Principles of Economics

I admit that I have a limited education in economics compared to real economists, but most of my friends know even less than I do, so I thought a few posts on the subject could be interesting. However, economics is called "the dismal science," and cynics say that economists "know the price of everything and the value of nothing," so to make my explanation more enjoyable I made it... silly.

Economics is ultimately all about the allocation of resources, because everything from metals to energy to mangoes is finite, and what we want far exceeds what we each could have. To understand the allocation of resources, economists have come up with all kinds of definitions for specific aspects of this process. For instance, the fact that resources are finite while desires are infinite is called scarcity. For a very long time the way this was dealt with was that whatever you could produce was yours, and you could trade it for things that other people produced, which is of course called the bartering system. Eventually your efforts were rewarded with bits of shiny metals with some guy's face stamped on them, and this system is called price rationing. Up until recently, if you were living in certain areas there would be no reward for your production, and instead you would get a share of total production, which we call communism but economists called central planning. Today we still use price rationing, although modern money is made out of paper, the person depicted is often dead, and on Canadian $5 bills there are kids playing hockey.

But I'm not done defining yet. In an earlier post I mentioned opportunity cost, but I'll define it again as the specific cost resulting from a choice. In our system, every resource that has an opportunity cost associated with it has a price. Things like air and water are free because you don't have to give up beer to have air, but because pollution has an opportunity cost, clean air and water are not free. In fact, if you pay taxes then you're paying to keep air and water clean. Resources that you can hug, lick, and generally touch are called goods, such as steel and teddy bears, whereas resources like banking are called services. You cannot lick your bank account, and if you lick an ATM you will probably get sick. The sum of our general transactions for a given resource is a market, and a bunch of markets and some policy wonks form an economy.

In economic theory, demand and supply govern the functioning of a market. Apple products are in high demand, so although I'm not entirely sure why they are they all cost hundreds of dollars. Teddy bears, however, are in high supply, so they're fairly cheap. In reality, you can't measure demand and supply, and not many people apply economic theory to their weekly grocery shopping. Incentives explain the everyday choices that we make, and they are a very important part of economics because they bridge the gap between theory and reality. As you may have started to see, economics is involved in every aspect of our lives because it can be defined extremely broadly.

The study of incentives, called behavioral economics, is closely related to psychology, while international trade combines law, politics, and finance. Unfortunately the broader your scope, the less accurate you'll be when it comes to specifics, which is why the study of human behavior is better left to psychologists and the running of businesses is better taught in business classes. What economics does is that it ties all these different areas together to explain the very simple concept of resource allocation, but its study is important because resource allocation is so complicated. And ultimately, no matter what you think of economics, you have to acknowledge its importance.