Principles of Economics/Archived Text
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[edit] Contents
[edit] Introduction
The material presented at this point is drawn from a specific and narrowly focused interpretation of economics, known as Neoclassical Economics. While this body of thought dominates textbooks, it is by no means unchallenged as the correct or sole method of understanding economic activity. Go to http://cepa.newschool.edu/het/ for an alternative view.
In Economics, we study how society makes decisions on how to allocate limited resources to meet unlimited needs. A society is composed of consumers, firms and governments, with differing aims so economists study the complex phenomenon of how decisions can be reached on what to produce, how to produce and for whom to produce.
Broadly speaking, there are two kinds of allocation mechanisms: the price mechanism and the centrally-planned mechanism. In the price mechanism, consumers, firms and governments with differing aims interact with one another to reach a decision via the price system, whereas in the other groups of central planners make such decisions with the aim of maximising social welfare.
[edit] Introductory Concepts
[edit] Basics of Economics
Economics can be described as a science of choice, because it analyzes how humans allocate their scarce resources. It analyzes human choices on both broad and more individual levels. Microeconomics tends to analyze individual choices of households (people, just like you) and businesses (Mom and Pop's Gasoline Station, Coca Cola, Microsoft etc...). Macroeconomics takes things a step up and analyzes whole economies (i.e. the economy of Los Angeles, the economy of California, the economy of the United States, and so on).
[edit] Scarcity
The basis of all economic theory is scarcity because scarcity creates the need to economize.
Scarcity occurs because the matter, energy, knowledge, people, and tools required to make products is fixed while humanity's desires for products is not.
We know that matter and energy are fixed because of the laws of conservation. Matter and energy cannot be created or destroyed, although they can be changed into different forms. The amount of carbon, oxygen, hydrogen, nitrogen, phosphorus, potassium, iron, aluminum, and other elemental matter on earth is fixed. The daily amount of solar energy that drives the climate, water, soil, and biological systems is fixed. The amount of energy that has been stored on earth in the form of oil, coal, natural gas, and wood is fixed. Thus, all the products that could be made from Earth's matter and energy are fixed.
We also know that humanity is not able to make all the products that could be made from Earth's matter and energy. We do not know how to make some products. We do not have enough skilled workers and tools to make more of other products. At any point in time, production knowledge, people's time, and tools are fixed.
We know that humanity's desires for products derived from matter and energy are not fixed because population and knowledge have grown throughout human history. Every year, humanity produces better food, clothing, health care, shelter, protection, communication, transportation, entertainment, and the like. Yet few people get as much as they desire. Just ask someone what they would do if they won a million dollars in a lottery.
Because the quantity of products that can be made is less than what people desire, there is scarcity. Scarcity creates the need to economize. We must decide which products to make and how much of each. We must decide which matter, energy, and labor to use and how. We must decide who will get the products that have been made. Economics is about how to make these decisions so that people get as much as possible of the products they want the most.
[edit] Opportunity Cost
The theory of opportunity cost is one of the most crucial and fundamental concepts in economics at any level. It analyzes costs economically rather than simply financially or otherwise. Opportunity cost is defined as the cost including direct costs and the cost of giving up the next best alternative. Although this is rather vague, it allows applicability to any situation. For example, the opportunity cost of writing a paper is not simply the time and effort spent writing the paper. These are without a doubt involved in the cost. However, if it is your best friend's birthday that night, the cost of writing the paper also includes the fun that you give up by missing the party and the emotional hardship that you will suffer knowing that your best friend will miss you. Another example is the opportunity cost of reading a book. You not only pay your local bookstore the monetary value, you must also spend several hours reading it. Therefore the opportunity cost entails the loss of pleasure or income from other things you could have been doing instead such as reading a different piece of literature or earning money mowing lawns. However, when you went to the bookstore and bought the book, you decided that you would gain the most satisfaction by reading that book instead of reading another one or playing basketball. Economists, of course, have a theory for this 'satisfaction' you derive as well!
[edit] Utility
If the Rolling Stones were economists instead of musicians, they might have named their mid-60's hit "I Can't Get Enough Utility." Alas, Mick Jagger (who attended the London School of Economics) must have fallen asleep during that lecture, or as an economist would say, decided that the opportunity cost of attending class was outweighed by the marginal utility derived from practicing his next hit. Utility is simply satisfaction. We all derive satisfaction from different things. Some enjoy adrenaline pumping roller coasters, while others would much rather sit at home on the porch and watch the sunset. However you get utility is individual only to you, but the one thing that is not individual to you is the fact that you try to maximize your utility. Regardless of how you get the most satisfaction, you always try to get as much as you can. However, how do we know that you always get the most out of it? If only you could do something that would make you happier, assuming you are rational, you would.
Utility does present one problem, how do we measure it? Satisfaction is impossible to measure due to its subjectivity. Simply ask someone how much they liked the latest Arnold Schwarzenagger movie. "It was good." How good is good though? To solve this problem, economists have invented the unit called the "utile." It arbitrarily assigns a number to the amount of utility someone receives out of a transaction. It is important to realize that the utile does not represent any real amount of satisfaction. The usefulness of assigning a number becomes apparent though when working with more concepts such as diminishing marginal utility and utility maximization problems. The numerical value is used to track the trend. For example, if the amount of satisfaction you get is decreasing quickly, it doesn't matter whether you go from 100 utiles to 50, 10 to 5, etc, as long as the decrease is significant.
One last thing about utility which was mentioned before but is worth repeating. Consumers are assumed to always maximize utility. That is, if they can get more utility/dollar, they will adjust accordingly. Things are not always in equilibrium because sometimes it takes time to find the combination of things that maximizes the utility of the consumer. For example, at the grocery store, there might be three equally priced cans of chicken noodle soup. You may pick the one you like least first, but the next time you will try a different one. If that one still does not satisfy you, you may try the third one. This may take three weeks, but eventually, you maximized your utility.
[edit] Positive and Normative
Everyday, just listening to the news for a few minutes, you will probably hear something about an economist from such and such predicting that the market for widgets is going down or the dollar versus the Filipino Peso is going to hurt our economy. Economics, however, does not attempt to predict anything. Many, if not all of these predictions are simply a matter of opinion and are easily up for debate. The reason for this is that economists make positive statements. These are statements that are matter of fact, and they are gathered through much research and data on past events. We, as economists, study what has happened in human history. From this, we have developed hypotheses, and through experiments or more detailed observation, we come to conclusions. It may be easier to understand positive statements better if you first understand the opposite: normative statements.
Normative statements attempt to say how things should be. "You should eat a peanut butter and jelly sandwich," or "That should have more salt in it." An example of this in economist-lingo would be "President Bush should increase tariffs to help reduce the trade deficit." Although you may be hungry and eating a peanut butter and jelly sandwich would cure it, it is not necessarily the only or the best possible solution. Similarly, although increasing tariffs may reduce the trade deficit, it may actually do more harm than good! Positive statements describe how things already are: "There is a trade deficit in the United States," "I am hungry," or "There is no salt in this soup." Although many economists will offer their opinion on things, it is necessary to keep in mind that their normative statements are never fact. Many economic theories are positive statements that are derived from previous happenings.
[edit] Conclusion
These basic theories in economics are the foundation that everything else is built on top of. Although when you get to higher levels you may not mention much about utility or opportunity cost, how you analyze situations will (hopefully) take these things into account. The problem of scarcity is the basic problem that underlies essentially all economic endeavors. With these tools, one can begin to think of supply and demand, different markets, governments and their policies, and much more.
[edit] A non-economic alternative
Think of the many countries in which their children usually are provided with free food, free shelter, free clothing, etc. They are not required to pay for what they get, or to work for their living, although in some cases punishments are meted out including, maybe, various means of deprivation in order to obtain some future compliance with required "normal" behavior/behaviour patterns. Profit and loss considerations do not usually exist in such welfare-based societies. There have been attempts, apparently, in special (experimental?) adult societies to implement similar welfare policies, but probably none of them worked in the long run, after the idealistic founders no longer participated.
