Price indexes allow us to measure the extent of this general increase in prices, a phenomenon that is also called inflation. Low inflation rates can be tolerated. The European Central Bank considers an inflation rate of slightly below 2% per year most beneficial to the economy. But if inflation rates are considerably higher, the purchasing power of money decreases considerably. As the amount of goods and services that can be bought for a certain amount of money continuously decreases, people lose their trust in money and try to get rid of it.
[11]In the circular flow of the economy (see figure 1), public authorities (mainly governments) also play an important role. They levy taxes from households and businesses and use the money to provide goods, transfer payments and subsidies. Such goods as infrastructure (e.g. streets and street lights) and services like national defence and public security (e.g. police) need to be provided by governments and financed by taxation. There is demand for these goods, but private businesses would not want to supply them as “free riders” (people who do not pay for a good or service) cannot be excluded from enjoying them. In many – but not all – countries health care and education are also provided (at least to a large extent) by public authorities.
Figure 1. The circular flow of goods, services and money within the economy
Division of labour and specialisation
Without exchange of goods and services, individuals would have to produce everything they need themselves. That would be very difficult, time-consuming and inefficient because they would have to spend time on performing tasks that they lack the skills for. Exchanging goods and services allows for the division of labour and therefore specialisation. Individuals and businesses can concentrate on what they can do best. This explains the wide variety of jobs and of businesses. Using a widely accepted means of exchange like money facilitates the exchanges.
Specialisation can be found on many levels:
■ Within households, for example where individuals can concentrate on what they can do best or what they like doing (like one individual does the shopping, the other one the cooking).
■ The same principle applies to businesses: within businesses, some people concentrate on production, others on procurement, some others on sales, on recording all[12] financial transactions or on managing human resources. Accordingly, these (different) tasks of a business are often summarised in different departments of a business: procurement, production, sales department, marketing, finance and accounting.
■ Specialisation can also be found between businesses as every business focuses on a special range of products: some offer all kinds of furniture, others just beds and couches, some others just produce kitchens. These businesses operate on the same level of production. But specialisation can also be based on division of labour between businesses on different levels of production (first level: production of wood and iron, second level: production of boards and nails, third level: production of tables, final level: selling them) or in different sectors of the economy (see chapter 3).
■ Specialisation can also be found on an international level, as countries differ in climate, natural resources, geographical position and many other characteristics. Due to very different characteristics, countries also differ in their conditions for different industries (industry being a number of businesses that produce or sell the same product) and different business functions. AT&S for example has production sites in Europe as well as in Asia (China, India and South Korea). While production in Europe is highly diversified and relatively low in volume, production in Asia reaches a much higher volume but has a lower product diversity. This kind of division of labour can be explained by differences in terms of know-how of the workforce, labour costs, availability of other resources and the legal framework in different countries.
While division of labour has many advantages, it also has some disadvantages that need to be considered: for very specialised workers, work may become boring over time. Being specialised also means less flexibility as it is hard to develop other skills or develop competencies in other fields. A specialised business may be brilliant in that field, but if – for some reason – that specialisation is not needed anymore, the business is at risk and people could lose their jobs.
2.5 Different economic systems
The role of governments described above is mainly true for the governments in some sort of market economy. While in market economies individuals and businesses are – more or less – allowed to make many of their own economic decisions, in planned economic systems the governments play a dominant role. They (mainly or partly) decide which goods are produced and which services are offered (at which prices). Furthermore, they (mainly or partly) control the resources and the means of production. People have a limited choice of which job to do and which products to buy.
In most countries of the world, economies can be characterised as some kind of market economy. In some of these countries, the governments play a minor role by only providing the legal framework and not influencing the economy much, so their economic system comes close to what is called a “free market economy”. In many other countries, the government plays a more important role by influencing the economy to a somewhat higher extent, by supporting the poor and protecting the environment for example. These systems are called “social market economies” or “eco-social market economies”.
Over the past decades, a lot of former communist countries that used to have planned economic systems have adopted the main principles of the market economy. Many Central and Eastern European Countries (CEE), China and former Soviet countries are examples of such a transformation.
2.6 Supply and demand: Households, businesses and the government meet in the market
[13]In a market economy, goods and services are offered and sold on/at markets. Buyers and sellers meet to communicate the conditions of exchanging goods and services and thus form a market. A market can be an actual place, like a flower market in the city of Rome or a flea market in a small village, but it can also be a virtual place like a market on the Internet (e.g. eBay, Amazon). Buying and selling take place in shops, but also on the phone. Therefore, there are many different markets, also depending on what is offered: consumer goods markets, labour markets (supply and demand for work), housing markets, money markets, capital markets, commodity markets (supply and demand for raw materials).
2.6.1 The law of supply
Supply of a certain good or service is the quantity of that good or service that is available for purchase. Basically, this quantity mainly depends on the businesses’ production capacities and the available resources, but also on the price that can be charged for the good or the service. The higher this price is, the higher the supply will be. All other things held constant (“ceteris paribus”), this relationship is true for most goods and services in the economy (law of supply).
In Tina’s and Steve’s case, the quantity of hours that they (as well as other providers of similar computer support services) are willing to work depends on the price they can charge and that will be paid. It is tiring work and the providers of this service need to be very skilled. If the price is low, let’s say below 30 euros per hour for example, no provider would offer that service. The opportunity cost would be too high: as the providers are very skilled, they could earn more money by doing something else (that is also less tiring), so they would leave this market and offer another kind of service. The higher the price, the higher the number of hours that would be offered. More potential providers would enter the market and would be willing to offer a higher number of hours of their service.
The