Economics Fundamentals: Scarcity, Choice, and Advantage
A Clinton Foundation success story is that it loaned $23,000 to Rwandan coffee growers to support improvements to coffee washing stations and provided technical support. What was the source of the success? The technical support allowed Rwandan coffee growers to improve their knowledge of coffee farming, which increased their human capital. The improvements to washing stations was a change in physical capital that allowed farmers to increase the quantity of washed coffee.
Economics: Core Concepts
Economics: The social science that studies the choices individuals, businesses, governments, and societies make as they cope with scarcity and the incentives that influence those choices.
Scarcity: The fundamental economic problem that arises because human wants exceed the ability of available resources to satisfy them. This necessitates choice. Example: You have $10. You want a new book ($10) and a movie ticket ($12). You cannot have both; you face scarcity and must choose.
Microeconomics: The study of the choices of individuals and businesses and how they interact in markets. It focuses on individual agents and specific markets. Examples: Why does a consumer buy more apples when their price falls? How does a tax on soda affect its sales? How many workers should a firm hire?
Macroeconomics: The study of the performance of the national and global economy as a whole. It focuses on aggregate (economy-wide) phenomena. Examples: What causes inflation? Why is the national unemployment rate high? What is the effect of a government budget deficit on economic growth?
Self-Interest vs. Social Interest: Do choices made in our own self-interest (what is best for us individually) also promote the social interest (what is best for society as a whole)? This is a central tension in economics, famously introduced by Adam Smith’s concept of the “invisible hand.”
A choice is a tradeoff: Getting more of one thing means getting less of something else.
Opportunity Cost: What you must give up to get something. It is the value of the next best alternative forgone. Example: The opportunity cost of going to a concert is not just the ticket price, but also the value of the time you could have spent studying or working.
Rational Choice: comparing marginal benefit and marginal cost.
Positive Statements: Claims about what is. They are objective, fact-based, and can be tested against evidence. (e.g., “An increase in the minimum wage will lead to higher unemployment.”)
Normative Statements: Claims about what ought to be. They are subjective, value-based, and involve opinions. (e.g., “The government should raise the minimum wage.”)
Households: Own and supply factors of production (land, labor, capital, entrepreneurship) and buy goods and services.
Firms: Hire factors of production and use them to produce and sell goods and services.
Factor Markets: Where factors of production are bought and sold (e.g., the labor market). Households supply factors; firms demand them. Money flows from firms to households as income (wages, rent, interest, profit).
Goods Markets: Where goods and services are bought and sold. Firms supply goods; households demand them. Money flows from households to firms as expenditure.
Governments: Collect taxes, make transfer payments (e.g., welfare, Social Security), and buy goods and services from firms (e.g., military equipment, infrastructure).
The Global Economy: The model expands to include international trade (the flow of imports and exports) and international finance (the flow of borrowing and lending between countries).
Absolute Advantage: A person or country is more productive than another. They can produce more of a good with the same resources (or the same amount with fewer resources).
Comparative Advantage: A person or country can produce goods at a lower opportunity cost than another. This is the fundamental basis for mutually beneficial trade. Example: A doctor is better at both medicine and typing than her secretary (has an absolute advantage in both). However, the opportunity cost of the doctor typing is the high income from practicing medicine. The secretary has a lower opportunity cost for typing. Therefore, the secretary has a comparative advantage in typing, and both gain if the doctor practices medicine and hires the secretary to type.
Free lunch when you move from an inefficient point to an efficient point in the graph.