Activity: Economics: the Science of Scarcity

Overview

User: Adam Gore

Activity: Economics: The Science of Scarcity

Curriculum: Economics

Date: Tue, Sep 2 12:30:45 GM

28 items printed. Tue, Sep 2 12:30:45 GM

of 12 Overview

Economics: The Science of Scarcity

DEFINITION OF ECONOMICS What is economics? Economics is a social science that examines how goods and services are produced, distributed, and consumed (that is, purchased and used).

What does this definition mean? First, economics is a science. This means that it follows very strict methods of examining facts methodically in an effort to study something and come to conclusions about it.

Second, economics is a social science, not a physical science (such as chemistry or physics). This means that it studies human society and behavior and not physical or nonhuman things like rocks or chemicals.

Lastly, what does economics study? It examines how goods and services are produced, distributed, and consumed. People make decisions that determine how this process occurs. Thus, although economics deals with goods and services, it actually is examining the efforts, decisions, and thought processes of people regarding these goods and services. This is why it is a social science and not a physical one.

Definitions Are Important to Economics In most things we do, strict definitions are not very important. In science, they are essential. In biology, if some scientists called monkeys and worms both "monkeys," they could not understand why some monkeys were in the ground and some monkeys were in the trees. Everyone studying biology must always mean the same thing when they use the word "monkey." Biology could not be a science if it did not have definitions so that the words that biologists use mean the same thing all the time to everyone involved.

Economics is also a science and, like all sciences, it must begin with precise definitions. Some of these words we use in everyday speech where the meanings may be imprecise, but their meanings are precise within economics . The most common reason for difficulty or failure in the study of economics may be that the student does not know or understand the basic definitions. It can become difficult to properly understand economic discussions that utilize these terms if a student does not fully understand the definitions of the terms used in those discussions. Some basic definitions and concepts are discussed in this introductory chapter and other terms are introduced elsewhere in the product where appropriate .

SCARCITY AND ECONOMIC VALUE

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Scarcity Scarcity means that there is a limited quantity of something and more of this something is wanted or needed than we have available. Human needs (the things that we MUST have in order to live) are limited, but human wants are not. Wants are the things that we do not have to have in order to live, but would like to have. However, most of the things that we want are scarce -- that is, limited in supply. Also, the resources that people have available to obtain their wants are also limited.

Remember that the definition of economics says that it examines how goods and services are produced, distributed, and consumed. The process of production, distribution, and consumption requires thought and effort because of the scarcity of resources. For example, there is only so much iron ore in existence and only a certain amount is mined each year. Iron ore is used in the production of steel. Steel is used in a number of products, such as cars. Thus, the quantity of iron ore mined can determine the number of cars and other products that can be built. We can only make a limited number of things from the iron ore that is mined each year.

Since almost everything on earth is limited in supply, there is almost always a scarcity of the things that people want. Thus, everyone cannot have everything that they want. Because it is natural for people to want many things and a lot of these things, almost everything is scarce in the sense that its supply is limited. This is why the science of economics ultimately involves people -- it studies how we make choices about getting what we want in a world where the quantity and availability of things is limited by scarcity. Thus, a short, but complete, definition of economics is that it is the social science that studies how people deal with limited (scarce) resources.

Economic Value Because the supply of almost everything is limited, scarcity is the primary factor involved in determining economic value. If something has economic value, it means that people are willing to give some of their limited resources in order to obtain it.

An example of how scarcity influences economic value is the different values placed on water and diamonds. Water is more necessary to humans than diamonds, but it is not as scarce. The result is that people will usually pay much more for diamonds than for water. If diamonds were as plentiful as water, they might have little or no economic value . As in all cases of economic value, this diamond/water example depends on its circumstances. Clean drinking water is plentiful here in the United States. However, this is not the case

throughout the world. In many countries, good clean drinking water is difficult to obtain and would have a higher economic value than it does here.

The factor that influences how many people want something -- and thus how scarce that something is and its economic value -- is how desirable or useful something is perceived to be. For example, many people view cell phones and computers as useful and are willing to spend money to have them. Diamonds are beautiful and fascinating to look at. Even if they were as plentiful as water, they might still have economic value. Even though water itself has little economic value, people are willing to pay more for beachfront property than the same size property two miles from the beach.

People may perceive an object to be desirable without the object being useful. An example is the periodic fads that appear. One classic example is the "pet rock" phenomena of 1975. Small ordinary rocks were sold as "pets" for about $4 each. The fad lasted only six months, but it was enough to make its originator a millionaire. Another example of fads is that there is usually one toy or game that is in high demand in the December holiday shopping season. In 1983, Cabbage Patch Kids were the "must-have" toy of that year's holiday shopping season. People were standing in line for hours to buy them. The dolls were in such strong demand that they were reselling them for 100 times over the original purchase price.

RESOURCES OF PRODUCTION Anything that is used to make or produce any type of good or service is called a "resource of production" (usually called just a resource). Some textbooks call these resources "factors" or "elements" of production or "productive resources." Resources of production are divided into three categories: natural (land), human (labor), and capital resources.

Natural Resources (Land) Natural resources are sometimes referred to as "land" in economics. Natural resources refer to any type of naturally occurring resource that can be used to produce a good or service. This includes land that can be used by humans for some purpose (farming, grazing animals, or mining), water that can be used for transportation or power, and mineral resources such as iron ore or coal.

Human Resources (Labor) Human resources are also referred to as "labor ." This is the human effort (both physical and mental) used to make or produce a good or service. This definition makes sure that we do not include all human effort because some human effort does not produce anything.

Children playing sports are using plenty of human effort, but it is not an economic resource of production. It is not labor as it is defined in economics. Professional athletes, on the other hand, are using economic resources when they play the same game because they are producing a service for sale.

Capital Resources Capital resources are anything that is produced that is then used in the production of other goods and services. A factory machine and tools are capital resources. A consultant hired by a company is providing a capital resource. This is the only category of resources of production that is the result of human production. Capital resources are not to be confused with financial capital. Financial capital is the money that is used to buy capital resources. When speaking casually, people sometimes refer to financial capital as "capital," but this is not what economists mean when they refer to capital resources.

Additional Possible Resources of Production Although all economists agree on the three resources of production already discussed, they disagree about whether or not there are additional resources of production. Their understanding of human resources (labor) has increased and changed over time. Not all labor is the same, nor is it valued the same economically. Two terms used to describe these different aspects of human efforts are human capital and entrepreneurs. Some economists include one or both of these as separate resources of production, arguing that there are four or five resources of production depending on whether they accept one or both as a resource.

Human Capital Why are some people paid more money to do their jobs than other people? For example, teachers, lawyers, doctors, accountants, or corporate executives are paid more than what teenagers are paid to work in a fast food restaurant. The reason is that these professionals have more "human capital." The phrase "more human capital" means that their labor or human effort is more valuable to a business. This is because these people have acquired specialized skills or knowledge that the business needs. Specialized skills and knowledge can be hard to find. Thus, the business is willing to pay the person with more human capital more money than it is willing to pay some other people with less specialized skills or knowledge.

The teenager working in a fast food restaurant does not usually have these types of skills or knowledge yet. Also, flipping hamburgers and working a cash register are skills that can be easily acquired by many people through a short training period. Not everyone

has the abilities necessary to become a doctor or is willing to spend the time, money, and effort to acquire the skills and knowledge necessary. Thus, people with certain specialized skills and/or knowledge can earn more money than other people.

Employers pay for the resources they use based on how much value the resources can produce. They will pay millions of dollars for a machine that can produce goods or services that are worth millions of dollars. Similarly, a professional baseball team owner will pay millions of dollars to a player who can contribute significantly to the team's efforts toward a league championship (which will increase ticket sales and broadcast revenues). The baseball player's skills and knowledge are his human capital. The same is true of the skills and knowledge of teachers, lawyers, doctors, and corporate executives -- they have human capital.

Entrepreneurs Someone has to organize the resources of production in order to produce goods and services. The people who do that are called "entrepreneurs ." They either start new businesses or purchase existing ones. To do this, they hire people, buy or build factories, and acquire any equipment needed. Thus, their effort -- their labor -- is to purchase and organize the resources of production such that goods and services are produced. As part of this, they contribute the money that they use to either start a business or purchase one -- and risk losing it if the business should fail.

In 2007, Bill Gates was listed as the world's richest person (with $56 million in wealth) on the annual list compiled by "Forbes" magazine. That year was the 14th year in a row that he had had the top spot. He was not born this rich. He and a partner founded a company called Microsoft to produce and sell computer software in the mid-1970s. Microsoft today is the world's leading developer and marketer of computer systems and applications, particularly operating systems and office suite packages. As a result, Gates became the richest person in the world. He is an entrepreneur . So is the person who opens a retail store or purchases a gasoline station. So are teenagers who hire themselves out to cut lawns and weed flowerbeds.

Entrepreneurs are important to economies because their efforts in organizing the resources of production provide benefits to the economy , which are explored in more depth in the "Entrepreneurship and Economic Growth" chapter of this product.

GOODS AND SERVICES Remember that the definition of economics says that it examines how goods and services

are produced, distributed, and consumed. What are goods and services?

Everything produced by businesses falls into one of two categories as far as economists are concerned: they are either goods or services. Goods are tangible, which means that they can be seen and touched. Services are intangible -- they are something that someone does for you. A battery for your car is a good. It is tangible -- you can see and touch it. If you already have the battery and pay someone to install it in your car, you are paying for labor alone -- that is a service. An airplane is a good, while a flight on an airplane is a service.

Sometimes you pay for both a good and a service together . If you go to a service station, purchase a battery, and ask them to install it, your bill will have separate charges for "parts" and "labor." That is everyday speech for goods and services: the parts are the goods and the labor is the service.

Types of Goods and Services There are two kinds of goods and services -- consumer ones and capital ones.

Consumer Goods and Services To buy something for your own use or benefit is called "consumption" in economics. The purchaser is called a "consumer." Consumption does NOT include purchasing something for the purpose of making something else that you intend to sell. Consumers engage in consumption to meet their own personal wants and needs, not for business purposes. Things that are offered for sale to consumers are called consumer goods and consumer services.

One common problem that students have with economics involves the process of consumption. In economics, to consume something means to purchase it for your own use or benefit. This may not always mean that the good or service is used to the point where it does not exist. This is especially true of many services. If you rent a DVD in order to watch it, you use it, but you do not use it up. Someone else can rent and watch the same film after you return it. However, many goods (such as food) are used up once they are consumed and are no longer available for reuse. Thus, if you consume something, it does not always mean that it is gone and cannot be reused.

Capital Goods and Services Businesses use the other kind of goods -- capital ones. Capital goods and services are used to produce other goods or services. For example, machine tools are always a capital good because their only purpose is to produce other goods for sale. Similarly,

cash registers, oil tankers, farm tractors, and office buildings are always capital goods. An example of a capital service would be a consultant hired by a company to provide management advice. The consultant is providing a capital service. Capital goods and services are the third resource of production, capital resources. When a business produces goods and services, they are either sold to other businesses (as capital goods and services) or to consumers (as consumer goods and services).

Some Goods and Services Can Be either Consumer or Capital Some goods and services can be either consumer ones or capital ones, depending on how they are used. Most automobiles are consumer goods, but if someone intends to use one as a taxi, that individual car is a capital good. A hunting rifle would seem to always be a consumer good. However, if it were purchased to be used by a professional hunting guide or a person who intends to sell the meat, then that individual gun would be a capital good because it would be used to produce something else for sale. Likewise, computers can either be consumer or capital goods.

RATIONAL SELF-INTEREST All sciences are based upon basic assumptions. A very basic assumption in economics is called "rational self-interest." Rational self-interest in economics means that the primary motivation for all economic decisions is what rational decision-makers think will be best for them. Still, different people gain pleasure and happiness in different ways. Therefore, different people will spend their resources differently and all of them will be quite rational in their choices. One person will spend money on a camping trip to the mountains because he or she gains great pleasure from nature. Another will spend even more money traveling to Paris or Rome because he or she loves the food, art, and architecture of Europe. Neither is wrong. Each made the best choice for themselves . Everyone is different.

MARGINAL ANALYSIS The statement "all economic decisions are made at the margin" expresses a fundamental idea that is at the heart of market economies. But what does it mean?

When we decide to purchase pizza ("consume" is the term that economists use), we do not intend to purchase all the pizza in the world or even all of the pizza for sale from a single pizza establishment. Instead, we intend to purchase just one pizza or perhaps two. After that, we probably will not want to buy more at that time. That is a decision "at the margin," meaning "at the edge" or "just one more." That is, when we decide to purchase a pizza, we are looking to purchase one more pizza than we have now. Thus, margin is the smallest amount of something that is bought or sold.

The size of the margin may differ depending on the intended use of the product. Nails are usually sold to builders by the pound. Sheets of paper are sold by the ream or box. In these cases the "margin" is really more than a single unit, but it is still the smallest amount which we want to buy or sell.

Because the economic decisions of buying and selling are made "at the margin," the economic study of how we decide to purchase or sell is often called "marginal analysis." This is because it is based on comparing the marginal benefits that we expect to get to the marginal cost that we will have to spend.

Marginal Benefit and Marginal Cost Marginal benefit is "the benefit gained from one more of something," while marginal cost means "the money spent to purchase one more of something ." If a candy bar is 50 cents, the decision to purchase a candy bar is really our personal belief that we will gain more pleasure (benefit) from that candy bar than we will from spending that 50 cents on something else. When marginal benefit exceeds marginal cost we will decide to make the purchase because we all seek to maximize our utility. Economists frequently use the term "utility" to mean what most people think of as "benefit" or "useful." Utility can be a satisfied feeling, a sense of well- being , or the quality of being useful to someone. Thus, economists use the terms marginal benefit and marginal utility interchangeably.

MICROECONOMICS AND MACROECONOMICS There are two branches of economics: microeconomics and macroeconomics .

Microeconomics Microeconomics focuses on the economic behavior of consumers and firms (businesses), including how their decisions influence and determine how goods and services are produced, distributed, and consumed. Thus, microeconomics studies why people purchase what they do and how much time they choose to work. It also studies why firms choose different production levels and products to produce.

Microeconomics is also called market economics because the majority of the economic behaviors studied take place in markets in most countries of the world. "Market" is a word that has a precise meaning within the study of economics, compared to its meaning in everyday speech. In everyday speech, it usually means a store or a single place where many different things are bought and sold. In economics, it does not necessarily mean a place, but instead is the mechanism, process, or means by which buyers and sellers are

brought together -- that is, the bargaining between those who are producing the product and those who want to consume it. Two things are determined by this bargaining: how much will be bought and sold (the quantity) and at what price. Thus, a market in economics may or may not be a physical place specifically devoted to selling (such as a retail store) -- it could be an electronic stock market, over the Internet, or a meeting on a street.

Macroeconomics Macroeconomics focuses on how an entire economy performs. It usually examines the national economy of a particular country, including such issues as growth, employment/unemployment , inflation, and how government policies affect the country's economy. Since it usually examines a national economy, it is also frequently called national economics.

CIRCULAR FLOW MODEL OF ECONOMIC PARTICIPANTS Economists group participants in an economy into three groups: households, firms, and governments . (A household is the people who live together in the same house and make some purchases as a unit. A single person may be considered a household if he or she lives alone.) These three interact in the economy such that each is interdependent on the others. For example, although you might normally think of households as simply consumers, they also provide labor to firms in order to earn the money to consume. They are the second resource of production. The interactions among these three economic participants are described more thoroughly in the "Circular Flow Model" tutorial.

OPPORTUNITY COST As mentioned, economics is the social science that studies how people deal with limited resources. A resource that is used for the production of one thing cannot be simultaneously used to produce another thing. To use all of our iron ore to make steel and use all of our steel to make automobiles means we can make nothing else with that same ore. Similarly, a consumer has limited resources and must decide what goods and services to obtain with them. This causes a "quandary of choice." We cannot produce or consume everything -- we must choose how we want to use our scarce resources.

As part of choosing how to use their scarce resources, people consider the possible alternatives that they have available to them. Both consumers and people involved in producing goods and services consider alternatives and make choices when choosing how to use their resources. As part of this evaluating process, people must consider trade-offs. A trade-off is what you give up in order to obtain the alternative you choose. For example, if you choose to purchase pizza for dinner, then you cannot use that same money to buy movie

tickets. The movie tickets are the trade-off for purchasing the pizza.

Scarcity and alternatives are the principles underlying opportunity cost. Opportunity cost is the value of the best alternative (money, time, or resource) that is given up when some other alternative has been chosen. Thus, the value of what is NOT chosen is the opportunity cost of having what is chosen.

Examples of Opportunity Cost What is the opportunity cost of using our farmland for housing developments? We can no longer use that same land for growing crops. A trial lawyer wanted to teach in a university, while continuing to work as a lawyer. He tried to do both, but had to give up the teaching because he could not adequately serve his clients when so much of his labor was going into teaching. The opportunity cost of being a lawyer was that he had to give up teaching.

A teenager faces the same quandary of choice whenever he or she uses time for one purpose or another. The opportunity cost of working an after-school job for 20 hours per week is that you will have less time for schoolwork. The choice to use your present labor to make money has the opportunity cost of possibly not doing as well with your schoolwork. When faced with the choice of studying for a test scheduled for the next day or attending a party, a student risks the prospect of not doing as well on the test if he or she attends the party.

Economic Rules Affect Everyone Equally Economics affects everybody and everything. The same rules or laws of economics affect consumers, businesses, and governments . The perfect example is opportunity cost. If you spend $20 for a large pizza, you cannot spend that same $20 on a CD. You must choose between them. But, you may say, "I can borrow $20 from a friend." Yes, this is true -- but you will have to pay your friend back. The $20 you pay back in the future is money that you are choosing not to spend on something else in the future.

Just as you or Icannot spend the same money on two different things, neither can businesses or governments . When the government collects $20 billion in taxes and decides to spend it all on guns, it cannot spend that same money on schools. If it collects $20 billion and chooses to spend $20 billion each on both guns and schools, it must find another $20 billion somewhere -- either by raising taxes or borrowing the money. Opportunity cost -- and all the laws of economics -- apply equally to individual consumers, businesses, and governments.

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