Today we are going to be discussing economics. Although economics seems like a very complicated topic, when broken down, it really is just a way to help us make decisions. And all the jargon and complicated charts are just ways to explain all of the concepts that come with it. When you’ve completed this course you will be better at making decisions! I hope you enjoy it!
Some of you may be unclear about what economics is. First off, economics is not the study of how to make money. Economics can help you make better choices with money. But generally, economics is the study of how people can make rational choices. Every decision we make is a choice so economics can help us in so many different ways! Economics helps individuals and governments that could affect millions of people.
Every second of the day you are using economics. You made a choice to do whatever you are doing at any given moment. This means that you believe whatever you are doing is more valuable than all the other things you could do. Or you believe that the benefits of whatever you are doing outweigh the costs.
And no matter what you are doing there is always a cost. The cost is the next best thing you are not doing. And if you didn’t enjoy the choice you made, the cost was the time you spent doing it. The economics term for this loss is called the “opportunity cost”. Right now the opportunity cost for you is what you would be doing if not reading this lesson.
Two of the most important assumptions used in economics are these:
People have unlimited wants
We don’t have unlimited resources
People use economics to get the most out of our limited resources. There would not be any economics if there were unlimited resources because then we wouldn’t have to make choices. And remember that economics is the study of making rationale choices. With scarcity, we must make a choice.
The government uses economics to decide which choices to make regarding public policy and spending taxes. By weighing the costs and the benefits and the impact choices, the government can try to improve the quality of life of its citizens. This is very helpful when it comes to keeping an entire country strong and stable.
For example...Should we close down schools to slow the spread of a virus? What are the costs? What are the benefits?
Feel free to share your thoughts! Bonus points if you use (correctly) the term “opportunity cost”.
Economists try to understand the different incentives. Incentives are things that encourage people to do certain things. As a rule of thumb, economists assume that people act in their own self interest and that means following their incentives to their logical actions.
Government policy makers sometimes create well meaning policies, but fail to see the knock on effects from changing incentives. For example, when seat belts were first mandated, drivers started speeding more because they felt safer...the end result being a similar number of deaths until rules were put in place to stop speeding. But getting the incentives right can potentially have great effects!
Key point: If you want to understand why people or doing something...think about their incentives.
There are two generalizations of economics. First is macroeconomics which looks at the big picture and studies the economy as a whole. This helps us try to predict big things like GDP and unemployment based on different decisions being made. Second is microeconomics that looks at all the individual businesses and aspects of the economy. It also looks at all the details that could potentially have big effects.
Macroeconomists spend a lot of time trying to figure out how economies grow. One measure of an economies size is “Gross Domestic Product” ... which is the total value of all final goods and services. GDP is important because it helps us measure our progress toward a higher standard of living.
For example, during the Industrial Revolution, we started to see people’s lives start to improve drastically. We started to live life without the constant fear of dying. Isn’t that nice!
A big reason for the improvement in GDP was “economies of scale”, which allowed more efficient production of manufactured goods. Individual businesses had an incentive to get bigger because the bigger they got the cheaper each unit of production became.
By analyzing the incentives of individuals we are thinking like a microeconomist ... a hat we must wear if we really want to know what happening in the broader economy. Macroeconomics should have “micro foundations” because at the end of the day the whole global economy is really just the shared actions of all the individuals.
We believe today that it was the division of labor that made countries wealthy. Especially because this leads to assembly lines. In an assembly line, you get to specialize in a certain field and people are able to do their job quicker and more effectively.
Specializing in something also goes beyond assembly lines. Think about one cheeseburger. In order for that cheeseburger to be made, a lot of steps would have to be done. You would have to grow wheat to make bread. Raise a cow for the meat and the milk to make cheese. And you would have to grow tomatoes and lettuce. Then after all of that, you would have to build yourself all the supplies needed in order to cook the cheeseburger. And after all that tiring work, you would have yourself a nice, homemade cheeseburger!
But when we have a specialization, we can have separate people do all the different steps for us, and all we have to do is buy the cheeseburger already made for us!
The modern era that we live in today has taken specialization to the extreme. Anyone who is a farmer is most likely only a farmer. And anyone who is an accountant is most likely only an accountant.
But even though we have benefited dramatically because of specialization. We wouldn’t be able to boost our economy and to use the best out of our resources as well as we have today without trade. This allows countries to specialize and trade with each other.
Here is a chart that illustrates why trade is so beneficial. It is called the Production Possibilities Frontier.
This chart illustrates the number of shoes and planes the United States and China can produce using their resources. You may think that this chart would not be beneficial because we don’t live in a world of only shoes and planes, but once you understand the tradeoffs between two goods, your knowledge can reach to any number and variation of goods.
If you produce an amount of goods on the Production Possibilities Frontier, that means you are being efficient with your resources. If the amount of goods that you produce is inside the Production Possibilities Frontier then you are using your resources inefficiently. Outside the Production Possibilities Frontier is impossible.
As you can see from the chart, the United States is better at producing planes than shoes. But the US also loses less when making planes. This means that the United States has a comparative advantage when it comes to planes. China, on the other hand, is good at producing shoes more than planes. So China has a comparative advantage when it comes to shoes.
If both China and the US do what they are best at and trade, they will get more out of their investment than if they didn’t trade. This makes the trade mutually beneficial. So, as you can see, trade is a very important part of our world so that if you do specialize in something, you’ll be able to have other things too.
When you have different countries focus on different things, or specialize. Then they will also probably feel obliged to trade as well. Different countries around the world use the Production Possibilities Frontier to calculate whether their trade is mutually beneficial, in their favor, or in the other countries favor.
This chart can help show the importance of economics too! Without this Production Possibilities Frontier chart, how would countries know if their trade was the right decision? How would they be able to calculate their benefits and losses? They wouldn’t, that’s the answer.
Even though economics disagree on many things, one thing is clear to all of us. Specialization and trade makes the world better off and helps us use our limited resources efficiently!
Thank you for reading about economics! I hope you see the real world importance economics plays, and how you will better understand this by learning economics! I hope that you will be able to better make decisions and understand why choices were made. Maybe your life will even improve because you can better weigh costs and benefits. Above all, I hope you learned a lot!
Thanks for reading!