What is Economics?
There are many definitions of economics out there, but there are two that I especially like.
- Economics is the study of people’s decisions and how they interrelate.
- Economics is the study of a society’s production and allocation of goods and services.
Many people think that economics is the study of money, or the study of the stock market. While economics can help explain how those things work, it is much broader. Many people probably see the debate of communism vs. capitalism as a political debate, but the fundamental difference between those systems lies in definition number 2 above. Below I will explain some basic economic concepts that will hopefully be useful to readers of this blog with no formal economics education.
Scarcity
Scarcity is something most people understand intuitively but don’t consider in depth. It has massive implications for everything else that happens in an economic system. Without scarcity economics would be unnecessary. An environment without scarcity is essentially what people consider heaven. Scarcity means that while society and the people in it have nearly unlimited wants, there are limited means to satisfy those wants. Even the most frugal people – those that are, or claim to be, happy in a basic cabin in the woods – have unsatisfied wants. Economic systems, speaking broadly, provide ways of allocating scarce resources that are considered “fair” by society. The communism vs. capitalism debate shows how the definition of fair may vary, but both systems pursue some notion of fairness.
The “invisible hand”
The notion of free markets being the best way to allocate resources goes back to the 18th century with Adam Smith’s The Wealth of Nations, the publication of which can be considered the founding of economics as its own discipline. The idea is that when people act in self interest, the greater good is still served by an “invisible hand” that works through trade to allocate resources fairly. For markets with perfect competition, which requires among other things a uniform product and equal information available to buyers and sellers, this is close to true.
However, few markets reflect perfect competition due to a number of possible “market failures.” A majority of modern economic research probably boils down to the study of market failures so I can’t list them all here. But one excellent example is the so-called “tragedy of the commons” problem in allocating shared public resources.
Imagine a medieval village with a grassy field in the middle. Shepherds inhabit the village and all let their flocks graze on the field. Because the field is public and “free”, the shepherds have every incentive to grow their flocks without limit, but at some point the field will be overgrazed and destroyed, cutting off the food for the sheep and destroying all the shepherds’ livelihoods.
You may suggest the obvious solution – divide the field in equal parts among shepherds who will then have an incentive to take care of their plots – but there’s a ton of problems with that, like incompetent shepherds being given the same share as experts who could use it better, and the fact that new arrivals to town will be left with nothing, and who will maintain the fences, and that the land at the top of the hill is better than at the bottom, and so on. Here we have a scarce resource – the field – which, on account of being public, is not properly allocated by the “invisible hand” when everyone acts in self-interest. If a simple medieval town has such problems it’s no wonder we can’t agree on anything today.
Supply and demand
This is the basic economic concept that most people think they understand but, in fact, most do not. All things being equal, larger demand or smaller supply raises the price of something; smaller demand or larger supply lowers the price. That part people understand. What people often overlook is that, first, there is an aggregate notion of demand and a separate, specific notion of quantity demanded, and second, that price is the dependent variable here – in other words, demand changes, then price changes to match, not the other way around.
Imagine there are 100 people willing to pay $20 for a soccer ball that costs $30. None of the 100 people buy a ball, but that does not mean there is no demand. Due to lack of sales, the manufacturer lowers the price to $20 and immediately sells 100 balls. Did demand go up? No, it stayed the same, but the quantity demanded at a new lower price was more than at the previous price.
Leave comments on this page to request additional boring economics lectures from an amateur. I’ll do my best to expand and clarify it as needed. I promise the blog posts won’t be as dry.
