Making Sense of Economics

                Economics is a behavioral or social science that studies how people and
societies make choices or decisions that allow them to get the most out of their limited
resources. In large measure, it is the study of how people make choices. The choices
that people make, when added up, translate into societal choices.  Since every country,
every business, and every person has to deal with constraints, economics is literally
everywhere. For instance, you could be doing something else right now besides reading
this book. You could be exercising, watching a movie, or talking with a friend. You
should only be reading this book if doing so is the best possible use of your very limited
time. In the same way, you should hope that the paper and ink used to make this book
have been put to their best use and that every last tax dollar that your government
spends is being used in the best way. Economics gets to the heart of these issues,
analyzing the behavior of individuals and firms, as well as social and political
institutions, to see how well they convert humanity’s limited resources into the goods
and services that best satisfy human wants and desires.
 
Scarcity: The Basic Economic Problem
            Economics studies how people allocate scarce resources to satisfy as many of
their wants and desires as possible. By trying to make a profit, businesses turn the
scarce resources into the goods that satisfy those wants and desires. Businesses that
make lots of profit are providing the goods and services that people value the most.
            Scarcity refers to situations where the wants exceed the means. In economics,
the wants are usually restricted to human wants, and means include the resources and
goods that contribute to fulfilling these wants. The reference to wants implies that
scarcity has its origin in human physiology as well as psychology. The human
metabolism requires a certain intake of energy in order to function and, if food intake
falls below a certain threshold, human beings cannot develop and will eventually
become sick and die. These physiological wants can be called objective, and their
fulfillment is indispensable for life. However, a lot of wants are not of this type. Fast
cars, big houses, and fancy clothes are not necessary for healthy survival but are
merely pleasant. These wants can be called subjective.
               Economics is the study of how individuals and societies manage goods and
resources, which can be objectively as well as subjectively scarce.  Scarcity is the
fundamental and unavoidable phenomenon that creates a need for the science of
economics: There isn’t nearly enough time or stuff to satisfy all desires, so people have
to make hard choices about what to produce and consume so that if they can’t have
everything, they at least have the best that was possible under the circumstances.
Without scarcity of time, scarcity of resources, scarcity of information, scarcity of
consumable goods, and scarcity of peace and goodwill on Earth, human beings would
lack for nothing.
              Economists analyze the decisions people make about how to best maximize
human happiness in a world of scarcity. That process turns out to be intimately
connected with a phenomenon known as diminishing returns, which describes the sad
fact that each additional amount of a resource that’s thrown at a production process
brings forth successively smaller amounts of output.
            The basic economic problem — scarcity of resources versus virtually unlimited
human wants and desires — requires all societies to determine how to allocate scarce
resources among competing uses. However, different methods are used to determine
this resource allocation with the most common methods involving markets, government,
or some combination of both. In a market economy, the production and distribution of
goods are undertaken by firms. Since firms are economic entities, they are best
analyzed with economic theory.
 
Microeconomics and Macroeconomics
Microeconomics focuses on individual people and individual businesses. For
individuals, it explains how they behave when faced with decisions about where to
spend their money or how to invest their savings. For businesses, it explains how profit-
maximizing firms behave individually, as well as when competing against each other in
markets. Firms’ choices about what to produce and how much to charge and
households’ choices about what and how much to buy help to explain why the economy
produces the goods and services it does. Another big question addressed by
microeconomics is who gets the goods and services that are produced. Wealthy
households get more than poor households, and the forces that determine this
distribution of output are the province of microeconomics. Why does poverty exist? Who
is poor? Why do some jobs pay more than others? Think again about what you
consume in a day, and then think back to that view over a big city. Somebody decided
to build those factories. Somebody decided to construct the roads, build the housing,
produce the cars, and smoke the bacon. Why? What is going on in all those buildings?
It is easy to see that understanding individual microdecisions is very important to any
understanding of society.
  Macroeconomics looks at the economy as an organic whole, concentrating on
factors such as interest rates, inflation, and unemployment. It also encompasses the
study of economic growth and the methods governments use to try to moderate the
harm caused by recessions.  Instead of trying to understand what determines the output
of a single firm or industry or what the consumption patterns are of a single household
or group of households, macroeconomics examines the factors that determine national
output, or national product. Microeconomics is concerned with household income;
macroeconomics deals with national income.
Whereas microeconomics focuses on individual product prices and relative
prices, macroeconomics looks at the overall price level and how quickly (or slowly) it is
rising (or falling). Microeconomics questions how many people will be hired (or fired)
this year in a particular industry or in a certain geographic area and focuses on the
factors that determine how much labor a firm or an industry will hire. Macroeconomics
deals with aggregate employment and unemployment: how many jobs exist in the
economy as a whole and how many people who are willing to work are not able to find
work.
Macroeconomics looks at the economy as an organic whole, concentrating on
factors such as interest rates, inflation, and unemployment. It also encompasses the
study of economic growth and the methods governments use to try to moderate the
harm caused by recessions.
 
Three Basic Economic Questions

  Knowing the definition of economics, let’s proceed to the three basic economic
questions.  Every society, no matter how small or large, has a system or process that
works to transform the resources that nature and previous generations provide into a
useful form. Economics is the study of that process and its outcomes. The three basic
questions that must be answered to understand the functioning of the economic system
are: a) What gets produced? b) How is it produced? c) Who gets what is produced?
The starting point is the presumption that human wants are unlimited but resources are
not. Limited or scarce resources force individuals and societies to choose among
competing uses of resources—alternative combinations of produced goods and
services—and among alternative final distributions of what is produced among
households. These questions are positive or descriptive. That is, they ask how the
system functions without passing judgment about whether the result is good or bad.
They must be answered first before we ask more normative questions such as:
      Is the outcome good or bad?
      Can it be improved?

The term resources is very broad.  Some resources are the products of nature:
land, wildlife, fertile soil, minerals, timber, energy, and even the rain and wind. In
addition, the resources available to an economy include things such as buildings and
equipment that have been produced in the past but are now being used to produce
other things. Perhaps the most important resource of a society is its human workforce
with people’s talents, skills, and knowledge. Things that are produced and then used in
the production of other goods and services are called capital resources, or simply
capital. Buildings, equipment, desks, chairs, software, roads, bridges, and highways are
a part of the nation’s stock of capital. The basic resources available to a society are
often referred to as factors of production or simply factors. The three key factors of
production are land, labor, and capital. The process that transforms scarce resources
into useful goods and services is called production. In many societies, most of the
production of goods and services is done by private firms.
Private airlines in the United States use land (runways), labor (pilots and
mechanics), and capital (airplanes) to produce transportation services. But in all
societies, some production is done by the public sector or government. Examples of
government-produced or government-provided goods and services include national
defense, public education, police protection, and fire protection. Resources or factors of
production are the inputs into the process of production; goods and services of value to
households are the outputs of the process of production.
 
The  Concept of Opportunity Cost
The concepts of constrained choice and scarcity are central to the discipline of
economics. They can be applied when discussing the behavior of individuals and when
analyzing the behavior of large groups of people in complex societies. Given the
scarcity of time and resources, if you decide to watch a movie, you will have less time to
study. You face a trade-off between these two activities.   If you have Php150, you need
to make a choice on where you want to spend this amount.  If you spend this to milk
tea, then you can’t buy any more pizza. If you will not attend the class, then you have
more time to sleep. The best alternative that we give up, or forgo when we make a
choice is the opportunity cost of that choice.  In making everyday decisions, it is often
helpful to think about opportunity costs. Should you go to the dorm party or not?  When
you pay money for anything, you give up the other things you could have bought with
that money. Second, it costs 2 or 3 hours. Time is a valuable commodity for a college
student. You have exams next week, and you need to study. You could go to a movie
instead of the party. You could go to another party. You could sleep. Hence,  you must
weigh the value of the fun you may have at the party against everything else you might
otherwise do with the time and money.  
 
The Production Possibility Frontier
A simple graphic device called the production possibility frontier (PPF ) illustrates
the principles of constrained choice, opportunity cost, and scarcity. The PPF is a graph
that shows all the combinations of goods and services that can be produced if all of a
society’s resources are used efficiently. The figure below shows a PPF for a
hypothetical economy. On the Y-axis, we measure the quantity of capital goods
produced. On the X-axis, we measure the quantity of consumer goods. All points below
and to the left of the curve (the shaded area) represent combinations of capital and
consumer goods that are possible for the society given the resources available and
existing technology. Points above and to the right of the curve, such as point G,
represent combinations that cannot be reached. If an economy were to end up at point
A on the graph, it would be producing no consumer goods at all; all resources would be
used for the production of capital. If an economy were to end up at point B, it would be
devoting all its resources to the production of consumer goods and none of its
resources to the formation of capital. While all economies produce some of each kind of
good, different economies emphasize different things. About 17.1% of gross output in
the United States in 2005 was new capital. In Japan, capital historically accounted for a
much higher percentage of gross output, while in the Congo, the figure was 7%. Japan
is closer to point A on its PPF, the Congo is closer to B, and the United States is
somewhere in between.
Points that are actually on the PPF are points of both full resource employment
and production efficiency. An efficient economy is one that produces the things that
people want at the least cost. Production efficiency is a state in which a given mix of
outputs is produced at the least cost.) Resources are not going unused, and there is no
waste. Points that lie within the shaded area but that are not on the frontier represent
either unemployment of resources or production inefficiency. An economy producing at
point D in Figure 2.5 can produce more capital goods and more consumer goods, for
example, by moving to point E. This is possible because resources are not fully
employed at point D or are not being used efficiently.