THE BASICS OF ECONOMICS
‘Economics is the study of people in the ordinary business of life’
Alfred Marshall, Principles of economics, 1890
There is no one universal answer to the question what economics is all about. Browsing the web, you will find various answers to the question. The Economist’s Dictionary defines economics as ‘the study of production, distribution and consumption of wealth in human society’. Very broadly, it may also be defined as a social science that studies economy. Any system – from a small household to the global economy – deciding what is produced, how it is produced, and who gets to consume it, is an economy. The economy is the sum of all business transactions, jobs, and goods and services produced, sold and purchased. Economics aims to explain how economies work and how economic agents interact.
We might also take our definition from the father of modern economics, Adam Smith. He entitled his famous book ‘An Inquiry into the Nature and Causes of the Wealth of Nations’ (1776), thus outlining the subject matter of economics itself. This was the first comprehensive defense of the free market, and continues to be an influential work to this day. Central to the work was the concept of the ‘invisible hand’, the idea that the market, while appearing chaotic, is actually guided to produce the right amount and variety of goods and services. If there are insufficient goods, there will be great economic incentive to produce more; if there are surplus goods, there will be an economic incentive to produce less or different types of goods.
In order to begin our discussion of economics, we first need to understand (1) the concept of scarcity and (2) the two branches of study within economics: microeconomics and macroeconomics.
Economics is about economizing, that is ‘making the most of what we have’. The reason why we face economic problems individually and as a nation is that none of us can have all we want – we live in a world of scarcity. Scarcity is the most basic concept in all of economics. It means that we do not and cannot have enough income or wealth to satisfy our every desire. Economics is the study of satisfying unlimited wants with scarce resources and how people choose to use limited resources.
Resources are the inputs that society uses to produce output, called goods. For an individual, resources include time, money and skill. For a country, resources include natural resources, capital, labor force and technology. These resources and goods are considered scarce or limited because of society’s tendency to demand more resources and goods than are available. So, because of scarcity, people and economies must make decisions over how to best allocate their resources. Important choices include how much time to devote to work, and to leisure, how much money to spend and how much to save, and how to vote and shape the level of taxes and the role of government. Economics, in turn, aims to study why we make these decisions and how we allocate our resources most efficiently.
Modern economics can be broken into a variety of different schools and methods of analysis, but the primary two methods are – microeconomics and macroeconomics. Macroeconomics (‘big economics’) considers the aggregate performance of all markets in the market system and is concerned with the large subsectors of the economy – the household sector, including all consumers; the business sector, which includes all firms; and the government sector, which includes all government agencies. Macroeconomics looks at the total output of a nation and the way the nation allocates its limited resources of land, labor and capital in an attempt to maximize production levels and promote trade and growth for future generations. It is not simply the sum of many ‘microeconomics’; many of the concepts are entirely different. Macroeconomics addresses issues of unemployment, inflation, monetary and fiscal policy for an entire economy.
Micro- and macroeconomics are interrelated. Microeconomics (‘small’ economics) looks into similar issues, but on the level of the individual people and firms within the economy. Where micro will study a single consumer, a paper-clip manufacturing plant or the airline industry, macro studies the entire economy within which those three exist. Microeconomics considers individual markets that make up the market system and small economic units such as individual consumers or firms. Microeconomics is concerned with how consumers (buyers) and producers (sellers) come together to exchange goods and services, how much is produced, what to produce, and the going prices.
An economic policy is intended to influence or control the behaviour of the economy. The main goals of economic policy are: economic growth, full employment, price stability. They are achieved depending on the nature of the economic system.
The systems by which nations allocate their resources can be placed on a spectrum where the command economy is on the one hand and the market economy is on the other. The market economy relies on the forces within a competitive market (the ‘invisible hand’) to determine how resources should be allocated. The command economic system relies on the government to decide how the country’s resources would best be allocated. In both systems, however, scarcity and unlimited wants force governments and individuals to decide how best to manage resources and allocate them in the most efficient way possible. Markets are an important means of allocating resources, so economists study markets.
Economic analysis is applied throughout society, not only in business and government, but also in education, the family, health, law, politics, social institutions, and science.