Finance and Economics: An Overview
Although they are often taught and presented as separate disciplines, economics and finance are interrelated, interact and communicate with each other. Investors care about these studies because they also affect the market to a large extent. It is important for investors to avoid “one or the other” debates in economics and finance; both are important and have effective applications.
As a general social science, the focus of economics is more on the overall picture, or on the general issues of human behavior surrounding the allocation of actual resources. The focus of finance is more on the techniques and tools for managing funds. Both the economy and finance pay attention to how companies and investors assess risks and returns. Historically, economics is more theoretical and finance is more practical, but in the past 20 years, this distinction has become less obvious.
In fact, the two disciplines seem to converge in some respects. Economists and financial professionals are employed by governments, companies, and financial markets. At some basic level, there will always be a separation, but the two may still be very important to the economy, investors, and the market in the next few years.
- Economics and finance are interrelated disciplines, even if the specific circumstances are different.
- Finance, as a discipline, has its roots in economics; it involves evaluating currency, banking, credit, investment, and other aspects of the financial system.
- Finance can be further subdivided into three related but independent categories-public finance, corporate finance and personal finance.
- Economics focuses on the ways in which goods and services are manufactured, distributed, and used, as well as the overall operation of the economy and the people who drive economic activity.
- The two main branches of economics are macroeconomics, which focuses on the overall economy, and microeconomics, which focuses on specific factors in the economy.
In many ways, finance is a branch of economics. Finance describes the management, creation and research of currency, banking, credit, investment, assets and liabilities that make up the financial system, as well as the research on these financial instruments. Finance can be divided into three categories: public finance, corporate finance and personal finance.
Finance usually focuses on the study of prices, interest rates, capital flows and financial markets. Thinking more broadly, finance often revolves around themes such as the time value of money, rate of return, cost of capital, optimal financial structure, and risk quantification.
Like corporate finance, finance involves managing the company’s assets, liabilities, income, and debt. Companies obtain financing in a variety of ways, from equity investment to credit arrangements. The company may obtain loans from the bank or arrange a line of credit-properly obtaining and managing debt can help the company expand and eventually become more profitable.
Personal finance defines all financial decisions and activities of an individual or family, including budgeting, insurance, mortgage plans, savings and retirement plans.
Public finance includes the tax system, government expenditures, budget procedures, stabilization policies and tools, debt issues, and other government issues.
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A degree in finance is common to many analysts, bankers or fund managers working on Wall Street. Similarly, many people employed by commercial banks, insurance companies, and other financial service providers have university backgrounds in finance. In addition to the financial industry itself, a finance degree can be a way for companies and senior managers of companies.
Finance involves evaluating the value of financial instruments, such as determining the fair value of various investment products. Finance includes the use of stock pricing models, such as the capital asset pricing model (CAPM) and option models, such as Black-Scholes. Finance also includes determining the company’s optimal dividend or debt policy or investor’s appropriate asset allocation strategy.
It can also be said that finance is influencing the market with seemingly a steady stream of new products. Although many derivatives and advanced financial products were slandered after the Great Depression, many of these tools were designed to meet and solve market needs. For example, derivatives can be used to hedge risks for investors, hedge funds or large banks, thereby protecting the financial system from damage during a recession.
Economics pays more attention to theory, while finance is more applied. However, both are interrelated disciplines with some overlap.
Economics is a social science that studies the production, consumption, and distribution of goods and services. It aims to explain how the economy works and how people interact. Although labelled as “social science” and often regarded as a liberal arts, in practice, modern economics is often very quantitative and mathematically oriented in practice. There are two main branches of economics: macroeconomics and microeconomics.
Macroeconomics is a branch of economics that studies how the overall economy behaves. In macroeconomics, various economic-wide phenomena are thoroughly examined, such as changes in inflation, national income, gross domestic product (GDP), and unemployment.
Microeconomics is the study of economic trends, or what may happen when individuals make certain choices or when factors of production change. Just as macroeconomics focuses on the performance of the overall economy, microeconomics focuses on the smaller factors that influence the choices of individuals and companies.
Microeconomics also explains what happens if certain conditions change. If manufacturers increase the price of cars, microeconomics says that consumers will buy less than before. If a large copper mine in South America collapses, copper prices will tend to rise because of supply constraints.
Macroeconomics can be used to track GDP, inflation and deficits to help investors make more informed decisions. Microeconomics can help investors understand why Apple’s stock price might fall if consumers buy fewer iPhones. Microeconomics can also explain why a higher minimum wage may force companies to hire fewer workers.
The difference between finance and economics
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When economists successfully understand how consumers and producers respond to changing conditions, economics can provide powerful guidance and influence for national-level decision-making. In other words, the way the government handles taxation, regulation, and government spending has practical consequences; economics can provide insight and analysis about these decisions.
Economics can also help investors understand the potential impact of national policies and events on business conditions. Understanding economics can provide investors with tools to predict macroeconomic conditions and understand the impact of these predictions on companies, stocks, and financial markets.
For those who choose to pursue a career in economics, academia is an option. Scholars not only spend time teaching students the principles of economics, but also conduct research in the field and formulate new theories and explanations about how the market works and how their agents interact.
Economists are also employed by investment banks, consulting companies and other companies. The role of an economist can include forecasting growth, such as GDP, interest rates, inflation, and overall market conditions. The analysis and forecasts provided by economists may contribute to the sales of the company’s products or be used as input for the company’s internal managers and other decision makers.
Market participants can use economics to help understand the causes and possible outcomes of market events, as well as the impact on various departments, companies, and the entire business cycle.
These applications include understanding how national income, inflation, long-term economic growth, and changes in interest rates affect the market and ultimately stocks. An important area of concern for economists is to determine how changes in the monetary policy of the Federal Reserve and other central banks affect the US and global economies.