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What Is Economics? Economics Is the Study of That How People Use Their What is Economics? Economics is the study of that how people use their limited resources into unlimited wants. Resources include the time and talent people have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services. Positive science: Economics is positive science because it shows the connection b/w causes and effects of economic phenomena. Normative science: Economics is normative science because it sets up ideas concerning wealth Applied science: Economics is applied science because it prescribed rules for achievement of material prosperity. Definitions of Economics from Historic Textbooks "Economics is the study of people in the ordinary business of life." -- Alfred Marshall, Principles of economics; an introductory volume (London: Macmillan, 1890) "Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses." -- Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: MacMillan, 1932) Economics is the "study of how societies use scarce resources to produce valuable commodities and distribute them among different people." -- Paul A. Samuelson, Economics (New York: McGraw-Hill, 1948) 1. Scarcity Scarcity (also called paucity) is the problem of infinite human needs and wants, in a world of finite resources. Society has insufficient productive resources to fulfill those wants and needs. Alternatively, scarcity implies that not all of society's goals can be pursued at the same time; trade-offs are made of one good against others. In an influential 1932 essay, Lionel Robbins defined economics as "the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses." Because all of our resources are limited in comparison to all of our wants and needs, individuals and nations have to make decisions regarding what goods and services they can buy and which ones they must forgo. For example, if you choose to buy one DVD as opposed to two video tapes, you must give up owning a second movie of inferior technology in exchange for the higher quality of the one DVD. Of course, each individual and nation will have different values, but by having different levels of (scarce) resources, people and nations each form some of these values as a result of the particular scarcities with which they are faced. So, because of scarcity, people and economies must make decisions over how to allocate their resources. Economics, in turn, aims to study why we make these decisions and how we allocate our resources most efficiently. Scarcity and Choice Scarcity means that people want more than is available. Scarcity limits us both as individuals and as a society. As individuals, limited income (and time and ability) keep us from doing and having all that we might like. As a society, limited resources (such as manpower, machinery, and natural resources) fix a maximum on the amount of goods and services that can be produced. 1 Scarcity requires choice. People must choose which of their desires they will satisfy and which they will leave unsatisfied. When we, either as individuals or as a society, choose more of something, scarcity forces us to take less of something else. Economics is sometimes called the study of scarcity because economic activity would not exist if scarcity did not force people to make choices. When there is scarcity and choice, there are costs. The cost of any choice is the option or options that a person gives up. For example, if you gave up the option of playing a computer game to read this text, the cost of reading this text is the enjoyment you would have received playing the game. Most of economics is based on the simple idea that people make choices by comparing the benefits of option A with the benefits of option B (and all other options that are available) and choosing the one with the highest benefit. Alternatively, one can view the cost of choosing option A as the sacrifice involved in rejecting option B, and then say that one chooses option A when the benefits of A outweigh the costs of choosing A (which are the benefits one loses when one rejects option B). The widespread use of definitions emphasizing choice and scarcity shows that economists believe that these definitions focus on a central and basic part of the subject. This emphasis on choice represents a relatively recent insight into what economics is all about; the notion of choice is not stressed in older definitions of economics. Sometimes, this insight yields rather clever definitions, as in James Buchanan's observation that an economist is one who disagrees with the statement that whatever is worth doing is worth doing well. What Buchanan is noting is that time is scarce because it is limited and there are many things one can do with one's time. If one wants to do all things well, one must devote considerable time to each, and thus must sacrifice other things one could do. Sometimes, it is wise to choose to do some things poorly so that one has more time for other things. 2. Macro and Microeconomics • Microeconomics examines the behavior of individual decision-making units—business firms and households. • Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. • Aggregate behavior refers to the behavior of all households and firms together. 3. Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources. The main sources of economic growth are capital accumulation and technological advances. 4. Demand Demand is the amount people are willing to purchase at each possible price. The amount of the product people are willing to purchase at a specific price is called quantity demanded. A demand schedule is a list of the quantity demanded at different prices. When constructing a demand schedule, everything else that might affect demand is held constant. Consider the following demand schedule for pizza: Price Quantity Demanded ($/slice) (number of slices) $5 2 2 4 5 3 8 2 12 1 17 The demand curve is a graph of the demand schedule. 5. Supply Supply is the amount producers are willing to offer for sale at each possible price. The amount sellers are willing to offer at a particular price is called quantity supplied. The supply schedule for pizza would be constructed by adding up the quantities that each producer offers for sale at each price, holding constant everything else that affects the supply of pizza. Price Quantity Supplied ($/slice) (number of slices) $5 18 4 15 3 8 2 2 1 1 The supply curve is a graph of the supply schedule. 6. Equilibrium Equilibrium is a situation in which there is no tendency for change. A market will be in equilibrium when there is no reason for the market price of the product to rise or to fall. This occurs at the price where quantity demanded equals quantity supplied. At this price, the amount that consumers wish to buy is exactly the same as the amount that producers wish to sell. Quantity Demanded Price Quantity Supplied 2 $5 18 5 4 15 8 3 8 12 2 2 17 1 1 Equilibrium occurs at a price of $3. The equilibrium quantity is 8 slices of pizza. When the price is above the equilibrium of $3, quantity supplied is greater than quantity demanded. Firms are unable to sell all they want to at that price. There is an excess supply and this surplus creates pressure for the price to fall. If the price is 3 below equilibrium, there is excess demand and the shortage creates pressure for the price to rise. Only at the equilibrium price is there no pressure for price to rise or fall. 7. Supply and Demand Curves Demand and supply curves are simply graphs of demand and supply schedules. Equilibrium occurs where the supply and demand curves intersect at an equilibrium price of $3 and an equilibrium quantity bought and sold of 8. Excess supply or excess demand at any price is simply the horizontal distance between the supply and demand curves. 8. Shifts of the Demand Curve An increase in demand means that consumers wish to purchase more of the good at every price than before. Graphically, the demand curve shifts up to the right. As a result of an increase in demand, the equilibrium price rises as does the equilibrium quantity bought and sold. Notice that an increase in demand has no effect on the supply curve. Firms do increase production, but only in response to the higher market price. A decrease in demand, on the other hand, means that people wish to purchase less of this good at every price than before. The demand curve shifts down to the left. The equilibrium price and quantity both decrease. Again, the shift of the demand curve has no effect on the supply curve. From the point of view of producers, all that has happened is that the market price has fallen. So, firms decrease the quantity supplied. The supply curve itself does not shift. A movement along the supply curve occurs. 9. Utility Analysis Utility is the Power of a Commodity to satisfy human wants. There are two different Approaches to Utility Analysis 1. Cardinal approach to utility analysis 2. Ordinal approach to utility analysis 4 9.1 Cardinal Approach This School believes that Utility is Measurable and is a Quantifiable entity.
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