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BASICS OF ECONOMICS
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What is economics
• All societies face the economic problem, which is the
problem of how to make the best use of limited, or scarce,
resources. The economic problem exists because, although
the needs and wants of people are endless, the resources
available to satisfy needs and wants are limited.
• Economics is the study of how societies use scarce resources
to produce valuable commodities and distribute them among different people.
• Behind this definition are two key ideas in economics: that goods are scarce and that society must use its
resources efficiently. Indeed, economics is an important subject because of the fact of scarcity and the
desire for efficiency.
Importance of economics
Examples of Importance of Economics:
• Dealing with a shortage of raw materials: Economics provides a
mechanism for looking at possible consequences as we run short of
raw materials such as gas and oil.
• How to distribute resources in society? To what extent should we
redistribute income in society? Is inequality necessary to create
economic incentives or does inequality create unnecessary economic
and social problems?
• To what extent should the government intervene in the economy Free market economists, like Friedrich
Hayek and Milton Friedman, argue for limited government intervention and free markets. Other
economists, like Joseph Stiglitz or Paul Krugman, argue government intervention can overcome inequality
and the underprovision of public goods. For example – should the government provide health care free at
the point of use or is it more efficient to encourage private health care?
• The principle of opportunity cost: Politicians win elections by promising more spending and cutting taxes.
This is because lower taxes and more spending is what voters want to hear. However, an economist will
be aware that everything has an opportunity cost. Spend more on subsidising free university education,
and it means higher taxes and lower spending elsewhere. Is it the best use of public money? Are there
better uses of money, such as spending on primary education?
• Social efficiency: For example, driving into the centre of town creates negative externalities such as
pollution and congestion. There is overconsumption. An economist can suggest a tax on driving into towns
to internalise the externality.
• Knowledge and understanding: One of the principal jobs for economists is to understand what is
happening in the economy and investigate reasons for poverty, unemployment and low economic growth.
• Forecasts: Economic forecasts are more difficult than understanding the current situation. However,
although forecasts are not always reliable, they can help give decision-makers an idea of possible
outcomes.
• How to deal with an economic crisis? In the 1930s, the Wall Street Crash precipitated a significant rise in
unemployment. There was a debate on how to respond. Many western governments increased taxes,
tariffs and benefits. This response caused John M. Keynes to develop a new branch of economics – focused
on dealing with persistent recession.
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• Behavioural economics: Why do people behave as they do? Can governments subtly nudge people into
better behaviour, e.g. banning cigarette advertising? Are we subject to bias and irrational behaviour? For
example, can we be sucked along by a bubble and lose a fortune on the stock market?
• Applying economics in everyday life: Modern economists have examined economic forces behind
everyday social issues. For example, Gary Becker argued that most crime could be explained by economic
costs and benefits.
• What is the purpose of this army of economists measuring, analyzing, and calculating The ultimate goal of
economic science is to improve the living conditions of people in their everyday lives. Increasing the gross
domestic product is not just a numbers game. Higher incomes mean good food, warm houses, and hot
water. They mean safe drinking water and inoculations against the perennial plagues of humanity.
