How does the Economy Work?

How does the Economy Work?

What is the economy?

The economy system is the general overview of the trade of commodities and services in every market or financial sector. The information is collected and used to analyze whether or not the country’s economic direction is improving or not, while also calculating that of the world.



Have you pondered upon the economy’s involvement in your daily life or why it is important? Today, we’re here to remind you that the economy should never be looked over!





The creation of an economy



An economy is created due to the trades of goods and services between people within a country. It depends on the notion of trading what we one has for something they don’t, initiating the first form of money in early civilizations.





Economic drive



Money is an important medium for the exchange of goods and services, starting at the civil level, which can include the trade for necessities or resources needed for manufacturing and for personal needs.



More importantly, money is also needed by organizations as capital funds that are utilized when manufacturing, as well as for salaries and organizational development to meet the needs of the market.



Hence, exchanges, or transactions, have become fundamental in driving the economy of various nations. Without it, money would not be able to flow.

Economy measurement



The Gross Domestic Product (GDP) is the overview of all income the country receives from exchanges, products, services and various assets. GDP is the indicator applied to analyze an economy’s stance and determine whether or not it is progressing forward.



Furthermore, GDP also implies a country’s credibility, when compared to statistics of previous years. It can indicate higher manufacturing capabilities, increased income rates and higher expense rates, and their depletions as well.



The calculation of GDP is also often used to predict an economy’s trajectory. Investors can apply this information to their investment strategies as well.





Importance of credit



Credit is the equivalent of a person’s trustworthiness and their capability to pay off debt, regardless of the amount. Credit can be measured by a person’s base salary and the assets they hold, including houses, cars or property. The matter of credit can be measured at an organizational or national level as well.



Credit can be positively influential on an economy. With credit, a country could be less wealthy than others, but with credit or trustworthiness, they can stimulate investment, spending and loans more, which can all aid their people’s income.



Individuals or companies with potential, but lack capital support can have stagnated growth. Therefore, credit can be highly integral when scaling businesses, which would be influential on a country’s economy as well.





Influential factors on an economy



Daily expenses can fluctuate, depending on the personal needs of those who hold funds. However, not everyone can have the capital funds for expenses, investment or organizational development, making them integral factors for driving the economy.



Credit can be a form of exchanges in goods and services, but sellers receive their payments afterwards. Banks can play a role by reserving the payments or loans.



Nevertheless, it can be viewed that credit is comparable to debt waiting to be paid off with interest. For instance, in the case that a total amount of 2.4 million baht is borrowed, it can be paid off in a span of 2 years with interest fees of 5% and the borrower can pay at a monthly rate of 105,000 baht. If a bank provided the loan, a small portion of the fees would be allocated to those who deposit funds as savings at their banks.

Interest rates are managed by central banks at a consistently high rate in order to control the quantity of money that is distributed in the economy, better known as inflation prevention. However, when interest fees are low, it is for the purpose of increasing the amount of money in the event of economic stagnation and deflation prevention.





Central banks, Deflation, and Inflation



Inflation is an event where all prices of goods and services adjust to a higher rate. If financial institutions are able to manage and suppress inflation rates, the economy’s growth would absorb little to no effects.



Deflation is a phenomenon that occurs when economies depress, affecting its people’s ability to purchase goods and services and making them desire to do less as well. Deflation can eventually lead to economic recession, damaging the economy immensely.



The prediction of a country’s probability of heading into a state of inflation or deflation can be calculated with the Consumer Price Index.



Banks or financial institutions are responsible for maintaining the economy’s safe step forward through the management of interest rates to coincide with the country’s financial situation to prevent imminent deflation-inflation.



After adjustment of interest rates, it is possible that people would spend their expenses less, but instead turn to paying off their debt and adding more to their savings, rendering inflation rates to drop, which may cause the economy to slightly stagnate.



Generally, reducing interest rates can stimulate the economy as it tends to draw the attention of people and organizations to submitting for loans. By doing so, dispenses and demand are increased, as well as the reduction in the probability of deflation. However, inflation can become a threat instead, as central banks would now be the main authority.





Economic crisis



During its growth, economies tend to slow down its development to maintain its inflation rates. In a short-term perspective, this can be beneficial, but what about in the long run?



Exceedingly rapid economic growth in a long term sense can cause an economic crisis, which is a result of increased amount of money in circulation from elevated salaries and credit. This sends demand and prices to skyrocket over its previous limit.



In such situations, civilians are forced to reduce their spendings, causing economic recession and not even interest rate reduction can help stimulate the economy. This is the very definition of Negative Interest Rate, which generally does not always aid the situation at hand.



Lastly, this causes the general public to stray from spending their money, causing prices of goods, services and even property to heavily decrease as there is more supply than demand.





How does all this affect the economy?



Credit is a vital factor to take in when stimulating an economy. Whether or not an economy is growing or stagnating, it all depends on the amount of accumulated credit that is distributed to borrowers.



Interest rates are indexes that control credit as every borrowed transaction includes interest and they can be set as high or low depending on the economic stance. Adjustments in interest rates are a part of inflation-deflation prevention.



Countries with well-managed economic stimulation, loans, borrowed funds and inflation observation can experience great economic and financial growth, which would undeniably uplift quality of life for its people.



However, if handled poorly by central banks, even with increased salary rates, inflation would still plausibly arise, damaging the country’s economy and goods and services prices.



Hyperinflation not only negatively affects the economy, but also drops the value of the country’s currency, reducing credibility and possibly even causing economic deterioration.





Conclusion



The functions within an economy have its highs and lows, all influenced by the management of domestic financial institutions or central banks. A well-managed economic system takes all factors into account, while keeping economic growth as its highest priority and being consistently cautious of economic crises as well.



Understanding economic cycles can immensely aid the process of risk management for investors as well as provide a clearer full picture during investment decisions.





Reference: 



Binance Academy, Investopedia, Youtube, Wikipedia

Economy

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