The Scope and Method of Economics
by
Charles Lamson
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At any moment in time every society faces constraints imposed by Nature and by previous generations. Some societies are handsomely endowed by Nature with fertile land, water, sunshine, and natural resources. Others have deserts and few mineral resources. Some societies receive much from previous generations---art, music, technical knowledge, beautiful buildings, and productive factories. Others are left with overgrazed, eroded land, cities leveled by War, or polluted natural environments. All societies face limits. Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided. The key word in this definition is choose. Economics is a behavioral, or social science. In large measure it is the study of how people make choices. The choices that people make, when added up, translate into societal choices. The purpose of the next several posts is to elaborate on this definition and to introduce the subject matter of economics. What is produced? How is it produced? Who gets it? Why? Is the result good or bad? Can it be improved? Why Study Economics? There are four main reasons to study economics: to learn a way of thinking, to understand society, to understand global affairs, and to be an informed voter.  To Learn a Way of Thinking Probably the most important reason for studying economics is to learn a way of thinking. A good way to introduce economics is to review three of its most fundamental concepts: opportunity cost, marginalism, and efficient markets. If your study of economics is successful, you will use these concepts everyday and making decisions. Opportunity Cost What happens in an economy is the outcome of thousands of individual decisions. Households must decide how to divide their incomes among all the goods and services available in the marketplace. People must decide whether to work or not to work, whether to go to school, and how much to save. Businesses must decide what to produce, how much to produce, how much to charge, and where to locate. It is not surprising that economic analysis focuses on the process of decision making. Nearly all decisions involve trade-offs. A key concept that recurs in analyzing the decision-making process is the notion of opportunity cost. The full "cost" of making a specific choice includes what we give up by not making the alternative choice. The best alternative that we forgo, or give up, when we make a choice or a decision is called the opportunity cost of that decision. The concept applies to individuals, businesses, and entire societies. The opportunity cost of going to a movie is the value of the other things you could have done with the same money and time. If you decide to take time off from work, the opportunity cost of your leisure is the pay that you would have earned had you worked. Part of the of the cost of a college education is the income you could have earned by working full-time instead of going to school. If a firm purchases a new piece of equipment for $3,000, it does so because it expects that equipment to generate more profit. There is an opportunity cost, however, because that $3,000 could have been deposited in an interest-earning account. To a society, the opportunity cost of using resources to put astronauts on the moon is the value of the private/civilian or other government goods that could have been produced with the same resources. Opportunity costs arise because resources are scarce. Scare simply means "limited." Consider one of our most important resources---time. There are only 24 hours in a day, and we must live our lives under this constraint. A farmer in rural Brazil must decide whether it is better to continue to farm or to go to the city and look for a job. A soccer player at the University of Vermont must decide whether she will play on the varsity team or spend more time improving her academic work.  Marginalism and Sunk Cost A second key concept used in analyzing choices is the notion of marginalism. In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that arise from the decision. Suppose, for example, that you live in New Orleans and that you are weighing the costs and benefits of visiting your mother in Iowa. If business required that you travel to Kansas City, the cost of visiting Mom would be only the additional, or marginal, time and money cost of getting to Iowa up from Kansas City. Sunk costs are costs that cannot be avoided, regardless of what is done in the future, because they have already been incurred. There are numerous examples in which the concept of marginal cost is useful. For an airplane that is about to take off with empty seats, the marginal cost of an extra passenger is essentially zero; the total cost of the trip is roughly unchanged by the addition of an extra passenger. Thus, setting aside a few seats to be sold at big discounts on the Internet can be profitable even if the fair for those seats is far below the average cost per seat of making the trip. As long as the airline succeeds in filling seats that would otherwise have been empty, doing so is profitable. Efficient Markets---No Free Lunch Suppose you are ready to check out of a busy grocery store on the day before a storm, and seven check-out registers are open with several people in each line. Which line should you choose? It is usually the case that the waiting time is approximately the same no matter which register you choose (assuming you have more than 12 items). If one line is much shorter than others, people will quickly move into it until the lines are equaled again.  As you will see you later, the term profit in economics has a very precise meaning. Economists, however, often loosely refer to "good deals" or risk-free ventures as profit opportunities. Using the term loosely, a profit opportunity exists at the checkout lines if one line is shorter than the others. In general, such profit opportunities are rare. At any time there are many people searching for them, and, as a consequence, if you exist. Markets like this, where any profit opportunities are eliminated almost instantaneously, are said to be efficient markets. (We discuss markets, the institution through which buyers and sellers interact and engage in exchange in detail in future parts of this analysis.) The common way of expressing the efficient markets concept is "there's no such thing as a free lunch." How should you react when a guy in a finance chatroom on the Internet has a hot tip on the stock market? With skepticism. There are thousands of individuals each day and looking for hot tips in the market. If a particular tip about a stock is valid, there will be an immediate rush to buy the stock, which will quickly drive its price up. There are clearly times when profit opportunities exist. Someone has to be first to get the news, and some people have quicker insights than others. Nevertheless, news travels fast, and there are thousands of people with quick insights. The general view that large profit opportunities are rare is close to the mark. The study of economics teaches us a way of thinking and helps us make decisions. To Understand Society Another reason for studying economics is to better understand society. Past and present economic decisions have an enormous influence on the character of life in a society. The current state of the physical environment, the level of material well-being, and the nature and number of jobs are all products of the economic system.  Economic decisions not only have shaped the physical environment but also have determined the character of society. At no time has the impact of economic change on a society been more evident than in England during the late 18th and early 19th centuries, a period that we now call the Industrial Revolution. Increases in the productivity of agriculture, new manufacturing technologies, and development of more efficient forms of transportation led to a massive movement of the British population from the countryside to the city. At the beginning of the eighteenth century, approximately two out of three people in Great Britain worked in agriculture. By 1812, only one in three remained in agriculture; by 1900, the figure was fewer than one in ten. People jammed into overcrowded cities and worked long hours in factories. The world had changed completely in two centuries---a period that in the run of history was nothing more than the blink of an eye. It is not surprising that the discipline of economics began to take shape during this period. Social critics and philosophers looked around them and knew that their philosophies must expand to accommodate the changes. Adam Smith's Wealth of Nations appeared in 1776. It was followed by the writings of David Ricardo, Karl Marx, Thomas Malthus, and others. Each tried to make sense out of what was happening. Who was building the factories? Why? What determined the level of wages paid to workers or the price of food? What would happen in the future, and what should happen? The people who asked these questions were the first economists. Similar changes continue to affect the character of life today. In fact, many argue that the late 1990s marked the beginning of a new Industrial Revolution. As we turned the corner into the present millennium, the "e" revolution was clearly having an impact on virtually every aspect of our lives: the way we buy and sell products, the way we get news, the way we plan vacations, the way we communicate with each other, the way we teach and take classes, and on and on. These changes have had and will clearly continue to have profound impacts on societies across the globe, from Beijing to Calcutta to New York. These changes have been driven by economics. Although the government was involved in the early years of the World Wide Web, private firms that exist to make a profit created almost all the new innovations and products. How does one make sense of all this? What will the effects be on the number of jobs, the character of those jobs, the family incomes, the structure of our cities, and the political process, both in the United States and in other countries? The tudy of economics is an essential part of the study of society.  To Understand Global Affairs A third reason for studying economics is to understand global affairs. News headlines are filled with economic stories. International events often have enormous economic consequences. The COVID crisis has led to a huge decline in both tourism and business travel. By October 8, 2020, 43 commercial airlines had gone bankrupt, and many more are expected to follow (cnbc.com). In late October, 2020, ACI Europe stated that 193 (mostly regional) of the 740 airports in Europe were also risking bankruptcy (politico.eu). In recent days, global markets have been gripped by the saga of a video game retailer's soaring stock price. GameStop, which makes most of its money selling video games in stores across America, saw its stock price rise as much as 1,700 percent this last week and a half, backed by fans who believe it is unfairly undervalued by large investors who had bet billions that its stock would fall. As small investors championed their purchases of the retailer's stock in viral posts online, the stock rapidly rose in price, forcing the large investors to spend billions of dollars to cover their losses (voanews.com). The market drama surrounding GameStop Corp. is spreading ever further beyond Wall Street whipsawing stocks from Amsterdam to Sidney as traders race to bet on where the flood of retail money might head next. The global GameStop effect has played out in different ways. Day traders in India have been piling into shares of the video game retailer, which accounted for about 15 percent of volume on one popular platform allowing locals to bet on U.S. equities. An Australian company with "GME" in its ticker symbol jumped as much as 60 percent last Thursday, an apparent case of mistaken identity. Some chat rooms frequented by retail investors in China were abuzz with opportunities to pump up stock prices (finance.yahoo.com). Some claim economic considerations dominate international relations. Certainly politicians place the economic well-being of their citizens near the top of their priority list. It would be surprising if that were not so. Thus, the economic consequences of things like environmental policy, free trade, and immigration play a huge role in international negotiations and policies. An understanding of economics is essential to an understanding of global affairs. To Be an Informed Voter When we participate in the political process, we are voting on issues that require a basic understanding of economics.  The Scope of Economics Some think that economics is all about the stock market or what to do with their money. Others think that economics deals exclusively with problems like inflation and underemployment. In fact, it deals with all these subjects, but they are pieces of a much larger puzzle. Economics has deep roots in, and close ties to, social philosophy. An issue of great importance to philosophers, for example, is distributional justice. Why are some people rich and others poor, and, whatever the answer is, is this fair? A number of 19th century social philosophers wrestled with these questions, and out of their musings economics as a separate discipline was born. The easiest way to get a feel for the breadth and depth of what you will be studying is to explore briefly the way economics is organized. First of all, there are two major divisions of economics: microeconomics and macroeconomics---to which we turn our focus in the next post.  *MAIN SOURCE: CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 1-6* end |
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