Adam Smith, the so-called father of modern economics, was born in Scotland in 1723. He went to the University of Glasgow when he was only fourteen years old. When he was seventeen he started his studies at Oxford University. He was there for six years but he didn’t start any important work there. He came back to Scotland in 1746. Later he published a book that changed economics forever: An Inquiry into the Nature and Causes of the Wealth of Nations. Today we simply call it “The Wealth of Nations”.
Smith realized that a nation’s wealth depended on its ability to produce goods. The value of these goods depended on the cost of production. The cost of production depended on the cost of workers, raw materials and land. This was really the first example of macroeconomics.
For classical economists, the value of goods depends on the cost of production. However, the price of goods is not always the same as their real cost. Later economists developed new theories to explain this weakness in classical economics. These were known as the neoclassical economists and they were writing at the end of the 19th and early 20th centuries.
In neoclassical economics, supply and demand make the economy work. In other words, the price of goods depends on how much people want them and how easily they can be found. Consumers want satisfaction from their resources (time and money). Firms want profit. In neoclassical economics, this is the basic relationship in the economy. These ideas are still the basis of economic thinking today.
Money is important in the operation of the economy at two levels. First, it is the means of financing the purchases of goods and services and a means of storing values. Second, the quantity of money in the economy helps to determine total spending and the general level of price.
Almost every society now has a money economy based on coins and paper bills. However this has not always been true. In primitive societies a system of barter was used. Barter was a system of direct exchange of goods. Somebody could exchange a sheep, for example, for anything in the market-place that they considered to be of equal value. Barter, however, was a very unsatisfactory system because people’s needs seldom coincided. People need a more practical system of exchange, and various money systems developed, based on goods, such as cattle, grain, salt, etc. Precious metals gradually took over, because, when made into coins, they were portable, durable and divisible into larger and smaller units of value.
A coin is a piece of metal, usually disc-shaped, which bears lettering, designs or numbers showing its value.
Most governments now issue paper money. Paper money or “bank-notes” are easier to handle and much more convenient in the modern world. Checks and credit cards are used increasingly nowadays.
People who work usually have a bank account.. If money is kept in a bank savings account, it will earn interest. What other services do banks offer?
The other main service is lending money. Individuals and businesses often need to borrow money and they need a lender they can trust. This is exactly what banks are – reliable lenders.
Apart from storing and lending money, banks offer other financial services. They give customers cheque books and credit cards to use instead of cash. They provide ATM (automatic teller machines) so that people can get cash any time of the day or night.
But how do banks make a living? Basically, they make a living by charging interest on loans. Of course, when you make a deposit into a bank savings account, the bank pays you interest on that money. However, the rate which banks pay savers is less than the rate which they charge from borrowers. The extra money they make by charging interest on loans is where banks earn most of their money.
All banks keep a reserve of money. The reserve must be a certain percentage of all the savings received from customers – for example 20 per cent. This figure is set by the central bank, and this is one of the ways that governments can control the amount of money circulating in the economy. (1049)