flows in the cashflow section of a company's financial statements. In French you would say 'flux', and find these figures in the États financiers section of the financial accounts. There are usually two kinds of flows, incoming (called revenues), and outgoing (expenses). The net value is called earnings, which loosely translate to profits.
Stock: a certain quantity AT a certain point in time. Q or $
You can take a "still photo" of this quantity.
Flow: a certain quantity OVER a period of time. Q/t or $/t
You can take a "video" of this quantity.
Both of these measurements are important, and should be used simultaneously. Stocks tell us how much stuff we have, and if we need to make more, or less. Flows tell us how fast the products are selling.
- Economic Resources
Economic outputs are the result of the transformation of inputs. In standard economic parlance, inputs and processors are called factors of production, or resources. Economists identify four categories of resources:
Labour:
Human effort used to process inputs.
Natural Resources:
Basic materials collected and extracted from the natural environment and used as inputs.
Capital:
Producted means of production. Objects, Knowledge and Technologies used to process inputs.
Entrepreneurship:
Human involvement in organizing inputs, and processors, to accomplish production. Synonym: Management.
Note there are three types of Capital.
Human Capital:
Knowledge and skills used to process inputs, such as recipes, language, mathematics, algorithms, experience, and formal education.
Financial Capital:
Monetary assets used to purchase inputs and processors, such as cash, loans, bonds, and other financial instruments.
Physical Capital:
Objects used to process inputs, such as machines, robots, tools, buildings, public infrastructure and equipment. May also include inventory.
Economic resources are quantified as stocks, which can contribute to production, which is quantified as a flow. The economy is basically a system where stocks of resources accumulate, then combine to be transformed as products. This production flows over time into peoples homes where they are consumed (food), or accumulate (furniture).
The idea of analyzing types of resources comes from Adam Smith, a father of economics, who insisted on the importance of land, labour and physical capital. He was isolating these factors of production from the obvious economic resource of money, in his case: gold. Smith's analysis was important for its time. First of all, Germany and England were rapidly industrializing their economies, which means they were adding constantly machines and building larger factories. So Smith is correct in pointing out the importance of physical capital, relative to labour.
Second, many kingdoms and empires were rushing to accumulate gold, especially through colonization in the Americas. Smith observed this phenomenon, and keenly remarked that gold is not a productive resource, it doesn't really add to your capacity to produce goods and services. Too much gold can be inflationary, which is a phenomenon the Spanish learned about in the 17th century.
We keep using Smith's nomenclature of resources to this day, because it allows us to track patterns in our capacity to produce.
Modern economics adds two notions to Smith's work: human capital, and entrepreneurship. First, human capital is the accumulation of knowledge and skills that belong to workers, to labour. However, it is not directly associated to production because one may have a very high stock of knowledge, but not be active on the labour market. For example, a woman with a PhD in chemistry may have won the lottery, and decide to retire at the age of 38. Her human capital is very high, but her labour is nil.
We defined resources as stocks, which they are mostly. But labour is an exception which can be measured as a stock, or a flow. For example, if Canada has 16 million available workers, with or without a job, that is a resource stock. However, labour is paid usually on a time scale, and people need to do the time, clock in, to be paid. So the act of processing inputs, which is mostly the job of labour, is a flow measurement. This is why we end up with an hourly, and/or yearly, measurement of labour income.
Economists have also added the resource of entrepreneurship. Notice that the economic definition of entrepreneurship differs from what most people are used to. Newspapers and business people will consider entrepreneurs to be risk-taking investors who are building new companies, in innovative sectors of the economy. Economists have a tendency to rewrite the dictionary, but nonetheless, in economics, entrepreneurship is viewed as a resource, for which it receives a flow of income associated to profits. As you will see later, each resource is associated to an income stream, and there has to be a resource associated to profits. This said, production cannot take place if no one is there to organize and coordinate the transformation of inputs, i.e. the traditional resources of land, labour and capital. Economists would not consider entrepreneurship to be an input, but rather part of the control and process components of the economic system. In economics, anyone managing an organization, such as the principal of High School, would be considered an entrepreneur.
-Green Policy
Understanding economic jargon, such as flows and stocks, is important if you want to protect land for wildlife, bugs and flora. Business people most definitely need land for its natural resources such as fuels, minerals, water, wind, or to farm cereals and livestock.
Unless we find a new planet soon, our land base is absolutely limited and scarce. So what to do?
One school of thought will encourage Greens to offer other solutions for business people to develop projects, such as sustainable energies, renewable energies, and even to farm in the city, rather than in the countryside. If these solutions don’t exist yet, Greens will encourage governments to spend on scientific research to accelerate the development of Green Technologies.
Other schools of thought may be less accommodating for industrialists and capitalists. They will encourage Greens to lobby for outright reductions of production to reduce the human imprint on natural environments. For a long time, politicians were very skeptical of this position. However, the 2020 COVID pandemic has shown many people on earth that consuming less is possible, and maybe even good for us.
Another school of thought is to present Nature as a producer of Natural Services. As we have mentioned before, nature is an excellent economy with zero waste. But is it an economy for humans? Absolutely.
The obvious part of the answer is that humans eat foods and use materials we find in nature, or that we garden intentionally. We have done this for millennia. But the full answer digs much deeper. There are many savings we can make in our daily lives, if we prefer natural solutions, to more expensive human technologies.
For example, engineers can calculate that a large tree on your front lawn provides the same cooling service in the summer as five window air-conditioning units. A tree is then providing a service to humans. For free. No hydro bills to pay for expensive cooling during the heat waves of July and August!
When it comes down to choosing an approach, economists will propose that one be aware of the costs and the existing alternatives.
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Climate Change Solution
One might say that Natural Services are great if you can use them. But how can I reduce greenhouse gas emissions when I travel? How can I get to Toronto to visit family using Nature?
Good point, the Saint-Lawrence River flows down stream towards Quebec City. It takes more energy to travel upstream on a river. That’s what the Kanien’kehá: ka (Mohawk) did for millennia, on the same river they call the Kaniatarowanenneh.
It’s hard to beat the convenience of modern travel machines such as aircraft, automobiles, and trains. One might say that we have become addicted to these machines. The solution therefore seems to be in a mix of approaches. Reduce the use of gasoline-fuelled transports. Walk, cycle, and take the electric transit systems as much as possible. Lobby politicians to build green alternatives such as a fast electric train between major cities.
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Democracy Booster
Industry lobbyists often use the “economic argument” to raise support for their projects. Often times, their projects are aiming at increasing the production of something we already produce, so be weary of calling that a “development.” It’s actually more ‘‘expansion’’, than development.
Industrialists will argue they create jobs, and generate fresh income for governments who need that money to provide social assistance and public services. This is all true, economists will agree.
However, the economy should produce what people need and want, in a way that is sustainable. Therefore, feedback loops and control incentives need to be in place to make sure that those who fund and manage these projects, are in tune with the needs of the people. Most often, we don’t need MORE of something, we need something ELSE.
- Business Case
On the one hand, the inventory at the College Book Store, on September 21st, is very low. In the English section, the stock of books is down to one copy of Macbeth. The manager is considering ordering more copies.
But, on the other hand, the weekly sales of books are slowing to a halt. The book store has not sold a single copy of Macbeth in the past week. This is probably because the semester is well under way and most students are done shopping for books.
Taking both stocks and flows into consideration, the manager decides NOT to order more books.
- Wrap-Up
Economists name people and objects. Producers transform resources into final goods and services.
Groups of producers are called industries.
The inputs that go into production are called resources. They are land, labour, capital, and entrepreneurship.
Economic factors and objects can be measured as stocks and flows.
- Cheat Sheet
Industry:
A group of producers making the same product.
Resources:
Objects and services used as inputs to produce final products.
Labour:
The human resource of work, whether physical, mental or both.
Land:
Includes all natural resources, such as wind, fish, gold, as well as soil for agriculture and land to build on.
Capital:
Intermediate goods used to produce a final product, such as money, machinery, buildings, equipment and stocks of knowledge (human capital).
Entrepreneurship:
Bringing together Land, Labour and Capital to produce final products.
Stock:
a certain quantity at a certain point in time.
Flow:
a certain quantity OVER a period of time.
- References and Further Reading
Louvet, B. (2019). Canicule : en ville, un arbre mature = 5 climatiseurs? SciencePost.fr. Retrieved from web.
Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations.
Statistics Canada. (2020). More vehicles on the road in 2019. The Daily - Statistics Canada. Ottawa: Government of Canada.
Statistics Canada. (2020). Automotive statistics. The Daily - Statistics Canada. Ottawa: Government of Canada.