This introduction covers the following topics:
- Economic methodology
- The nature and purpose of economic activity;
- Economic resources;
- Scarcity, choice and the allocation of resources
Economic Methodology
Economics is a social science – it studies human behaviour and interactions.
Similarities and differences in methodology between economics and other sciences:
- Economists cannot easily conduct scientific experiments as is the case for the natural sciences.
- Economists create models and use real-life scenarios to build those models.
- When creating models, economists often assume other factors remain the same. This is the ceteris paribus assumption. Sciences similarly make these kinds of assumptions in experiments on real world data. However economists cannot usually rely on other factors remaining the same when dealing with data about the real economy. To conduct a fair test, you have to keep other factors equal.
Imagine you observed a positive correlation between the number of police in an area and the crime rate in the area. Does that mean that having more police in an area increases the crime rate? If you can answer this question, you can understand why it is difficult to estimate the effects of economic policy (for example, what if the axes were government spending and economic growth rates instead?).
Statements and Judgements
Positive statements are ‘objective’ statements that are testable.
– Example: a rise in the tax rate on cigarettes will reduce demand for cigarettes.
Normative statements are ‘subjective’ statements of opinion, involving value judgements. – Example 1 – the government should ban smoking in public places.
– Example 2 – economic growth is more important than inflation.
Value judgements influence economic decision making and policy. For example a government might choose policies to reduce income inequality, for example higher taxes on the rich, if it believes income inequality is too high.
There are several factors that may influence people’s opinions about policies: 1) the scientific or verifiable (“positive”) consequences, 2) value judgements and 3) political judgements (for example, will a particular policy be popular or win votes).
The nature and purpose of economic activity
The main purpose of economic activity is to satisfy needs and wants.
Key economic questions:
1) What to produce – cars or buses?
- In a “command” economy, the government decides what to produce.
- In a “free-market” economy, the free market (in other words the supply of and demand for goods) decides what gets produced.
- There are also “mixed” economies where both the free market and the government play a role in deciding what to produce.
2) How to produce – should firms use workers or machines for example?
- For example will machines replace some workers in the near future because robots can automate workers’ jobs? Truck driving could well become automated in the next decade for example. See the article here for a deeper discussion on automation in the context of the Covid-19 pandemic.
3) Who is to benefit – those most in need or those who can (or are willing to) pay the most?
- For example, in the free market those who pay the most benefit from the good. In a command economy the government may decide to give everybody the same amount of goods.
- In the UK for example, while most markets are free, there are some markets where provision does not depend on who pays the most. For example the National Health Service provides healthcare that is free at the point of use.
Economic resources
Factors of production are inputs into the production process.
There are four types of factors of production:
Land – physical land as well as natural resources e.g. oil.
Labour – workers and their abilities.
Capital – primarily machinery.
Enterprise – the entrepreneur’s risk-taking, innovation and organisation of other factors of production to form a production process.
The environment
The environment is itself a scarce resource.
• There are non renewable resources that cannot be replenished such as fossil fuels.
• There are renewable resources that can be replenished, for example solar energy.
• However if consumption rises more quickly than the resource can be replenished, then stocks could decline over time. Examples of this could include deforestation of the Amazon rainforest.
Scarcity, choice and the allocation of resources
The basic economic problem is scarcity. There are infinite wants and needs, but only a finite amount of resources.
Scarcity means we have to choose how scarce resources are allocated between different uses. Do we use workers to build skyscrapers, provide financial services, or as teachers?
Choices have an opportunity cost. Opportunity cost means the value of the next best alternative forgone when an economic decision is made.
For example, imagine choosing between watching a movie at the cinema or eating at a restaurant. If you choose the movie, the opportunity cost is the value of eating at a restaurant. Other agents face opportunity costs. The government may have to choose between extra spending on the NHS versus extra spending on schools. Firms may have to choose between buying more machines or hiring more workers.
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