What is “Labor”?

“Labor” is how much a person works. It is the use of time and exertion of effort to produce something of value. Generally speaking, the more valuable a person’s labor is, the higher their wage.

Skilled And Unskilled Labor

Each person starts off as an Unskilled Worker, meaning they do not have any specific training or professional skill sets that set them apart from any other worker. If a person goes to school or gains enough experience to become a Specialist or Expert, they become a Skilled Worker (read our article on Specialization for more details).

Skilled workers almost always earn higher wages than unskilled workers, but both groups have specific pressures that push their wages up or down.

Skilled Workers – What Makes Wages Go Up?

If a person has two master’s degrees in Engineering, a doctorate in Biology, and completed trade school to be an Electrician, they would still be considered an Unskilled Worker if they currently have a job as a pizza delivery driver.

There are two factors that contribute to higher wages for skilled workers – labor market competition, and labor productivity.

Labor Market Competition

Skilled workers have skills that most people do not. This means that any time a new job posting arises that requires a particular skill, the Skilled Workers who have it have less competition for that post. As a person becomes more specialized with a more and more narrow focus, they typically have a much higher chance of getting a job that fits their particular qualifications.

For example, these are two job postings for an “Economist”. One is for a “Junior Economist”, meaning a Skilled Worker in Economics, but with little additional training other than school. The other is for a “Financial Economist”, or an economist that has additional training in financial markets.

The Junior Economist has far more people who have those skills, where the Financial Economist has a lot less. Since there are so many people applying for the Junior Economist job, the company that is hiring can offer a lower wage, since the potential employee can be more easily replaced. The Financial Economist, on the other hand, requires more skills and the company would have a harder time replacing a candidate that gets a better salary offer elsewhere, so this job likely offers a higher wage.

Labor Productivity

The wage of Skilled Workers also goes up as the value of what their labor produces increases. If the skills you bring to a job creates more value and more profits for your employer, you will typically be able to earn more money than someone who adds less value.

Sales people in particular have a direct link to their productivity in the form of Commissions. More effective salespeople are able to sell more and higher valued products, so companies offer a percentage of their total sales as a bonus to the salesperson as motivation. Other companies offer Profit Sharing, where a percentage of profits is distributed to all the workers, or Stock/Investment Options, where employees can earn company stock, which goes up in value when the company is performing well.

Skilled Workers – What Makes Wages Go Down?

Skilled workers do not always stay ahead of the game forever, there are some important changes that can cause the wages of particular skilled workers to fall quickly.

Changes to the Economy

A horse caretaker used to be an extremely important skilled job in the economy, but almost overnight after the Ford Model T car was invented, city streets were emptied of horses entirely. This can be what happens when a formerly valued skill becomes redundant by a technology or an overall economic change – the market demand of those skills starts to fall, and the wages of the people with those skills falls with it.

Changes to the Labor Market

Doctors are almost always in demand, but only if they keep their skills up to date.

In the 1950’s and 1960’s, very few people held college degrees in business. This meant that the people who had those degrees had a huge advantage when they were looking for a job. Since then, millions of people “Caught On”, and people are graduating with university degrees in more numbers than ever before. This means that these skills are becoming “Cheaper” for employers, since far more people have them.

This is a pressure that pushes wages for each skill down, since it becomes less “Rare” to find someone who has a general university education.

Unskilled Workers – What Makes Wages Go Up?

Unskilled workers, by definition, do not have expertise that will set them apart from any other worker, so they will generally be applying for the same jobs as all of the other unskilled workers in their area. While an Unskilled Worker is able to apply for a very wide variety of jobs, because there are so many others applying for the same jobs, it tends to push the wages down, since each individual worker can be easily replaced. There are some particular economic mechanisms that can cause the general level of unskilled wages to increase or decrease.

Labor Unions

Labor unions exist for both skilled and unskilled workers as a collective agreement between all (or most) of the workers at a company to bargain with their employer for better working conditions. For skilled workers, the unions typically fight for better conditions (like vacation days, healthcare, and pensions). For unskilled workers, they fight for those same goals, but also to increase the wages for all of the employees in the union.

Labor unions started in the 19th century as a way for workers in the Industrial Revolution to fight back against employers who had unsafe work practices, extremely long work days (12+ hours a day, 6 days a week), and extremely low pay. They still work today to try to protect the rights of the workers and secure better wages and working conditions across many industries.

Minimum Wage

The government has also mandated that all workers must be paid a minimum wage. This is to set a minimum standard of living for all workers in an economy, and a floor that ensures that all workers are earning at least a base amount of money per hour of work. Minimum wage laws were first passed in the early 20th century, partially as a response to labor strikes to try to make sure that labor unions were not the only organization trying to promote the welfare of unskilled workers.

Unskilled Workers – What Makes Wages Go Down?

Generally speaking, when the average wage for unskilled workers starts to go up, more people are willing to work, but companies are less willing to hire more people.

Wages get Too High

This is the constant balance being made with labor unions and minimum wage laws. If the labor unions force the wages and benefits in a company too high, that company will be less willing to hire new workers because they earn less profit on the productivity of each person they hire. If minimum wage laws increase, unemployment also tends to increase in the short term, since fewer of the lowest-paying jobs are created.

Technology and Automation

Unskilled workers also see a lot of tasks that were once accomplished by hired workers now being done by machines. More advanced computers and robots are able to do some of the more repetitive tasks for cheaper than it would cost to hire someone for the same job (like dishwashers, or robots that automatically vacuum carpets). The more advanced technology gets, the more it generally hurts the wages and employment rate of the most unskilled workers.

Economic Changes That Effect Everyone

There are also some big changes for the economy that can impact the wages of large groups of people at once.

Changes in Tastes and Preferences

If, all of the sudden, everyone woke up and decided they preferred Pepsi over Coca Cola, Coca Cola sales would drop by a huge amount overnight. This means that the actual revenue generated by employees of Coke would fall just as fast, and wages with it. On the other hand, Pepsi would suddenly be making huge profits, and so they would be paying their workers overtime to keep up with demand, and hiring a lot of new ones.

Swings in the tastes and preferences around the entire economy causes smaller versions of this shift to happen every day, which impact the wages of the people making the goods on both sides of the shift.

Changes in Prices of Inputs

The most common example for the price of inputs is the price of Oil. Oil is used for electricity in some places, and powers the transport of goods from one location to another. When the price of Oil increases, it means that the cost of moving goods from one place to another also increases. This means that the wages of people making goods that need to travel long distances will be effected, since the profits their employers are making suddenly dropped.

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What is Competition?

“Competition” is when many producers try to sell similar goods to the same set of consumers. The producers need to “compete” to try to attract more consumers, usually by lowering prices, offering better versions of the goods or services, or through marketing.

Competition is the core concept of the Market Economy.

Why Does Competition Work?

Competition generally leads to lower prices, more choice, and better qualities of products for consumers than other types of economies. The reason for this is that with competition, there is very little “central planning” of the economy, while producers and consumers are able to act in their own self-interest.

For a producer, this means that they want to attract as many customers as possible, and earn the highest profit. In an ideal setting, there are thousands of potential producers for any good.

Example – Selling Ice

Lets say that a new market has opened – there is a street full of people who want to buy ice cubes. On this street is a building full of people who have freezers and tap water, so they are able to make ice cubes, and sell them.

Immediately, one person makes and sells 100 ice cubes for $10, with no cost other than time. Because of Supply and Demand, very few of the consumers are willing to buy at this price (see our article on Supply and Demand Examples in the Stock Market for details). 

Price War

Seeing this profit, everyone else in the building starts making and selling ice. To get more profit, they also lower their price to attract more customers. Since there is no difference in the ice made by each of the producers, all of the consumers always take the lowest possible price, which forces the producers to keep matching the lowest price offered by anyone else.

At this low price, some of the producers decide that it is not worth their time and effort to keep producing, and so they drop out of the market. This means that the remaining producers can raise their prices a bit, since there is no longer as big of a market surplus.

The Price War caused the market price to fall by a huge amount (70% at one point), and caused some of the less efficient producers to drop out of the market. In the end, the consumers finished with a large reduction in the overall market price.

Product Innovation

The remaining sellers still want to attract more buyers and earn higher profits, but at this point it is not possible while they are selling identical products. The result is product differentiation, or making their ice slightly different from the competition.

Product Differentiation is a form of innovation that requires investment, this can include things like new machines or processes that reduce cost, or new features or product advantages that make it more attractive to consumers.

For our Ice Sellers, lets say that some of the sellers used their profits to invest in new higher-capacity and energy-efficiency freezers that make it cheaper and easier for them to produce the same ice.

At the same time, some of the other sellers used their profits to research methods to make “Luxury Ice“, like ice spheres and crystal-clear large cubes, which they can then sell at a higher price.

Notice that at this point, there aren’t any more people buying the $5 ice anymore. This is because the “low-cost” producers are making the same ice for cheaper, while the “Luxury” ice makers are getting all the customers who are willing to pay more for a better product.

The companies that don’t innovate lose their profits, and eventually are forced to close. The competitive market resulted in a greater range of products, and a greater range of prices, for the consumers.

Other Factors That Influence Competition

In the ice makers example above, all of the producers and consumers started in equal footing – all of the producers started with everything they needed to start making ice, and all the consumers knew who was selling what kind of ice and at what price. This is not usually the case in the real world, which can distort the normal competition.

Barriers of Entry

A “barrier of entry” is something that prevents a new producer from entering the market and selling a competitive good. At the start of our Ice Makers example, there were no barriers to entry, since all of the potential producers had the same freezers and the same water.

At the end of the example, however, some barriers had appeared. One group of ice makers invested in better freezers that could make the same ice as everyone else, but cheaper. This means that any new seller would have to invest in the same class of freezer in order to compete. One major barrier to entry in almost every industry is the ability to raise capital, or get the necessary investment to start producing and selling. The ability to raise capital is called a “Natural Barrier“, since it is the direct result of competition and improvements to the market. These barriers are not seen as “bad”, since they are the natural result of market innovation and product differentiation.

Artificial Barriers, on the other hand, are other arbitrary costs that potential producers must face before they can get to the market. Artificial barriers are not necessarily a bad thing either. These include:

• Licensing Requirements (such as a health code license to open a restaurant)
• Permits For Operation (very common if you need dangerous chemicals as part of your operations)
• Licenses to Operate (some countries require a special permit to operate a business)
• Safety Restrictions (both worker safety requirements and product safety)
• Taxes

Artificial barriers usually exist where the welfare of your employees or customers are at risk if certain precautions are not taken (like health code certifications at restaurants, or workplace safety inspections at a factory). Unfortunately, artificial barriers are also the most likely to be manipulated when there is a high level of corruption, either by inspectors demanding bribes for permits, or by businesses pressuring governments to put up restrictions to prevent new competition from entering the marketplace.

Artificial Barriers cause the market price to increase for the goods being sold, since the producers need to pay these costs before they can even start to sell their products.

Information

In our Ice Makers example, we also said that all of the consumers had the same information about the producers. In the real world, you usually have to do some research to find out what all of  your buying alternatives are.

This means that if the consumers do not have a lot of extra time to dedicate towards researching different products and producers, they might not get the best prices.

Building a recognizable brand is an important part of marketing

Marketing is the manipulation of information you are probably the most familiar with. Marketing serves two functions for businesses:

1. It makes more consumers aware of their products and where to buy them. This is usually the biggest information barrier new producers face.
2. It tries to make consumers believe their product is better than the competition. If a consumer believes one product is better than another, they might still buy it even if it costs more.

Producers will often put a lot of their resources into marketing – having a well-marketed product that consumers know how to buy can be just as important as being the cheapest or best product on the market.

Cartels and Monopolies

Not all markets have much competition. Cartels and Monopolies are the result of a breakdown in competition, either because of collusion, market dominance, or government intervention.

Cartels

A Cartel is a group of independent producers who come to an agreement (either official or unofficial) to not directly compete against each other, even though they are both in the same market. This is usually done by:

• Agreed minimum prices
• Agreeing only certain producers will conduct marketing in certain territories
• Cutting prices in unison to force other producers out of the market, then re-raising to previous levels
• Capping production levels to create an artificial shortage and raise market prices

One of the most well-known cartels is OPEC, or the Organization of the Petroleum Exporting Countries. OPEC members try to maintain strong oil prices to benefit their member countries, mostly by controlling the total output.

When producers within a country form a cartel, it is also called a Trust. Trusts exists mostly to just increase the profits of its members – in the late 19th century, Trusts in the steel and oil industries in the United States caused market prices to rise to much that the practice was made completely illegal.

Anti-trust laws help prevent collusion between producers to raise prices for consumers, but they can occasionally have unintended consequences. There have been several cases where some producers simply accuse larger competitors of anti-trust violation just to force them to waste resources defending themselves against the accusations.

Monopolies

A Monopoly is when a market is entirely served by a single producer, while competition is either barred completely or impractical to establish. Monopolies can arise naturally by a single producer simply forcing its competition out of business, buying any competing firms, but it more often arises from very high barriers to entry.

Monopolies almost always cause the market price for consumers to increase, because rather than comparing two alternatives with different prices, they are forced to choose “have or have not” entirely. This can also cause innovation and research to stagnate, since the monopoly no longer requires as much innovation to maintain profits.

In the United States, monopolies are usually illegal – there are many cases where large firms attempted to merge into one, only to be blocked by anti-trust laws fearing a monopoly.

Beneficial Monopolies

In some rare cases, the government will give a business the right to have a monopoly on a certain market. This happens when it is deemed that a single large producer will be able to provide better prices and quality than many producers acting independently.

Sponsored monopolies that you might be the most familiar with are public utilities like electricity and water – these producers are allowed a monopoly in certain cities and regions, but under the condition that they have limits to how much they can charge and they must uphold certain quality standards.

Another example is mining, fishing, and logging operations – governments might give exclusive rights to mine, fish, or log in a particular area to just one or very few companies in order to limit the environmental damage and avoid too much destruction taking place.

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What Is The Business Cycle?

The Business Cycle is the broad, over-stretching cycle of expansion and recession in an economy.

The Business Cycle is concerned with many things – unemployment, industrial expansion, inflation rates, but the most important indicator is GDP (Gross Domestic Product) growth. Below you can see a graph of the GDP growth rate in the United States since 1946 – the grey bars highlight periods of a recession.

The Business Cycle can also be thought of as how Real GDP moves above and below its Potential Levels.

What Is Real GDP?

GDP, or “Gross Domestic Product”, is the total amount of finished goods and services produced in an economy during a given year (for more information, read our full article on Common Economic Indicators). If you just add up the value of all the finished goods and services in one year, you will have the Nominal GDP.

Unfortunately, you cannot directly compare the Nominal GDP of one year with the Nominal GDP of another year, because the same goods and services change price over time. If we want to compare the GDP of different years, we need to adjust the Nominal GDP by the Inflation Rate. Once you adjust your Nominal GDP by the Inflation Rate between years, you have the Real GDP, which you can use to directly compare different years.

What is the Potential Level of GDP?

The “Potential Level” of GDP is the total output an economy can sustainably produce in a year.  This is the potential output if every laborer is using their skills the most efficiently, with businesses using their capital goods to the best of their design at the current levels of technology, and public institutions are operating at their peak efficiency. Every time workers learn new skills, technology increases that allows us to make new goods (or the same goods but more efficiently), or changes to the government or culture take place that promote economic growth, the Potential Level of GDP increases.

The Real GDP growth rate swings above and below the Potential GDP growth rate, which is called the Business Cycle.

Running Below Potential Levels

It is easy to see how an economy can be running below the potential levels – if workers are not matched with jobs that make the best use of their skills, or if machines are not properly maintained, or even if the government has poor leaders that make less-than-optimal laws and policies, it will cause the Real GDP growth rate to fall below the potential level. If it falls too far below, the economy could enter a Recession. Inflation is usually low when an economy is running below its potential levels.

Running Above Potential Levels

The economy can also run above Potential Levels. Remember – the Potential Level is based on what can be sustainably produced. This means that if current growth levels are the result of over-borrowing, or asset bubbles, output might actually be growing at a higher-than-sustainable rate. Economies very often run above their potential levels for short periods of time with no problems, but going too far above for too long can result in a crash. Inflation is usually higher when the economy is running above its potential, which serves to bring the Real GDP back down to its potential levels.

Expansions and Recessions

When the GDP growth rate is positive and unemployment is relatively low, it is called an Expansion. If the GDP growth rate is very low or negative, with higher unemployment, it is called a Recession.

Economic Expansions

This part-time lifeguard would prefer to be a full-time stock broker

Most of the time, the economy is an “Expansion” phase. This does not mean everyone is doing well – even during very strong expansions, the unemployment rate usually stays around 5% (meaning 1 out of every 20 people who wants a job can’t find one), with the underemployment rate (people who are working part-time but want a better job) is usually much higher.

What an Expansion does mean is that new jobs are being created, and the total value being produced by an economy is going up. Growth also promotes growth – the more resources that are available, the more resources can be allocated towards researching new technologies and building new skills.

Economic Recessions

Recessions typically occur every 7-15 years, often following an asset bubble bursting, followed by a large loss of value in an economy. Recessions typically have higher levels of unemployment, with low or negative GDP growth. Even if GDP growth is never negative, recessions hurt. Other than GDP, the biggest indicator of a recession is a sharp decrease in consumer spending, and inflation tends to fall.

Higher unemployment rates mean that people lose their jobs, and new workers have a hard time finding their first position. Losses in the financial sector hurt retirement accounts and individual savings and investments, which can severely disrupt life plans. Thankfully, recessions are temporary, and the business cycle can usually move back into an expansion phase fairly quickly.

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What is Economic Growth?

Economic Growth means that the economy is growing – more goods and services are being produced and consumed than they were before. The most common measurement of economic growth is the Gross Domestic Product (or GDP), which measures the total number of finished goods and services produced in an economy in a year.

Why is Economic Growth important?

Governments usually do everything they can to encourage economic growth in order to create more jobs and wealth for their citizens.

Where Does Economic Growth Come From?

Long-term economic growth comes from more workers entering the economy (either through immigration or by lowering the unemployment rate), and the output per worker increasing through higher skill levels or more advanced technology. This is called Labor Productivity.

Labor Productivity

Labor productivity is just the total output divided by the total number of workers. If this ratio goes up, that means workers have become more productive. If it goes down, it means workers have become less productive.

Skill Building

Labor productivity is increased directly by giving more workers more skills, so they are able to produce something of higher value. For example, if a construction worker learns a new technique for building a house that makes the finished building stronger but uses less materials, his labor productivity increases.

Most countries invest heavily in schools to try to increase their labor productivity. People who can read are generally able to do more work than people who cannot, so over the last 60 years governments around the world have been working hard to increase their literacy rates.

Chart showing the average number of years a student in different countries have attended school

Generally speaking, the more years of school and training a person has, the higher their labor productivity is (including training they acquire on-the-job while working). As the average skill level of a country increases, they are able to produce more and better goods and services, which leads to economic growth.

Technology

Technology also plays an important role in increasing labor productivity and driving economic growth. As new machines and techniques are invented, each person is able to produce more output in less time. This includes better tools, but also better management techniques for helping large teams of people to work together.

For example, a farmer today with a modern tractor and harvesting machines can work nearly 500 times as much land as a farmer in 1800 using horses, oxen, and hand tools, and they need to work fewer hours per day.

This means that fewer people need to be farming to produce enough food, so more people can enter other industries (like manufacturing).

Another example of this is when personal computers became widely accepted in businesses around the world. This allowed people to keep more documents and records saved in an electronic format, making them easier to read, find, and share. This, in turn, allowed companies to spend less money on paper, and more on other technologies that helped workers be more productive.

Investment

Individuals do this by saving or investing directly in businesses. Even if you just have a savings account, your savings are used by your bank to make loans to new businesses and older businesses that want to expand, so this helps drive future growth.

Businesses do this by directing their profits back into research and development, or direct re-investment (like buying new computers).

Governments do this by reducing taxes for individuals who invest most of their income, or providing other incentives for people and companies to drive research and direct investment.

Interest Rates

One of the most direct ways that the government tries to drive growth is by managing the interest rates that bonds pay out and banks charge for loans. When interest rates are low, it makes it cheaper for people and businesses to borrow money to use for growth. There is a constant balancing act between lowering interest rates to promote growth and raising interest rates to discourage risky borrowing.

Why Is Growth Different Between Countries?

Economic growth is wildly different between countries. The reasons for this are not always clear, but the biggest factor is that countries that have a lot of resources (both a skilled labor force and advanced technology) to start with will have an easier time developing newer and better skills and technologies, giving them a head start for growth.

Poorer countries might not have the same cultural drives that help encourage growth. For example, in many places in the world, it is heavily discouraged to ever borrow money. This can make it very difficult for a new business to get the funding they need to open, and also makes it difficult for established businesses to expand.

The opposite is also true, though. A country that starts off poorer can have much faster growth, since they can take advantage of the newer technologies and techniques developed elsewhere. This can help them “catch up” to richer countries.

Even very similar countries might have very different economic growth rates, since every country has slightly different economic incentives driving how resources are allocated, different levels of research and development in different sectors of the economy, and different changes that take place inside the economy over any given year.

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Definition

“Economics” is often called the Dismal Science – it studies the trade-offs between making choices. The purpose of economics is to look at the different incentives, assets, and choices facing people, businesses, schools, and governments, and see if there is any way to improve outcomes.

This is done by looking at how supply and demand are related throughout the economy, exploring different allocation methods, and investigating how to change (and what impacts there are from changing) the distribution of wealth.

Examining Costs and Benefits

The central problem in all economics is exploring different costs and benefits of choices made by everyone in an economy. This is not just the dollar cost of an action, but also what is being given up.

Every time a road is built in one place, that means there are not enough resources to build it somewhere else, so governments need to carefully plan construction to make sure each project gets the most possible benefit given all available alternatives. Likewise, if a school decides to build a new computer lab, they cannot use that money to hire a new teacher, do renovations on classrooms, or improve the school lunch menu.

Every choice made is a balancing act – trying to make sure the benefit you get from one action is greater than the benefit you would get from any other alternative.

Supply and Demand Throughout The Economy

At a bigger scale, when there are many people making the same kinds of decisions all at the same time, the economy as a whole also needs to balance everyone’s choices. This is how “Supply” and “Demand” appears, and how prices are determined.

For more examples on how prices are determined through Supply and Demand, read our full article on Supply and Demand Examples in the Stock Market.

Supply and Demand together are called “Market Forces“, large trends that result in one market outcome or another (such as the price of a good, and how much pollution is made in the production of those goods). When the supply and demand result in a particular number of goods to be produced and sold at a certain price, this is called a “Market Outcome“.

Market Outcomes

This means that all of the Market Outcomes are related – if a change in supply or demand cause the price of a good to go up, the people who make that good will earn more, and more people will start making it. This means that the income of those people goes up, which means the goods they like will have an increase in demand, and the cycle continues. The specific market outcome, and resource allocation, depends mostly on the total resources available (all raw materials, all available capital, and the entire work force number and skill level), previous market outcomes, and government policies.

Not Just Prices – Different Allocation Methods

Using “Prices” is just one of many possible ways to allocate the total resources available. Depending on what market outcome we are focused on, a different allocation method might be better or worse. Economists often try to determine what the best allocation method is for particular goods or services to try to improve market outcomes.

Market Prices

“Prices” let individuals measure their own individual level of demand against a prevailing market price – how much they have of a good or service depends on how much others are willing to make it, and how much everyone else values it. Market prices work best when there are many buyers and sellers of the same good or service. You can get more information on how market prices are determined from our article on Supply and Demand Examples in the Stock Market.

Auctions

Auctions are commonly used when there is a large imbalance between the number of potential buyers and sellers of a good or service, and the quantity available is limited. Economists spend a lot of time analyzing auction systems

For sellers, individual goods or services are left for potential buyers to “bid” on. This means that the person who values the good or service the most (in this case, who is able to pay the most) will get the good, and the seller gets the best possible price.

Auctions can also go in the other direction – a buyer could ask for sellers to “bid” to sell their good at a particular price, and the buyer will take the offer of the seller who can offer the lowest price. This is generally the case when a government hires a contractor to build a road – many competing companies provide “bids”, and the government makes its choice based on the bid price and the expected quality of the work.

Entitlements

Entitlements is a different allocation method – everyone gets a certain amount of a good or service, which is then paid for by taxes. This allocation method is generally used for “Essentials”, or otherwise things where it is impossible to charge someone based on their usage. The availability of public parks, drinking water, and clean air all use an “Entitlement” distribution system. Certain levels of basic housing and food is also generally provided as an Entitlement.

Price Controls

Even in a normal supply and demand system, price controls can be put in place by the government if a society is not satisfied with the pure market price allocation. This can be things like adding extra taxes to increase the price, giving subsidies to decrease the price, or telling sellers they can’t sell a good or service above or below certain prices.

Changing The Distribution Of Wealth

The distribution of wealth is more complicated than just how much the top 1% earn compared to the bottom 99% – it also examines how wealth is distributed between industries in an economy, how much different skill levels are worth relative to others, how taxes are paid and collected, and much more. When economists look at changes in the distribution of wealth, it is usually by making subtle changes to these smaller factors which add up to changes on a bigger scale, rather than trying to find a single way to transfer wealth from the “Rich” to the “Poor”.

Taxes and Transfers

For example, the Rich use most of their income for investment, while the Poor use almost all of it for direct consumption. This is because the rich generally don’t get much benefit out of an extra $100 worth of groceries in a month, but that might be a very large boost in living standards for the poor.

By giving a single rich person an extra $10,000 in taxes, and using that revenue to give $100 directly to 100 people, those 100 people will almost certainly be made much better off than the one rich person was made worse off. However, that means that $10,000 would not be invested to help new companies grow, which in turn means fewer jobs are created to help build new wealth. A central problem of economics is trying to balance the consumption and benefit of people today against taking measures to help more growth for the future.

Government Spending

Another example comes from direct government spending – some countries spend a large amount of money on biotechnology research to build a new sector of their economy, while other countries spend more on building more public housing connected to public transit, to try to help the poor get better jobs in economic sectors that already exist.

Every part of economics is measuring these trade-offs – the benefits and costs of one choice versus another.

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Have you ever wanted to start a business? Maybe you want to know the difference between a lemonade stand and Minute-Maid, besides just the size of the companies.

Different types of companies have different levels of liability (meaning level of responsibility) for the owner or owners. What this means is that the more liability an owner has, the more that owner is responsible for the company’s debts. Different types of businesses also have different rules on how they can be managed, and how the owners can be paid.

Sole Proprietorship

This is the simplest type of business – the entire business is owned by one person. There generally are no requirements to operate a sole proprietorship – if you ever sold something, you have already worked as a sole proprietor.

Sole proprietorships can have many employees, but the key factor is that the business itself is owned by just one person.

Ownership Liability

In a sole proprietorship, the owner takes the full liability for the entire company’s debt. That means that if, for example, the owner took out a loan to start the business but then goes bankrupt, he or she could have their other assets seized by creditors (such as their car or home).

This also means that if someone wants to sue the business, they can also just sue the owner directly (even if the business has already closed).

Most larger businesses don’t want to always have that much liability, so usually as businesses get larger, they tend to move on from sole proprietorships into other business types.

Owner Compensation

With a sole proprietorship, everything that is owned by the company is owned directly by its owner. This means that most owners can (and usually do) mix their personal finances and business finances. An example of this would be taking money directly from your cash register to buy your personal groceries.

This means that the owner keeps 100% of the profit from the business for him or her self, and reports all the income, profit, and loss on their own personal taxes.

“Doing Business As”

A sole proprietor may still want to register a company name (although this is optional), which they can then use for bank accounts and legal paperwork. This is known as “doing business as” another name, and the rules vary by state. In this case, the sole proprietor still has unlimited liability, but can use another name for their business.

Partnerships

“Partnerships” exist when two or more people decide to run a business together. There are “General Partnerships” and “Limited Partnerships”.

Unlike a sole proprietorship, a partnership requires a contract in order to exist, where the partners establish the existence of the partnership. Like a sole proprietorship, the owners still own the entire company themselves, along with all its profits (and losses), and the partners can choose to use a “Doing Business As” name.

General Partnerships

With a general partnership, the business works just like a sole proprietorship, but with several owners instead of just one.

Ownership Liability

All of the partners are fully liable for the entire business, just like a sole proprietorship. Partners are also liable for the actions of their other partners any time one of them is acting on behalf of the business.

For example, if you have a partnership that sells stereos, and your partner agrees to sell them at $1 each, you are obligated to honor that agreement.

Ownership Compensation

All of the profits and losses are divided equally between the partners (although in the initial contract, the partners can specify that one gets a greater share than the others).

Limited Partnerships

With a “Limited” partnership, there is at least one general partner, plus at least one “Limited Partner”. The limited partner does not have all the rights, responsibilities, and obligations as the general partner, but also does not share the full liability either.

Ownership Liability

The general partner has the same liability has the same rights as a general partnership, but the limited partner has somewhat less (usually only as much as they invested in the company to start with). This also means that the general partner might not be liable for the agreements made by the limited partner, if he or she can show that those actions were “negligent” or purposely harmful.

Ownership Compensation

The limited owner usually has their compensation set to the same restrictions as their liability – there might be a cap to how much they can “take out” of the business. The specific rules depend on the terms in the partnership contract.

Why A Company Might Have A Limited Partnership

Limited partnerships are very common – even more common than general partnerships. A limited partnership will often occur when one person wants to start a business, but gets help (both financial and practical) from someone else. Rather than offering a loan, this “helper” might instead want to share in the future profits of the business, so they would prefer becoming a limited partner.

As a limited partner, they might not have a role in the day-to-day management of the company, but they might still have a role in the overall “vision” and the direction of the company. They also do get a share of all profits, but since they have limited liability, they are not risking their own personal assets (beyond what they specifically invested in the company), unlike a General Partner.

Corporations

The biggest type of business is a corporation. These operate under different rules from sole proprietorships and partnerships – a Corporation is its own legal entity (meaning it can have its own bank accounts, and be sued directly). Corporation’s most useful feature (as far as the owners are concerned) is totally limited liability, but this comes at a high cost of management and organization.

Corporations can sell pieces of their ownership as stock. This allows a corporation to raise a large amount of cash to invest in new equipment and operations, which can help companies become profitable much sooner.

Ownership

When a corporation is created, it exists with a certain number of shares of stock. Whoever holds those shares is a part owner in the company – how much they own is based on how many shares they hold.

Instead of the company being managed directly by the owners (like a sole proprietorship or partnership), the shareholders then elect a “Board of Directors”. The day-to-day management of the company is overseen by the Board, but for some larger decisions there are occasionally calls for each stockholder to vote. The Board of Directors is also responsible for hiring and firing the highest levels of management (like the CEO), and the Board is the direct “boss” of those managers.

Ownership Liability

The owners of the company (stockholders) have entirely “limited” liability – they can only lose as much as their stock is worth. This means that if a Corporation goes bankrupt, the individual stockholders will lose the entire value of their stock, but nothing more.

Ownership Compensation

The shareholders of a corporation are entitled to the company’s profits, which are paid out as dividends. Read our full article on Stocks for more information.

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