What is Economics? – Foundations of Microeconomics

What is Economics?

Introduction to Economics

Economics is the social science that studies how individuals, businesses, governments, and societies make choices to cope with scarcity and the incentives that influence and reconcile those choices. All economic questions arise because resources are limited and human wants are unlimited, leading to the fundamental problem of scarcity.

• Scarcity: The condition in which human wants exceed the resources available to satisfy them.

• Choice: Because of scarcity, individuals and societies must make choices about how to allocate resources.

• Incentive: A reward or penalty that motivates or discourages an action.

Branches of Economics

• Microeconomics: The study of choices made by individuals and businesses, the way these choices interact in markets, and the influence of governments. Examples: Why are people streaming more movies? Would a tax on online shopping affect Amazon?

• Macroeconomics: The study of the performance of the national and global economies. Examples: Why does the unemployment rate fluctuate? Can the Federal Reserve reduce unemployment by keeping interest rates low?

Key Ideas in the Economic Way of Thinking

Six Key Ideas

The economic way of thinking is defined by six key ideas:

• A choice is a tradeoff: Every choice involves giving up something to get something else.

• People make rational choices by comparing benefits and costs: Rational choices maximize the net benefit to the decision-maker.

• Benefit: The gain or pleasure that something brings, determined by preferences.

• Cost: What you must give up to get something; specifically, the opportunity cost is the highest-valued alternative forgone.

• Most choices are "how-much" choices made at the margin: Decisions are often about how much more or less to do of something.

• Choices respond to incentives: Changes in costs or benefits alter the incentives and thus the choices people make.

Tradeoffs and Opportunity Cost

Every choice involves a tradeoff. The opportunity cost of an action is the value of the next best alternative forgone.

• Example: The opportunity cost of attending a concert includes both the money spent on the ticket and the value of what you could have done with your time instead.

Marginal Analysis

Many decisions are not all-or-nothing but involve marginal choices—deciding how much more or less to do of something.

• Marginal Benefit: The additional benefit from a small increase in an activity.

• Marginal Cost: The additional cost from a small increase in an activity.

• Rational Choice: If the marginal benefit exceeds the marginal cost, it is rational to do more of the activity.

Incentives

Incentives are central to economic analysis. A change in marginal cost or benefit changes the incentives and thus the choices people make. Incentives help reconcile self-interest with the social interest.

Economics as a Social Science and Policy Tool

Positive vs. Normative Statements

• Positive Statement: A statement that can be tested by checking it against facts (describes "what is").

• Normative Statement: A statement that expresses an opinion and cannot be tested (describes "what ought to be").

Economic Models and Methods

Economists use models to simplify and understand the economic world. A model includes only the features necessary for the purpose at hand. Models are tested by comparing their predictions with real-world data, using:

• Natural experiments

• Statistical investigations

• Economic experiments

Economist as Policy Adviser

Economics provides a toolkit for advising governments, businesses, and individuals. While economics cannot determine goals (normative), it can help evaluate alternative solutions for achieving a given goal by comparing marginal benefits and marginal costs.