Economics: Defining Economics

+

02/07/2012

~ Michael97

+

• View all learner reviews »

Students sometimes begin the economic course with a misperception, and that is that economics is about money. Absolutely not! Economics is a much broader set of tools that can apply to all kinds of decisions that you make in daily life. The definition of economics is this: economics is the study of rational choice under conditions of scarcity. That definition has two terms in it that are key. The first is scarcity. Scarcity means an imbalance between the amount of something that people want and the amount that's freely available. One of the best ways to come to grips with the concept of scarcity is to try to imagine something that isn't scarce. What would that be? Sometimes students suggest air isn't scarce; it's all around us. Yes, but the kind of air that people want, clean, breathable air, is certainly scarce, and especially scarce in cities with a lot of pollution. At one point in Tokyo there were vending machines on the street where people would insert a coin to buy a breath of breathable, clean air. In that case, air was scarce. There was an imbalance. People wanted more of it than there was freely available.
Well, what about space? There seems to be plenty of space. Yes, but there's not a lot of space in cities. There's less space in your dorm room than you'd want. All this stuff has to be parceled out because there isn't as much as people would like to have it were freely available.
What about garbage? There seems to be plenty of garbage; no scarcity of garbage. Aha! But see, that's where the definition comes into play. It's not that there is an infinite amount of garbage. There is a strictly limited amount of garbage. The reason garbage is not scarce is that nobody wants it. Scarcity is an imbalance between the amount of something that people want and the amount of that good that is freely available. Anytime something is scarce we've got to figure out how to use it, how to share it, how to parcel it out among its competing uses, and that requires some kind of decision, some kind of choice, and that leads us to the second term - rational choice.
Rational choice, or the word "rationality," in economics, refers to people making calculated, self-interested decisions. It requires that you be willing to consider costs and benefits, all of the factors that are involved in a decision, and choose that course of action that is most satisfying to you, the one that maximizes your wealth, the one that maximizes your company's profits, the one that maximizes your satisfaction from the way you use your limited income or your limited amount of time. We say that an agent is rational if that agent considers cause and effect; if that agent considers the consequences of his or her choices and chooses those courses of action that provide the most satisfaction. Rational choice is calculated self-interest.
So if we have calculated, self-interested people operating in a situation of scarcity, then we've got economics. One example of this is the concept of opportunity cost. We imagine that when people make a choice they consider the opportunity cost of that choice. The opportunity cost of a choice is the best alternative you give up when you make that choice. For instance, if you go to your economics class one morning, the best alternative might have been an extra hour's worth of sleep. Rather than staying in bed and sleeping, you chose to come to your economics class instead. Your sleep was the opportunity cost of your choice. If you are enrolled in college this year, you're getting a good education, which might be satisfying in its own right. It may also be that that education is your key to a higher salary that leads to more goods and services in the future. But the opportunity cost of those goods and services in the future, and the satisfaction of your expanded mind, is the money that you're not making now, and all of the toys that you could be buying with the income that you're giving up. Because you're in school you aren't holding down a job with all the time that you are using studying and attending classes. The time away from work is lost income, lost goods and services, and lost satisfaction. So the opportunity cost of your investment in your future is the present satisfaction you can get from a higher paycheck. There's an opportunity cost.
There's no such thing as a free lunch. Anything that you enjoy, you enjoy at the cost of giving up something else. If you enjoy driving a pick-up, the opportunity cost is you're not driving a Volkswagen that day. If you enjoy a vacation to the Bahamas, your opportunity cost might be a trip to California. Every choice you make involves an opportunity that you don't choose.
Well, what does this have to do with money? Not very much. You see, the point is, economics is not about money; economics is about analyzing the way people make choices in conditions of scarcity. We can make predictions about how you choose to use your time between studying, working, playing, spending time with friends. We can come up with an economic model that predicts the way you'll respond if we know enough about your preferences, your abilities, and the constraints that are put on you from the outside. We can also come up with economic models of who people choose to marry, economic models of when countries go to war. There are even economic models of which religions people choose to affiliate with. One economist has even suggested that you can come up with an economic model of who chooses to commit suicide as an economic calculation if the costs and the benefits are aligned properly, people just choose to checkout. Now, some people are offended by this. They think, "Well, why should we have an economic model of these very personal things?" And maybe you're right, but the point is economics is a very flexible set of tools, and it seeks to apply itself anywhere rational agents are operating in a situation of scarcity; anywhere that there are goods and services that are strictly limited, that have to be shared in some way.
In the next lecture we'll look at another definition of economics, one that has to do with value, and this might seem a little more applicable to business.
Introduction to Economics
The Basics of Economics
Defining Economics Page [2 of 2]