What is Economics?
Ultimately, economics is the study of choice. Because choices range over every imaginable aspect of human experience, so does economics. Economists have investigated the nature of family life, the arts, education, crime, sports, job creation—the list is virtually endless because so much of our lives involves making choices.
How do individuals make choices: Would you like better grades? More time to relax? More time watching movies? Getting better grades probably requires more time studying, and perhaps less relaxation and entertainment. Not only must we make choices as individuals, we must make choices as a society. Do we want a cleaner environment? Faster economic growth? Both may be desirable, but efforts to clean up the environment may conflict with faster economic growth. Society must make choices.
Economics is defined less by the subjects economists investigate than by the way in which economists investigate them. Economists have a way of looking at the world that differs from the way scholars in other disciplines look at the world. It is the economic way of thinking; this unit introduces that way of thinking.
Economics is a social science that examines how people choose among the alternatives available to them. Economics can be described as social because it involves people and their behavior. Economics is also a science because it uses, as much as possible, a scientific approach in its investigation of choices.
- Consumers decide how resources are allocated and what is produced.
- Since resources are limited, people must make choices related to goods and services.
- Scarcity is the condition of not being able to have all of the goods and services one wants because wants exceed what can be made from all available resources at any given time.
- The wealth that an economy generates is made possible by the circular flow of economic activity.
- What kinds of goods and services are required to meet peoples’ needs and a wants?
- What goods will be produced? How will they be produced? For whom will they be produced?
Scarcity, Choice, and Cost
All choices mean that one alternative is selected over another. Selecting among alternatives involves three ideas central to economics: scarcity, choice, and opportunity cost.
Our resources are limited. At any one time, we have only so much land, so many factories, so much oil, so many people. But our wants, our desires for the things that we can produce with those resources, are unlimited. We would always like more and better housing, more and better education—more and better of practically everything.
If our resources were also unlimited, we could say yes to each of our wants—and there would be no economics. Because our resources are limited, we cannot say yes to everything. To say yes to one thing requires that we say no to another. Whether we like it or not, we must make choices.
Our unlimited wants are continually colliding with the limits of our resources, forcing us to pick some activities and to reject others. Scarcity is the condition of having to choose among alternatives. A scarce good is one for which the choice of one alternative requires that another be given up.
Consider a parcel of land. The parcel presents us with several alternative uses. We could build a house on it. We could put a gas station on it. We could create a small park on it. We could leave the land undeveloped in order to be able to make a decision later as to how it should be used.
Suppose we have decided the land should be used for housing. Should it be a large and expensive house or several modest ones? Suppose it is to be a large and expensive house. Who should live in the house? If the Lees live in it, the Nguyens cannot. There are alternative uses of the land both in the sense of the type of use and also in the sense of who gets to use it. The fact that land is scarce means that society must make choices concerning its use.
Virtually everything is scarce. Consider the air we breathe, which is available in huge quantity at no charge to us. Could it possibly be scarce?
The test of whether air is scarce is whether it has alternative uses. What uses can we make of the air? We breathe it. We pollute it when we drive our cars, heat our houses, or operate our factories. In effect, one use of the air is as a garbage dump. We certainly need the air to breathe. But just as certainly, we choose to dump garbage in it. Those two uses are clearly alternatives to each other. The more garbage we dump in the air, the less desirable—and healthy—it will be to breathe. If we decide we want to breathe cleaner air, we must limit the activities that generate pollution. Air is a scarce good because it has alternative uses.
Not all goods, however, confront us with such choices. A free good is one for which the choice of one use does not require that we give up another. One example of a free good is gravity. The fact that gravity is holding you to the earth does not mean that your neighbor is forced to drift up into space! One person’s use of gravity is not an alternative to another person’s use.
There are not many free goods. Outer space, for example, was a free good when the only use we made of it was to gaze at it. But now, our use of space has reached the point where one use can be an alternative to another. Conflicts have already arisen over the allocation of orbital slots for communications satellites. Thus, even parts of outer space are scarce. Space will surely become more scarce as we find new ways to use it. Scarcity characterizes virtually everything. Consequently, the scope of economics is wide indeed.
Video: Scarcity and Markets
Think about scarcity this way. According to the U.S. Bureau of Labor Statistics in 2012, the labor force in the United States contained over 155.5 million workers. Similarly, the total area of the United States is 3,794,101 square miles. These are large numbers for such crucial resources, however, they are limited. Because these resources are limited, so are the numbers of goods and services we can produce with them. Combine this with the fact that human wants seem to be virtually infinite, and you can see why scarcity is a problem.
Click on the links below to see how cities in our area, to include El Paso, have been dealing with water scarcity:
- Does everyone need food to eat?
- Does everyone need a decent place to live?
- Does everyone have access to health care?
Scarcity and the Fundamental Economic Questions
The choices we confront as a result of scarcity raise three sets of issues. Every economy must answer the following questions:
- What should be produced? Using the economy’s scarce resources to produce one thing requires giving up another. Producing better education, for example, may require cutting back on other services, such as health care. A decision to preserve a wilderness area requires giving up other uses of the land. Every society must decide what it will produce with its scarce resources.
- How should goods and services be produced? There are all sorts of choices to be made in determining how goods and services should be produced. Should a firm employ a few skilled or a lot of unskilled workers? Should it produce in its own country or should it use foreign plants? Should manufacturing firms use new or recycled raw materials to make their products?
- For whom should goods and services be produced? If a good or service is produced, a decision must be made about who will get it. A decision to have one person or group receive a good or service usually means it will not be available to someone else. For example, representatives of the poorest nations on earth often complain that energy consumption per person in the United States is 17 times greater than energy consumption per person in the world’s 62 poorest countries. Critics argue that the world’s energy should be more evenly allocated. Should it? That is a “for whom” question.
Every economy must determine what should be produced, how it should be produced, and for whom it should be produced. We shall return to these questions again and again.
It is within the context of scarcity that economists define what is perhaps the most important concept in all of economics, the concept of opportunity cost. Opportunity cost is the value of the best alternative forgone in making any choice.
The opportunity cost to you of reading the remainder of this chapter will be the value of the best other use to which you could have put your time. If you choose to spend $20 on a potted plant, you have simultaneously chosen to give up the benefits of spending the $20 on pizzas or a paperback book or a night at the movies. If the book is the most valuable of those alternatives, then the opportunity cost of the plant is the value of the enjoyment you otherwise expected to receive from the book.
The concept of opportunity cost must not be confused with the purchase price of an item. Consider the cost of a college or university education. That includes the value of the best alternative use of money spent for tuition, fees, and books. But the most important cost of a college education is the value of the forgone alternative uses of time spent studying and attending class instead of using the time in some other endeavor. Students sacrifice that time in hopes of even greater earnings in the future or because they place a value on the opportunity to learn. Or consider the cost of going to the doctor. Part of that cost is the value of the best alternative use of the money required to see the doctor. But, the cost also includes the value of the best alternative use of the time required to see the doctor. The essential thing to see in the concept of opportunity cost is found in the name of the concept. Opportunity cost is the value of the best opportunity forgone in a particular choice. It is not simply the amount spent on that choice.
The concepts of scarcity, choice, and opportunity cost are at the heart of economics. A good is scarce if the choice of one alternative requires that another be given up. The existence of alternative uses forces us to make choices. The opportunity cost of any choice is the value of the best alternative forgone in making it.
Video: I, Pencil
Needs vs. Wants
Consumers may use the terms “needs” and “wants” interchangeably and not realize the subtle differences between them. Needs are a basic requirement for survival and include: food, clothing, and shelter. Wants are a way of expressing those needs. To satisfy the “need” for food, a person may express it as a “want”. For example: I need food, I want pizza. I need clothing, I want Nike tennis shoes. I need shelter, I want to live in a mansion.
There is no such thing as a free lunch!
Resources are limited and everything we do has some cost. The idea of “Buy One, Get One Free” is not actually correct; someone must pay for “the free” one. The cost of the “free” item will get passed on to someone else. For example, if a restaurant is giving away “free appetizers” then the business will need to recover these costs by passing the charges on to other customers by raising prices. Therefore the idea that “there is no such thing as a free lunch” is another way to say that the consumer may not always be getting the great deal that he thinks he is getting because someone always has to pay for the production in the end.
What is scarcity? Can you think of two causes of scarcity?
2. What are the three basic questions that must be asked in relation to economics?
3. List three examples of goods or services that are not scarce.
4. How does scarcity affect you and your life? Provide at least three examples of items that you have had to do without because of limited resources. How did you adjust to this situation? Were you able to find suitable substitutions?
5. Explain the concept of opportunity cost. Explain how opportunity cost affects choices that you make in your own life.