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What is Economics?

Submitted by dfto on Wed, 07/11/2007 - 1:21pm

The fact that you are reading this document means that you are considering a choice. It may be the choice to go to University or not. Or having decided to go, which university, and what to major in. Economics is fundamentally about understanding the choices made by individuals and how the sum of those choices determines what happens in the economy.

2.1 Economic Puzzles: Examples

For instance, economics provides insight into, and possibly answers, questions and issues involving choices made by individuals and society. Consider the following ten examples:

  • What are the implications of making it illegal for you to buy or sell a kidney? If it is illegal for individuals to sell their organs, where will organs come from? Should there be forced organ donation? Should organs come only from cadavers, from living donors, or both? How should we determine who gets a kidney transplant? What are the advantages and disadvantages of different means to source kidneys and distribute them among those in need?
  • Why does automobile insurance cost so much for young males—especially relative to the price young female drivers pay? Is this not discrimination and should it not be illegal? What would be the effects of prohibiting the basing of insurance rates on an individual's characteristics? While it would appear to make young men better off, what would be the effect on other drivers and would other things change in such a way that young men would not be better off?
  • Why should pedestrians, joggers, and cyclists NOT be in favour of mandatory seat belt legislation, airbags, anti lock brakes, padded dashes, and collapsible steering wheels? How do these safety features affect the care and attention of motorists?
  • Should Bill Gates be canonized as the patron saint of capitalism or Microsoft rendered in two as ordered by a District Court Judge, guilty of monopolization? Should there be economic crimes in a democracy? If so, when and why? Why was Microsoft guilty and what will be the effect on innovation in computer software?
  • Why did Metallica sue to shutdown Napster while other musicians pledged their support for Napster, seeing it as a first shot in a brave new world where they are free from the tyranny of the major record labels—who incidentally were successful in using the courts to shut down Napster? What is a copyright, and why do copyrights exist? Why do record labels exist and what does Napster, the internet, and other innovations mean for the production and distribution of music?
  • The recent "deregulation" of the Alberta's electricity industry has prompted howls of mismanagement and incompetence. What were the changes in the electricity sector and what effects will they have? Has it been mismanaged or will the restructuring of the industry and its regulation result in lower cost and more reliable electricity for consumers?
  • Every day many students take public transit—the bus or C-Train— to school; others drive on roads built and paid for by taxpayers. Why is it that governments provide things like buses, C-Trains, and roads, and even a large part of university funding, but they don’t provide things like cars, stereos, nacho chips and beer? What is it about buses, roads and education that makes them different from cars, stereos and beer?
  • There has been an increase in the levels of drug use by youths and drug-related violence. With these increases come increased costs for prevention, policing, and prosecution. Is there an economic argument to be made for the legalization of drugs? What are the real costs of illegal drug use and what factors influence a person's decision to use drugs? In terms of the benefits of reducing drug related violence and health risks, what types of drugs does it make most sense to legalize? (The answer may surprise you.)
  • Voters often hear politicians assert that they can reduce unemployment by introducing new government spending programs. On the face of it, it seems obvious that a government program that involves hiring 1000 people will reduce unemployment. Why then do economists NOT believe this? Why do economists argue that government spending can at best create a temporary increase in employment, while over the longer term government spending can create no additional jobs? Why do some economists assert that more government spending actually reduces employment? You might want to think about how the government pays for the new program.
  • Taxes – even though we know that we have to pay them to finance government goods and services, we all hate paying them. Every time you buy concert tickets, CDs or jeans, you have to pay the GST. Every pay cheque you receive from that part-time job you have to help finance your university education is that much smaller because of the taxes you pay — Employment Insurance, Canada Pension Plan premiums, and personal income taxes. But did you know that every extra dollar you pay in taxes actually takes more than one dollar out of the economy? That every dollar you pay in taxes actually destroys income? Depending on the type of tax, every extra dollar in taxes you pay reduces total income in the economy by anywhere from 10 cents to 10 dollars – that’s right, 10 dollars! Why?

2.2 Scarcity: Life and Economics are about Choices

All of these examples are about making or explaining the choices individuals, organizations, and societies make. Life is about choices. Even doing nothing is a choice! Choices would not be a problem if our time, innate abilities and all the things we wanted to consume were unlimited. But limited resources mean individuals and societies must make choices and every choice made involves a sacrifice—forgoing the alternative that might have been. As economists often put it: “There is no such thing as a free lunch.” Even if your friend invites you to lunch and is picking up the cheque, you could have played squash, studied, spent time with your parents or done something else with your time.

Economics is the systematic study of the logic of choice and human action under conditions of scarcity. Its concern is with how economic activity—the production, consumption, and trade of goods and services—is organized when resources (labour, land, capital and even such things as clean air and water) are scarce. It seeks to develop an understanding of how individuals and societies structure economic activity, and the relative effectiveness of different institutions in relaxing, or mitigating, scarcity constraints.

Scarcity means that it is not possible to satisfy all demands or wants. If there was no scarcity there would be no economic problem, or the discipline of economics! Scarcity is pervasive because it arises when there are competing uses for resources and all cannot be satisfied. Scarcity arises because the goods and services we consume wear out and we have finite life times. Just imagine how different the world would be if everyone lived forever and nothing ever wore out! In such a world there might not be an economic problem, no need for choices, and no sacrifices.

This, alas, is not the world we live in.

In our world individuals make choices and their choices lead to action. We cannot do everything and our choices preclude other options: becoming a lawyer likely means that you cannot become a tennis star; investing in computer stocks means you have less to invest in oil and gas companies; spending your last hundred dollars on tickets to the Rolling Stones may preclude catching the Calgary Philharmonic Orchestra; watching David Letterman or the Tonight Show means less time to study or sleep. The problem of choice doesn’t exist only for individuals but for society as a whole. Economists try to understand these choice problems and are particularly interested in the social institutions which determine how society's scarce resources are used, or in the words of an economist, allocated.

2.3 The Big Three Questions: The Scope of Economics

The three big questions at the heart of economics are:

  • What gets produced? How are our productive resources allocated between the production of submarines and helicopters (more generally guns) and the production of healthcare, food, and housing (more generally butter)? Between private goods (compact discs, automobiles, and clothing ) and public goods (education, parks, roads, and a clean environment)?
  • How does it get produced? In building roads, what determines whether workers with shovels and picks or earthmoving equipment is used? Computers and the internet or typewriters and books to produce term papers? Skilled craftsman and hand tools or robots on an automated assembly line in the production of cars? Is steel, plastic, aluminum, fiberglass, or some combination used for autobodies? Private clinics or regional health authorities to provide surgical procedures requiring overnight recuperation and observation?
  • Who gets what is produced? What determines the quantity and quality of the goods and services each of us consumes? A rental apartment, an estate house in Church Ranches, or a cot in a shelter? Should income alone determine what an individual consumes? Why do rock stars, athletes, and chief executive officers earn 500 times or more than a university professor or a welder? What is the role of governments in providing goods and services to individuals or augmenting incomes? A particularly important trade-off is between efficiency—getting the most from society's productive resources—and equity—a fair distribution of the goods and services individuals consume.

Economics is about how society manages its scarce resources, and what the implications are of using different social institutions—for example relying on the market to produce food or having the government provide each of us with a daily ration. The primary focus of economics is understanding the strengths and limitations of markets relative to alternative institutions.

In doing so economics provides an understanding of the effects of government policies and a foundation for determining the appropriate role for government. In other words, Economics examines when government decisions will improve our situation, and when they will not.

2.4 Economics is a Theoretical Science

Economics is a theoretical science. Starting from an assumption regarding human behaviour—that individuals act in a manner consistent with their self-interest—economic theory uses the laws of logic to derive propositions, or make predictions, regarding how individuals will behave in response to changes in their situations. Economics provides a single consistent theoretical framework which can be applied to explain choices and behaviour. The logic of economics provides for clear hypotheses which can be tested against real world experience. For example economic theory suggests that a decrease (increase) in gasoline prices will result in increases (decreases) in the purchases of large cars and sport utility vehicles. This prediction can be tested using statistical methods and the observed behaviour of purchasers of new automobiles.

The economic way of thinking is a powerful tool that can be harnessed to understand the behaviour of individuals and the effects on economic activity of various institutions and government policies. Starting with the simple question "Why is it that way?" economic theory often provides the answer. Indeed so powerful is economic logic that it has been fruitfully applied in areas that are not necessarily considered to be part of the economy. These areas range from politics, law and history, to art, education, health, the environment, crime and language.

2.5 Why Study Economics?

There are five main reasons why you might want to study economics:

  • First, you might want to make society a better place. Life for almost everyone 200 years ago was "brutish, nasty, and short" and for most had always been like this. Even now life is a struggle for most of the Earth's inhabitants. Economics explains why a handful of countries have been able to attain a degree of affluence for most of their citizens that is unparalleled. Fundamentally, the study of economics provides insight into the operation of different social institutions and their effect on resource allocation. By understanding the effects of different institutions, such as alternative government policies or the scope of private property rights, economics provides a basis upon which society can choose institutions and government policies which produce desirable results.

For example, "great experiments" in transforming how society allocates its resources—such as collectivization of farming and central planning in the old Soviet Union—typically involve widespread suppression of markets and are founded on ideologies based on the false and dangerous premise that incentives are irrelevant. Because they ignore basic economics, the human costs of these social reengineering experiments are, tragically, immense. The same lessons, however, apply on a smaller scale and closer to home: for instance the critical shortage of electricity in California in 2000 and 2001 is in no small part due to retail price controls, government fixing the price of electricity instead of letting the price be set by market forces.

As a voter, a leader in the community or a more direct participant in policy making, it is important that you be able to understand and make rational judgements on increasingly complex issues and the potential, as well as the limits, of government policies.

  • Second, studying economics will enhance your employment and career prospects. The undergraduate degrees in economics at the University of Calgary are designed to develop many of the analytical, quantitative, contextual, information and communication skills that are valued by employers.
  • Third, the study of economics will help you understand many important aspects of the world in which you live—from things that affect you directly, such as understanding the factors responsible for the fluctuations in your utility bill, to issues of global importance, such as determining whether population growth is, or is not, a problem.
  • Fourth, the study of economics will make you a more astute participant in the economy. Whether it is making personal decisions such as whether to buy or lease a car, or business decisions such as whether to open a store that exclusively imports audiophile stereo components from the United Kingdom, the study of economics is invaluable for sound decision making. Economics provides the foundation for much of the practice of management, especially the fields of accounting, corporate strategy, finance, and marketing.
  • Fifth, economics is FUN! Economics provides you with a tool kit to solve mysteries and puzzles—explaining why things are as they are.

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