The Economic Approach
Scarcity and choice are the two essential ingredients of an economic
topic. Goods are scarce because desire for them far outstrips
their availability from Nature. Since scarcity prevents us from
having as much of everything as we would like, we must choose
among the alter natives available to us. Any choice involving
the use of scarce resources requires an economic decision.
Scarcity and poverty are not the same thing. Absence of poverty implies
that some basic level of need has been met. Absence of scarcity
would mean that all of our desires for goods have been met. We
may someday be able to eliminate poverty, but scarcity will
always be with us.
Economics is a method of approach, a way of thinking. The economic way of
thinking emphasizes the following:
(a) Among economic goods, there are no free lunches. Someone must give up
something if we are to have more scarce goods.
(b) Individuals make decisions purposefully, always seeking to choose the
option they expect to be most consistent with their personal
goals. Purposeful decision-making leads to economizing
behavior.
(c) Incentives matter. People will be more likely to choose an option 'as
the benefits expected from that option increase. In contrast,
higher costs will make an alternative less attractive, reducing
the likelihood that it will be chosen.
(d) Marginal costs and marginal benefits (utility) are fundamental to
economizing behavior. Economic reasoning focuses on the impact
of marginal changes.
(e) Since information is scarce, uncertainty will be present when
decisions are made.
(f) In addition to their initial impact, economic events often alter
personal incentives in a manner that leads to important
secondary effects that may be felt only with the passage of
time. (g) The value of a good or service is subjective, and will
differ among individuals.
(h) The test of an economic theory is its ability to predict and to
explain events in the real world.
Economic science is positive. It attempts to explain the actual
consequences of economic actions and alternative policies.
Positive economics alone does not state that one policy is
superior to another Normative economics is advocative; using
value judgments, it makes suggestions about "what ought to
be."
Testing economic theory is not an easy task. When several economic
variables change simultaneously, it is often difficult to
determine the relative importance of each. The direction of
economic causation is sometimes difficult to ascertain.
Economists consult economic theory as a guide and use
statistical techniques as tools to improve our knowledge of
positive economics.
Microeconomics focuses on narrowly defined units, such as individual
consumers or business firms. Macroeconomics is concerned with
highly aggregated units, such as the markets for labor or goods
and services When shifting focus from micro- to macrounits, one
must be careful not to commit the fallacy of composition. Both
micro- and macroeconomics use the same postulates and tools. The
level of aggregation is the distinction between the two.
The origin of economics as a systematic method of analysis dates back to
the publication The Wealth of Nations by Adams Smith in 1776.
Even though legal restraints on wealth would increase if
individuals were left free to work, produce, and exchange goods
and services. Smith believed that individuals pursuing their own
interests would be led by the "invisible hand" of
market incentives (prices) to employ their productive talents in
a manner "most advantageous to the society." Smith's
central message is that when markets are free- when there are no
legal restraints limiting the entry of
producer-sellers--individual self-interest and the public
interest are brought into harmony.
