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Economics is the study of how individual and societies choose to use the scarce resources that nature and previous generations have passed to them. In a large measure, it is the behavioral science studying individual choices and more broadly societal choices added up from them. Either you are planning the upcoming holiday against limited time or slicing a gigantic watermelon with several of your siblings, you are doing economics.
You are probably surprised that this brimming page is just a very rough introduction to economics, narrating only on some of the most fundamental terms. Yes, economics has deep roots and close ties in most society problems and global affairs, it also has come a long way with social philosophy, thus bringing about the breadth and depth of this discipline. Anyway, let's first take a brief look at the two major divisions of economics: microeconomics and macroeconomics.
Microeconomics studies behaviors of individual decision makers such as you in a particular market such as that for refrigerator, and their interrelationships. Microeconomics examines the factors that influence individual economic choices and how the choices of various decision makers are coordinated by markets. To illustrate, microeconomics explains how price and quantity supplied for a certain product interact, determine each other and finally come to equilibrium.
Unlike microeconomics that studies particular markets, macroeconomics dedicates itself into the overall behavior and performance of an entire economy. What happens in an economy is the outcome of thousands of millions of individual decisions, and macroeconomics puts all the small pieces that are subjects of microeconomics together to focus on the big picture, as at a national or a global level.
A key assumption for economic analysis is that individuals, be it a person, a family or a firm, tend to make choices and select alternatives rationally, that they believe in their best interest. By rational, economists mean simply that people try to make the best choice they can, given the available information and resource. Uncertainty exists and people do not know what will turn out to be the most self-benefiting, so they simply select the alternatives that they expect to yield them the most satisfaction and happiness or the ones with the highest possibility to achieve it. In general, rational self-interest means that given a certain condition, individuals try to minimize the expected cost for a benefit or maximize the expected benefit with a cost.
Opportunity cost is one of the most frequently used tools for modern economic analysis, deriving many important economic theories and models. It is also a powerful tool in analyzing individual decision-making process. Whoever you are, an individual, a company or a nation, you face opportunity cost when making decisions.
Nearly all decisions involve trade-offs. When we are choosing, we are also giving up. Every action and choice is associated with advantages and disadvantages, costs and gains. A key concept that recurs again and again in analyzing the decision-making process is the notion of opportunity cost. The full cost of making a specific choice is what we give up by not taking the alternative. That which we forgo, when making a choice or decision is called the opportunity cost of the decision. More precisely, opportunity cost is not all that we are not choosing added up, instead, it is the most valued one among all that we let go. Sometimes opportunity cost can be measured in terms of money, although money is usually not the only part of it.
What is the opportunity cost of attending college full time this year? What is the best alternative you give up to attend college? Suppose you have a job that guarantees $24,000 a year, by subtracting your summer part-time earning of $7,000 in college, you know you are giving up net earnings of $24,000 - $7,000 = $17,000 for attending college this year. In addition, you are paying $ 6,000 for tuition, various fees and books, which is unavailable for you (or your family) to spend elsewhere. Thus the opportunity cost of paying for tuition, fees and books is the value of the goods and services that could have purchased with the money. To sum up, by choosing to attend college full time this year, your opportunity cost in money would be a total of $17,000 + $6,000 = $23, 000. However, time spent on lessons may well be over and above that spent on going a routine job, leaving less time for you to go to parties or hanging out with family and friends. So you see, opportunity cost does not solely talk about money, in fact, it is usually bigger than those tangible things that we have forgone in the form of money.
Opportunity cost is subjective. Only the chooser can determine the most attractive alternative for itself from its special point of view. We each has a different list of things valued in decline from top to bottom due to our different aims of life and philosophy. Even for the same activity or good or service, different individuals take it with different opportunity cost.
I started building this website bearing the hope that it would one day become popular so that I could benefit from the commercial value. I made the decision to do this because I believe the other activities I could otherwise be involved in will generate less or no value for me in future as opposed to writing this crash course. Bill Gates, on the contrary, with much more serious and far more profitable business to do, he would have never seen any good in doing this. The opportunity cost he would have to undertake by spending his precious time on this is so huge that it is almost impossible for it to happen to a rational economic man like him.
Nevertheless, the chooser seldom knows the actual value of the second best alternative forgone, since focusing on only the expectedly best alternative makes all other possible alternatives irrelevant. In light of this, you will never know the exact value of what you let go if you give up an evening of pizza and conversation with friends to work on a term paper.
A second key concept used in analyzing choices is the notion of marginalism. In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that is derived directly from, or contingent of the decision. See the example below.
Suppose you live in London and that you were weighing the cost and benefits of visiting a friend in the City of Atlanta. Very luckily you won a free ticket of the Great Atlantic Liner setting out from London to Miami, Florida, and of course you decided to take the journey. In this situation, the cost of visiting your friend in Atlanta would be only the additional, or marginal, time and money spent in order to get Atlanta from Miami.
Economic choices are largely based on a comparison between the expected marginal cost and the expected marginal benefit of the action under consideration. Marginal means incremental, additional, or extra. Rational decision makers will make the choice as long as the expected marginal benefit from the change incurred by the choice exceeds the expected marginal cost. To acquire an intuitive vision of marginalism, refer to the illustration below.
In marginal analysis, one of the concepts that cannot be missed out is sunk cost. Sunk costs are costs that cannot be avoided for any nonzero units of products and that do not change regardless of the quantity of production. As opposed to sunk cost, marginal cost is the cost that is relevant to the quantity produced and that do not occur with a zero production. To simplify, marginal cost is the very cost incurred by one additional unit of production.
Consider the cost of producing a book, say Michael Parkin's Macroeconomics. Assume that 15,000copies are produced. The total cost of producing the copies includes the cost of the authors' time in writing the book, the cost of editing, the cost of making the plates for printing, the cost of the paper and ink, and perhaps the cost of advertising. If the total cost amounts up to $900,000, then the average cost of one copy would be $60.
Suppose a second printing is brought onto agenda. Should another 10,000 copies be produced? In deciding whether to proceed, the costs of writing, editing, making plates, and so forth are irrelevant in that they have already been incurred in the previous 15,000 copies. That is, they are sunk costs.
The questions economics asks and attempts to answer fall into two categories. Positive economics is an assertion about economic reality that can be supported or rejected by reference to the facts. It is used to understand the behavior and operation of economic systems, rather than passing judgments on them. Normative economics reflects opinions and values, judging whether the outcomes are good or bad. Simply speaking, positive economics deal with what is while normative economics is concerned with what should be.
Theories or models are formal conclusions achieved or discovered through scientific procedures. In economic analysis and research though, it is not so "scientific". As in physical experiments, variables and factors can be controlled and manipulated very precisely, enabling you to anticipate almost everything. Economists, nevertheless, do research and perform experiments in a much more complex and unpredictable situation, trying to achieve conclusions primarily by observation. They are unable to control known variables in ways they want them to, not to mention those possibly missed out, scrambling the data or simply misleading them. What physicists discover can be formulated exactly in mathematics as they are in reality, and always correct; whereas things an economist discovers do not always hold true and some of them arouse dispute.
|ENVIRONMENT||Fully controlled||Slightly controlled|
|PRIMARY STRATEGY||Math. induction & deduction||Observation|
|CORRECTNESS||Always true||Not at times|
|UNANIMITY||Yes||Not at times|
Anyway, to study economists problems, economists employ a process of theoretical investigation called the scientific method comprised of 4 steps:
If the answer to step 4 is negative, then either the hypothesis is incorrect or the previous two steps do not go smoothly; otherwise, hypothesis passes the validity test and a theory or model is confirmed.
A model is a formal statement of a theory. No matter what discipline, be it physics, meteorology, astronomy or economics, researchers use models to explain the world, and models are built upon variables. A variable is a measure that can change from time to time or from observation to observation. Price is a variable, it differs from time to time. But why does it alter itself? No, it does not alter itself. That it hardly stay still is because other variables have impacts on it, either positive or negative, linear or nonlinear. The real world is so complex that we just cannot make out all the variables that govern it, but abstract some of them, to put together a model. In this sense, models are all simplifications, stripping away detail to expose only those that are important to the question being asked. An intuitive example of modeling is the charting of a map. Most maps are two-dimensional representations of a three-dimensional world, showing only things we are concerned about, omitting pretty much of the geographical details.
Now we know what a variable is and why a model is different from the real world. But how exactly it is built? One of the techniques, or scientific methods, is the device of All Else Equal, or ceteris paribus. Very handy it is when we try to isolate the impact of one single factor upon something. What is the impact of a 10% rise in gasoline price on driving behaviors, ceteris paribus, or assuming that nothing else changes? We can tell that a reduction in driving occurs, but how much less, assuming no simultaneous change in other related things, income, number of children, population, laws and so forth?
In a word, the concept helps us simplify reality in order to focus on the relationships that we are interested in. We can then delve into the relationship between just two variables by simply assuming that all else remain intact during any procedure.
Economists literally find 3 means to represent a model or convey an economic idea, words, graphs, and equations. Pros and cons exist for each of them. Words convey simple ideas effectively, but not adequate for multi-variable models or two-variable model that is to show the mathematical nature of the quantitative relationship. Graphs do this job intuitively, and in a more specific as well as accurate way. It does not only give you the big picture, but also shows you what it is like at a specific point. Equations are not used as frequently as the former two, but presents us the underlying process, so more suitable for in-depth research and modeling. Below is a graph depicting the demand curve how Matthew responds to telephone price changes.
Theories and models are positive statements, helping us understand the mechanism of the world, but the formulation of economic policy requires a second step, the step to further these theories and models into practice to get to what we think it should be. What are the objectives? How to define better, that is what changes to our situation are positive? Do we better off or worse off? Four criteria are frequently applied in making these judgments:
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