5 Economic Concepts Made Easy via Systems Thinking
These will be presented uncritically with minimal commentary. The main purpose is to show how Systems Thinking can make economics easier to digest.
Law of Supply and Demand
For this we’ll just go left to right back to left.
When demand goes up price increases and quantity supplied increases. (Higher price means suppliers will produce more.)
When quantity supplied increases, price goes back down, so quantity demanded goes up. (Lower prices mean more buyers.) These are all ongoing processes which continuously balance themselves.
Bubbles
So a bubble is when prices of an asset go up consistently and that asset is therefore seen as a good investment. In a counter intuitive, but still understandable paradox when the price goes up, demand also goes up instead of down. Higher demand leads to higher prices, and the cycle continues… until it doesn’t. When the bubble bursts prices fall, so demand falls, so prices fall and so on… The virtuous cycle becomes vicious.
To be sustained, bubbles require a perpetually increasing supply of buyers. Each person has to sell to another person higher to be a winner. When the bubble bursts whoever’s stuck with the declining asset is the loser. There have been a lot of losers in the last 30 years or so. First it was the Dot-com bubble for tech company investments. Then it was the housing bubble for real estate investments. Bitcoin had a bit of an issue last year. So what’s next? Car Loans? Or just Bitcoin again? Haha just kidding. Not really though.
Crowding Out
When the government borrows money and spends it it may raise GDP, but that spending also increases real interest rates so that private firms will invest less which reduces GDP.
Keynes suggests that this is only relevant if the economy is already firing on all cylinders.
Hyperinflation
When prices go up continuously people expect prices to go up, so they buy items as soon as possible to avoid paying more later. Velocity of money (Number of times a dollar is spent in a year) increases which increases prices, validating the expectations and leading back to more expectations of higher prices. It’s a sort of self fulfilling prophecy.
Solution is to reduce the money supply however you can. (Higher reserve rate, raise taxes, reduce spending, reduce currency printing etc.) It will be painful in the short term, but at least it breaks the cycle.
Deflation
This one was a bit more complicated than the rest, since there can be so many different causes of deflation but I think it still works as a basic tool.
Deflation reduces spending since as prices are going down people anticipate lower prices in the future, so they put off purchases. Lowered spending can also contribute back to deflation. (R1) Our first reinforcing feedback loop wouldn’t be as significant if it weren’t for the other two reinforcing loops strengthening it.
Less spending means less employment which lowers spending in two ways. First there’s the unemployed people who no longer have an income and thus spend less. (R2)
Second, more unemployed people mean they have less leverage in wage negotiations. Lower wages mean lower spending again. (R3)
Reductions in spending can lead to reductions in GDP and cause a recession.
Intervention could be made to increase demand and therefore spending via fiscal policy. More spending means more employment means more wages means more spending means less deflation and higher GDP.
