Economics is a study of rationing systems. It is the study of how scarce resources are allocated to fulfill the infinite wants of consumers. In other words, Economics studies the allocation of scarce resources among people— examining what goods and services wind up in the hands of which people.
To the economist, all goods and services that have a price are relatively scarce. This means that they are scarce relative to people’s demand for them. It may seem that, in your town or city, cars are not scarce as there are a great number of them around.
However, it is certain that not everyone who would like a car in your area has one, usually because they cannot afford to buy a car. Their ability to purchase a car is affected by the amount of money they have and the price of the car, so the price is being used to ration the cars that are available. Any good or service that has a price, and is thus being rationed, is known as an economic good.
The term “scarcity” has a particular meaning in economics that is different from the way that the word is used in everyday life. A normal person would not say that cars were scarce in Mexico City, but an economist would be happy to state that they were relatively scarce.
Since people do not have infinite incomes, they need to make choices whenever they purchase goods and services. They have to decide how to allocate their limited financial resources and so always need to choose between alternatives. This leads to one of the key concepts of economics.
The Basic Economic Problem
We have already seen that resources are relatively scarce and wants are infinite, which leads to choices to be made. These choices are often expressed in terms of three questions and represent the basic economic problem. The questions are:
- What should be produced and in what quantities? Using these scarce resources, how many computers should be produced, how many bicycles, how much wheat, and how much milk? This has to be decided for all economic goods.
- How should things be produced? There are many different ways of producing things and there are different combinations of resources that may be used in production. Should sports shoes be produced by an automated production line or by manual workers? Should crops be grown with high usage of fertilizer or organically?
- Who should things be produced for? Should they go to those who can afford them or be shared out in some “fair” manner? How will the total income (the national income) of the economy be distributed? Will teachers get higher incomes than nurses?
Economics is a Social Science
Economics is a social science, which is a study of people in society and how they interact with each other. Other social sciences include sociology, political science, psychology, anthropology, and history.
How is Economics Used?
The economic analysis serves two main purposes. The first is to understand how goods and services, the scarce resources of the economy, are actually allocated in practice.
This is a positive analysis, like the study of electromagnetism or molecular biology; it aims to understand the world without value judgments. The development of this positive theory, however, suggests other uses for economics.
Economic analysis can predict how changes in laws, rules, and other government policies will affect people and whether these changes are socially beneficial on balance.
Such predictions combine positive analysis— predicting the effects of changes in rules—with studies that make value judgments known as normative analyses. For example, a gasoline tax to build highways harms gasoline buyers (who pay higher prices) but helps drivers (by improving the transportation system).
Since drivers and gasoline buyers are typically the same people, a normative analysis suggests that everyone will benefit. Policies that benefit everyone are relatively uncontroversial.
In contrast, cost-benefit analysis weighs the gains and losses to different individuals to determine changes that provide greater benefits than harm. For example, a property tax to build a local park creates a benefit to park users but harms property owners who pay the tax.
Not everyone benefits since some taxpayers don’t use the park. Cost-benefit analysis weighs the costs against the benefits to determine if the policy is beneficial on balance. In the case of the park, the costs are readily measured in monetary terms by the size of the tax.