Trade, Market, and Economics are all related. Trade refers to the exchange of products or services. A market is a place where trading takes place. conomics is the study of trading and markets and how they interact with each other. In today's world with its millions of people, trading has become complicated and is referred to as the economy. To understand the complexity of economics, one, needs to go to the beginning and look at why and how trade started. Examples will be used to explain the principals involved in economics, and are in no way historically accurate.

Because people develop different skills according to their talent and ability, they produce different products and services. In the following example, a farmer and a hunter will be used. The first exchange of goods and services was likely between a person who was a farmer, and someone who was a hunter. The farmer offered vegetables to the hunter for meat and the hunter who was in need of vegetables offered the farmer meat. When they agreed on the amount of vegetables and meat to be exchanged, the trade was completed. Direct trading of products and services between two people is called bartering. This simple illustration demonstrates a basic exchange between two people, which is the building block of an economy. As you can see when there are only two people involved in exchanging goods and services, there will be few if any problems that will develop in an exchange, other than disagreeing on how much would be offered by each person to make the trade.

In the preceding example goods refers to the meat and vegetables. The service part of the trade between the farmer and the hunter refer to the labor expended to produce the meat and vegetables. This is what gives value to objects being traded. You need to understand that labor and time are tied together. That is the labor required to produce something or perform a service is measured in units of time. The principal introduced here is that in all trading, a person's time is what is really exchanged. Any economy is nothing more than the exchange of goods and services between two people. The problems and complexity of an economy arise when many people are part of a particular economy. In the next section problems and complexities will added to the examples of a market economy.

The list of products and services gets larger and more varied as more people enter into trading with each other. When a number of people all with different products and services trade among themselves, a problem develops on how to exchange products and services that is satisfactory to each person. In the next example, more people will be added, each with a different product or service. To the farmer and hunter will be added a clothes maker, a toolmaker, and a big husky fellow, who provides a service of moving objects. To see where a problem develops in trading of products and services, a series of trades will be set up between the five people in this economic group. The farmer has need of tools to help in the growing of vegetables, and the toolmaker has a need for vegetables. A trade of vegetables and tools is completed between the farmer and toolmaker. An exchange of vegetables and clothing is made between the farmer and the maker of clothes. The hunter trades meat with the big husky fellow in exchange for his services. The maker of clothes has need of tools to make clothes with. At this time the maker of tools does not have any need for clothes. Now what? How is the maker of clothes going to get the tools needed, when the maker of tools does not want clothes in exchange? The clothes maker in exchange with the farmer received more carrots than he could use. So the clothes maker offered the extra carrots received in the trade with the farmer, for the tools he needs to make clothes. Carrots were accepted by the toolmaker in exchange for tools. The toolmaker felt it would be easier to trade extra carrots for products or services needed than extra clothing.

As you can see in the above example, an exchange of products and services is becoming complicated and it can be difficult to complete an exchange of products or services without the use of a common object to trade with. The use of carrots could be used as a way to exchange products or services, which would eliminate the problem of trading between two people, where one of them has no need for the other persons product or service. All persons in this example have to agree to use carrots as the means for trading goods and services for it to work. By using carrots in a trade of products or services, an exchange can be completed when only one person has need of a particular product or service, as in the case of the clothes maker and toolmaker. In order to make trading easier between people, a number of carrots can be assigned to each product or service. In this way products and services can be exchanged effectively. That is a pound of meat can be exchanged for a certain number of carrots, a jacket would be traded for a given number of carrots, and a tool would require a certain number of carrots in trade. Stones, shells, grain, corn, gold, or silver could have been used as objects for trading instead of carrots.

The principal introduced here is that it makes no difference what is used in the exchange of products and services, just as long as it makes trading easier and is accepted by all persons. In the preceding example try substituting one of the other trading objects in place of carrots. You see it really makes no difference what object is used in trading. The results are always the same. This principal is important for you to understand. In the example, if the use of carrots seemed to be the same as money, you are correct.

Carrots was used to get you to understand that money could be anything, as long as it was agreed on, to be used by all parties engaged in trading. I can think of reasons why carrots would be a bad choice to use as money. The supply of carrots would fluctuate causing inflation or deflation, explained in the next section. They would not be all the same size and after time would rot. Remember that whatever object is being used in exchanges, it represents a persons time.

Carrots will be used again to illustrate how inflation and deflation takes place. Let's say that a jacket from the clothing maker is traded for 30 carrots, and a knife from the toolmaker is traded for 5 carrots. The number of carrots used to trade for a particular product or service will stay the same as long as the total number of carrots in circulation (circulation as used here means, the total number of carrots used for trading in an economic unit) does not change. Let us examine what happens when a bumper crop of carrots is harvested.

Now with an unusually large supply of carrots on hand, the farmer is able to buy 2 or three jackets instead of one, and two or three knifes instead of one. This causes the total number of carrots in circulation to increase. This causes problems for the clothing maker and the toolmaker. Each can only make a given number of jackets and knives. Because the clothing maker now has a shortage of jackets, the cost to trade for a jacket is increased to 60 carrots. The toolmaker is experiencing a shortage of knives and raises the price of a knife to 10 carrots.

It appears that the value of jackets and knives is going up. Not So! Remember that carrots are only a representation of a person's time in producing a product or service. Now lets see what is really being traded. When the cost of a knife was 5 carrots and a jacket 30 carrots, It took 6 knifes to purchase one jacket. When the cost of a knife is ten 10 carrots and a jacket 60 carrots, it still takes 6 knives to trade for one jacket. The principal shown here is, as the supply of money (carrots in this case) increases, the amount of money needed for an exchange will increase. This is called inflation.

Now we will examine what happens when the number of carrots harvested drops. The farmer now is in a dilemma. There are not enough carrots to trade for a jacket or a knife. The clothing maker has extra jackets, and the toolmaker has extra knives on hand. Because jackets and knives are slow in trading, the clothing maker will accept 20 carrots for a jacket, and the toolmaker will accept 4 carrots for a knife. Again we see what appears to be a change in the value of jackets and knives. Only this time the value looks like it is dropping. But again it still takes 5 knives to trade for one jacket. All that has changed is the decrease in the total number of carrots in circulation. The principal shown here is, as the supply of money (carrots in this case) decreases, the amount of money exchanged for a product will decrease. This is called deflation.

What is money? Money is an object or commodity that is used in the trading of goods and services, instead of direct exchange of goods or services. We will start by looking at what money is not. Bartering is a system where by 2 people directly trades products and services. When bartering is used, different products and services are used in each individual trade. There is no common trading object used in bartering. Bartering uses only products or services, and because each individual exchange is different, nothing traded can be considered as money.

We can now define money as a common trading object or commodity used in all exchanges of services and products. When money is used, an exchange is no longer considered bartering. In the preceding examples carrots were used as the common trading object. Seeing carrots were used in all exchanges, carrots by definition is MONEY.

There are 2 kinds of money, tangible and intangible. Tangible money is always a commodity. A few of the commodities that have been used by people as money, are gold, silver, copper, shells, and stones. Commodities used as money has 2 values. One value is called the real value, and the other is called the trading value. The real value of tangible money is the value of the money (commodity) itself. If we use carrots as an example, the real value of carrots as money is the value of the carrots, not the value of the products or services traded. The trading value of carrots when used, as money is the value of the products or services exchanged. When only one commodity is used as money it is impossible to determine the difference between the real value and trading value of a particular commodity used as money.

Intangible money has no real value of its own. It is a note (more commonly known as paper money) which is exchanged for products or services. When a commodity backs intangible money, it still has no value of it's own, but takes on the value of the commodity that backs it. We will look at Intangible money and how it is created in the next section.

Banks offer many services other than accepting money for safe keeping and making loans. The bank that will be used in this example will only accept deposits and make loans. In this example, the cyclic flow of money will be followed as it is deposited and loaned out. Carrots will again be used as money.

The farmer deposits 100 carrots in the bank and receives a receipt of deposit for 100 carrots. The hunter is in need of some new equipment, but is short 50 carrots to trade for the needed equipment. The bank loans the hunter 50 carrots to buy the needed equipment. The person, who traded the equipment for carrots, deposits the 50 carrots in the bank and receives a receipt of deposit for 50 carrots.

In examining the preceding example, we find that the bank still has 100 carrots on deposit, even though the bank loaned out 50 carrots to the hunter. The bank has two receipts of deposit outstanding, one for 100 carrots and one for 50 carrots, for a total of 150 carrots. The results of the three transactions are as follows. One: Money leaves the bank as a loan and comes back as a deposit. This demonstrates the cyclic natural flow of money. Two: Intangible money was created in the amount of 50 carrots.

The bank would be 50 carrots short if the farmer and equipment maker wanted to redeem their receipts of deposit at the same time and would have to wait until the hunter repaid the 50 carrots to the bank. In this simple banking example, a receipt of deposit was used. A more practical way would be to issue bank notes instead of deposit receipts, (intangible paper money) which would be backed by carrots on deposit with the bank. A bank note could be in different amounts. Say for example a bank note good for 5 carrots, and a bank note good for 10 carrots, which could be given back to the bank and exchanged for carrots, depending on the face value of the bank notes, that is 5 carrots for a 5 carrot note etc. These Bank notes can be traded for products or services instead of carrots, in the same manner as carrots are used in trading.

Whenever money is loaned, it is created at that instant. Money creation is a natural occurrence of money loaned by a bank. If an individual or business trades a service or product for credit rather than money, no money is created. This is because a product or service is loaned and no money changes hands. Money is only created when money is loaned, not when a product or service is sold on credit. Money created in this way has no value. In the example the bank only has 100 carrots, and yet there are bank notes (Receipts of Deposit) outstanding for 150 carrots. Because the bank has only 100 carrots to cover bank notes worth 150 carrots, there are bank notes worth 50 carrots that have no backing. These bank notes with a value of 50 carrots are intangible. The value of these bank notes is based solely on the promise of the hunter to repay the loan to the bank for 50 carrots. Its real value is only in the paper and ink the bank notes are printed on. This practice used by banks to create money leads to inflation. The amount of inflation depends on the amount of money created. Inflation increases as money is created and deflation occurs when loans are paid back, which causes the money supply to decrease.

A central bank is unlike a local bank that serves a community. It has to be sanctioned by a national government and not by a state or province. A central bank sometimes is known as a national bank. This type of bank is usually not owned or controlled by a national government. It is owned and controlled by private banking interests, which only have to follow the guidelines set by the government that gives them a charter. A central bank differs from local banks in that it accepts no deposits, and has no financial transactions with individuals or businesses. Its only purpose is to loan money to the national government and local banks. It does not offer any of the many other banking services local banks do. The only income a central bank has comes from interest on the money it loans to other banks and the national government. It is interesting to note that a central bank has no expense on the money it loans out, because it has no deposits that it has to pay interest on. The only expense a central has is its physical building, equipment and labor.

As was shown in the last section money was created out of thin air through loans. A central bank needs no commodities on deposit to make loans. All money that is circulated by a central bank is intangible money and has no value. The money supply depends solely on the amount of money loaned out. It should be noted that the money supply of a central bank is endless. If all loans from a central bank would be paid back, there would be no money left in circulation. Of course this would never happen, as there would always be someone wanting to borrow money and a local bank willing to lend money.

As can be seen from the previous discussions on inflation, if too much money is loaned out increasing the money supply too fast, runaway inflation will occur. One way to control the money supply is to vary interest rates. By increasing interest rates borrowing is less attractive. Likewise lowering interest rates makes borrowing money more attractive.

One of the more interesting aspects of central banking is that the supply of money is endless. No matter how large the demand for loans is, the supply of money never runs out. It's as if a central bank has a money tree growing in their backyard. This is because there are no commodities on deposit to limit the money supply. The central bank can print (Sometimes this is hidden by having the actual printing done by a national government) more money (bank notes) to meet the demand or simply write a check.

If a commodity is used to back loans made by a bank. The bank is limited to the amount of money it can loan out by the quantity of the commodity that it has available to it, thereby limiting inflation. Inflation thereby is limited to the increase of the supply of the commodity. That is why gold and silver is used to back money, because of its limited supply.

During a boom cycle banks continually increase their lending putting more and more money into circulation. There is usually a period of inflation associated with booms. The increase in inflation may or may not be a lot, depending on other conditions in the economy. A boom cycle ends, when banks start to tighten credit by increasing interest rates or limiting the money they loan out, causing the money in circulation to drop, triggering a bust cycle. Most bust cycles that start this way are called recessions and do not cause a big disruption in economic conditions and happen every few years or so.

A boom that precedes a deep recession or depression is different than the period that leads to a more mild recession. Banks use less discretion in their lending practices, and make higher risk loans. People change their lifestyle from save and then spend to one where their spending is based on credit. Also a boom of this type has the feeling of unending prosperity. The economic system eventually becomes over saturated with money. When this happens and the amount of the loans exceeds the ability of the people to pay them back. People start defaulting on their loans. This not only causes a bust, but usually causes a deflation of prices too. When many people start defaulting on their loans, in a relatively short time, banks start loosing money and stop loaning money, causing the money in circulation to shrink. This causes the bust to worsen and doesn't stop until the money in circulation stops shrinking. A bust of this severity is called a deep recession or depression. How long a bust cycle of this severity lasts depends on how willing people are to start saving and live below their means. It will also be shorter if a central bank and or government will not try to stop the excess money in an economic system from being purged. Not all busts are catastrophic, but all are caused by a preceding boom period.

As you relate these simple economic basics to real life, you will find that there is no ideal money system. In the real world of economics you will find most, if not all of the basic economic principals presented in this booklet in use. In a nation where a true central bank is in existence, there will be no banks that will accept commodities for deposit, usually gold or silver.

Regardless of the money system used, money does not represent the true value of a product or service. The true value of a product or service is found, by the amount of time one has to labor to buy it. Also the true value of a product or service can be stated, by the amount of time it takes to make a product or perform a service. As you think about this, remember that different people will receive different rates of pay per period of time worked. So the true value of products and services will be different for different people. The only way the true value of a product or service goes down, making it more affordable, is through technology, by shortening the time it takes to produce a product or service.

If economics is new to you, this booklet will give you a basic understanding of how products and services are traded. If you are well versed in the complexities of economics, this booklet will be a reminder to you of the basics.

In conclusion, I would like to add a personal note. To save and then spend, is far better than to buy everything on credit and make monthly payments.