Fundamental Economics Terms

Before diving into theories, models, or policy debates, every student of economics needs a shared vocabulary. Think of these terms as the alphabet of economics: once you know them, everything else starts to make sense. This topic walks through the most basic building blocks, from the two main ways economists look at the world to the forces that push prices up and down.

Two Lenses for Studying the Economy

Economics can be studied at two different scales, and each scale reveals different insights.

Microeconomics (the study of individual economic behaviour) zooms in on the decisions of individual players in the economy. It asks questions like: How does a single consumer decide what to buy? How does a single producer decide what to manufacture and at what price? The focus is always on the individual unit, whether that is a household, a firm, or a particular market for one product.

Macroeconomics (the study of the economy as a whole) takes the opposite approach. Instead of looking at one consumer or one firm, it steps back and looks at the entire economy in totals. These totals are called economic aggregates (combined values that represent the economy as a whole). For instance, when you add up the incomes of every person and every business in a country, you get national income, which is one of the most important economic aggregates.

Macroeconomics does not stop at just measuring these aggregates. It also studies how they change over time. The growth rate of national income, for example, tells you whether the economy is expanding or shrinking. This kind of change over time is called the behaviour of an economic aggregate.

Demand and Supply: The Building Blocks of Every Market

Two concepts sit at the heart of how markets work.

Demand is the quantity of goods and services that a consumer is willing to buy at different prices. Notice the phrase “at different prices.” Demand is not just about wanting something; it is about how much of it you would actually purchase as the price goes up or comes down.

Supply is the mirror image from the seller’s side. It is the quantity of goods and services that a producer is willing to sell at different prices. Just as buyers adjust their purchasing with price changes, sellers adjust how much they are willing to put on the market.

How Market Forces Shape Prices

Demand and supply together are known as market forces because they are the two pressures that determine the price of anything bought and sold.

Here is how they interact:

• When demand rises but supply stays the same — more buyers are competing for the same pool of goods. Sellers can charge more because buyers are eager. The result: market prices go up.
• When demand falls but supply stays the same — fewer buyers want the goods. Sellers have to lower prices to attract the remaining buyers. The result: market prices go down.
• When supply rises but demand stays the same — there are more goods on the market than buyers want. Sellers cut prices to move their stock. The result: market prices decline.
• When supply falls but demand stays the same — goods become scarcer relative to the number of buyers. Sellers can raise prices. The result: market prices rise.

This push and pull between demand and supply is what keeps prices moving in every market, from vegetables in a local market to crude oil on the global stage.

Inflation: When the Overall Price Level Climbs

One of the most important macroeconomic concepts is inflation (a general rise in the aggregate price level across the economy). The word “general” is key here. If the price of just one item, say onions, shoots up, that is a change in relative prices, not inflation. Inflation means that prices across a broad range of goods and services are going up at the same time.

Economists track inflation using price indices, which are standardised measures of the overall price level. Two of the most commonly used indices are:

• WPI (Wholesale Price Index) — tracks price changes at the wholesale level, before goods reach consumers
• CPI (Consumer Price Index) — tracks price changes at the retail level, reflecting what consumers actually pay

Both indices capture the aggregate price level from different points in the supply chain, and both are widely used to measure how fast inflation is moving.

Closed and Open Economies

Every economy can be classified by how much it interacts with the rest of the world.

A closed economy is one where only domestic sectors (households, firms, and the government within the country) interact with each other. There is no trade with or investment from foreign countries. In practice, fully closed economies are rare today, but the concept is useful for understanding how an economy would work if it operated entirely on its own.

An open economy is one where domestic sectors interact not only with each other but also with external sectors (foreign governments, businesses, and consumers). This includes importing and exporting goods, receiving foreign investment, sending workers abroad, and other cross-border economic activities. Most modern economies are open economies to varying degrees.