1.1 What Is Economics?
If you’re typical of students taking a first course in economics, you might be wondering exactly what economics is. Economics The study of how society manages its scarce resources to satisfy its wants. is the study of how society manages its scarce resources to satisfy its wants. An economy’s resources Items such as land, labor power, raw materials, fuel, factories, machinery, and people’s skills that a society uses to create goods and services. include land, labor power, raw materials, fuel, and factories and machinery (which economists generally call capital). But they also include people’s time, talent, knowledge, willingness to take risks, and uncountable other traits and abilities that can be used to help meet society’s desires.
Economics is often used to explain business-related questions, including why interest rates change and what price a firm should charge for its products. But the tools of economics can also be used to answer more arcane (but no less interesting) questions that aren’t directly related to business. For example, why do people who buy expensive gym memberships often fail to use them? Why do tall people tend to earn more than shorter people? Is online social networking a valuable activity or a big waste of time?
Economics has a reputation for being a difficult and abstract subject, but it can be clear, fascinating, and fun. Throughout this book, you’ll tear apart social problems using a small but powerful economics toolkit. You will discover that many of society’s big issues—like global warming, the shortage of organ donors, and economic recessions—have remarkably similar origins.
Key Features of an Economy
No matter how commonplace or how unusual they are, the topics that economists study all relate in some way to the overall functioning of the economy. But what exactly do we mean by “the economy”? If you spend a lot of time watching TV news channels, you might have a sense of “the economy” as some vaguely-defined entity whose performance is measured by job creation and the behavior of the stock market
But “the economy” encompasses much more than just those things. An economy A type of organization that produces goods and services and then allocates those goods and services to its members. is simply some type of organization that produces goods and services and then allocates those goods and services to its members. Economies can be small organizations, such as households, whose job might be to grow a garden to produce vegetables—vegetables that will eventually be transformed into a hearty stew to be ladled out into everyone’s bowl come December. In fact, the word economy comes from the Greek oikonomia, which translates roughly as “household management.” Economies can be big organizations, too, like the United States, the European Union, or the Pacific Rim, each of which produces hundreds of thousands of different goods and services. In each of these larger economies, just as in households, you’ll find legal and cultural conventions that determine how production and distribution decisions will be made.
The Count of Monte Cristo and the Meaning of Economics
Edmond Dantes, wrongfully imprisoned in the Chateau d’If, begins to dig an escape tunnel. In the meantime, he takes advantage of a long imprisonment to improve himself. His starting point? Learning economics from the world’s first textbook, Adam Smith’s Wealth of Nations.
The Two Key Questions Every Economy Must Answer: What Gets Produced? And for Whom?
Whether an economy is as big as a continent or as small as a household, it needs to address these two questions:
In the United States, we generally let the market system decide what is going to be produced and how to distribute goods. The market system A form of economic organization in which individual buyers and sellers are free to exchange goods and services. is a form of economic organization in which individual buyers and sellers are free to exchange goods and services. In a market system, the ultimate decision about what to produce is left to sellers. But sellers do not make that decision in a vacuum; they must satisfy the tastes of buyers if they hope to earn a living. Once goods and services have been produced, they are given only to the buyers who are willing and able to pay for them. This means that the only people who end up getting plaid sweaters are the people who buy them . . . or who receive them as birthday presents.
In the market system, sellers must also decide how to produce the things they’ve decided to make. In other words, sellers determine what resources will be used. Will a furniture maker, for example, build tables and chairs by hand, using only a primitive set of tools? Or will he build those things using a lot of expensive power tools and a relatively small amount of human power? Choosing the right mixture of labor and machinery will help the furniture maker increase his profits and remain competitive in the furniture market.
Markets are only one mechanism society might use to answer the two key questions of what goods to produce and how to distribute them. For example, in North Korea, most decisions about what (and how) to produce are not made by markets but are instead made by a dictator. Economies where production and distribution decisions are made by government are called command economies An economy where the government makes production and distribution decisions. . Do you think it’s a bad thing to have a dictator making such important decisions on behalf of society? There are plenty of reasons you might think so, but before rushing to judgment, consider that sometimes command can be a highly effective way to organize production and distribution. This is often true for household-sized economies: If every family decision were open to debate by every family member, you’d spend every waking moment in family meetings, and very little would get done. And sometimes things need to be done quickly. This is why so many children’s “Why?” questions are answered by their parents with “Because I said so. Now get moving!”
Every household is a small economy that must decide what to produce and how to distribute what it’s made. Sometimes decisions in the household are made collectively, but sometimes households more closely resemble command economies.
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Just as a command can be used to mobilize households, it can also be used to mobilize nations. That’s not always a blessing, but sometimes the ability to say “Because I said so” enables leaders to accomplish extraordinary things that might never be achieved if left to private initiative. It was a series of “Because I said so” orders, for example, that mobilized the labor necessary to build the 13,000 miles of the Great Wall of China, an architectural marvel of such tremendous scale that it is visible from outer space.
Most economies today are neither purely market economies nor purely command economies. Instead, they are hybrids where buyers and sellers make some production decisions and governments make others. Economies like this are called mixed economies Economies where buyers and sellers make some production decisions and governments make others. . Different economies have different mixtures of market and governmental decision making. In the United States, which is fairly market oriented, private firms decide how many shoes, tablet computers, and loaves of bread to produce. The government, on the other hand, generally decides how many miles of highway to build, how many schools to staff, and how many post offices to operate. In more centralized economies, government is responsible for either directly providing or for planning the production of goods and services that the United States leaves to private individuals or firms, like electricity and telephone service, health care services, and food.