Economics can be a dry and boring subject, especially if it’s all about mathematical calculations and economic charts. However, when economics is taught in a way that is relative to what is going on in our present world, the subject can suddenly become pretty interesting. There is no better example of this than the recent vote by Great Britain to leave the European Union. This single event sent shockwaves across the global financial markets creating fear and uncertainty as stock markets around the world plunged. So what does this event show us about simple economic models at work in the real world? For the answer, let’s first turn back to a lesson on simple economics and how markets determine pricing.
Markets are all around us and we make economic decisions on a daily basis without even realizing it. From going to a store that sells items at a lower price, deciding which home to buy, or deciding what to invest in. These are all economic based decisions that are made regularly by almost everyone. If this is true, then how come so many of us think that economics is so complex? It’s because we really don’t understand the concept at all. Economics is defined simply as the branch of knowledge concerned with the production, consumption, and transfer of wealth. While this definition may seem complex, it really is just saying something simple using fancy words.
• Production – Wealth is produced through goods and service being made and by the creation of money. For most of us, this is the income we earn from a job.
• Consumption – This is the part where most of us in America excel, spending money. Consumption is the sale and trading of the goods and services created in production.
• Transfer of Wealth – Although the transfer of wealth is a big topic these days, it also refers to wealth transfers on a smaller scale. If I buy a lemon from George for $1, then $1 transfers from me to George and he is $1 richer. The more people that buy lemon’s from George, the richer he becomes as more wealth transfers from the public to George.
This simple economic exchange model helps explain why people buy lemons from George instead of Mark or why people choose to invest in the British Pound or London real estate. The concept is simple: make money, consume some of it and try to transfer more of it to yourself through market participation. We see this time and time again when it comes to investment markets. Investors want to flock to the hottest stocks and the hottest markets so they can make the most money possible. Of course, they don’t always get it right and some people end up losing money, sometimes lots of it. That being said, this is the basics of what drives any market including stock markets, trade, Forex and others.
Demand Affects The Price
Another important principle that we need to understand here is demand and how it affects price. Demand is a concept in economics that describes the desire by consumers to purchase a good or service. In the lemon example above, the demand was 1 (just me) but what if there was a line of 20 other people who also needed lemons that day. Even better, what if George only had 10 lemons left? He could raise the price on those lemons to make more money. This is what happens when demand increases, a price increase typically follows. This is also how stocks reached ridiculous prices during the tech boom of 2000 and why people are selling British Pounds right now. It’s all a change in the demand for a good or service. Hopefully I’ve broken this complex subject down so that it’s more easily understood. Now let’s move on to how we see these principles playing out in the Brexit.
The experts predicted that a Brexit would be suicide for the United Kingdom’s economy. While it remains to be seen, the behavior of investors is following simple economic principles like the ones described above. Because Britain was a part of the European Union, they benefited from advantageous trade deals with the rest of Europe. In addition, it made it easier for other Europeans to travel, work and invest in the UK as well. With the Brexit, that will all likely change in the coming years. A sudden change has happened to both the public and investor mindset where they believe that it will be difficult to buy things from Britain, invest in the country or even travel there. This shift is causing people to take their money elsewhere and can be evidenced by the fall in the FTSE, London real estate prices and the fall in the price of the British Pound in relation to other currencies. The prediction is that the increased scrutiny will decrease interest from outside firms and consumers from investing in anything in Great Britain. It is this decreased demand prediction that is causing people to sell investments related to the UK. This is why we’re seeing large drops in the stock market, currency and other investments tied to the UK. With less people demanding British Pounds, London real estate or goods coming out of England, the prices of these and all goods will naturally drop and profits soon after.
Economics can be a dry and boring subject when we only study graphs and compute economic equations, but when we apply it to current events, economics can suddenly take on life. I hope that after reading this, you not only have a better grasp of some simple economic concepts but also begin to see how these principles can be applied to current events and other real life purchasing decisions.