What is economics? Where you start influences where you go

'The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.' Joan Robinson

'The enterprise of economics is better characterized by the content of elementary texts than by what goes on at the frontiers of economic theory.' Stephen Marglin (2008)

1 THE STANDARD TEXT

1.1 economics is the science of choice

It seems obvious that economics is about the economy; so a commonsense definition of economics might be that it concerns itself with money, markets, business and how people make a living. But this definition is too narrow. Economics is not just the study of money and markets. It studies families, criminal behaviour and governments' policy choices. It includes the study of population growth, standards of living and voting patterns. It can also have a shot at explaining human behaviours in relation to dating and marriage.

The fact that economics can examine subjects traditionally studied by other social sciences suggests that content does not define the discipline. As long as a topic has a social dimension, we can look at it from the perspective of any social science.

Most textbooks define economics as the science of choice. It's about how individuals and society make choices, and how those choices are affected by incentives. This definition includes all aspects of life: a couple's choice to have a child, or a political party's choice of its platform. Its drawback is that it doesn't help to differentiate economics from the other social sciences, since they too look at how we make choices.

What distinguishes economics from other social sciences is its commitment to rational choice theory. This assumes that individuals are rational, self-interested, have a stable set of internally consistent preferences, and wish to maximize their own happiness (or 'utility'), given their constraints – such as the amount of time or money that they have. Social situations and collective behaviours are analysed as resulting from freely chosen individual actions. Just as science attempts to understand the properties of metals by understanding the atoms that comprise them, so economics attempts to understand society by analysing the behaviour of the individuals who comprise it.

1.2 Scarcity

Why is choice necessary? Textbooks emphasize that people have unlimited wants. Therefore, no matter how abundant resources may be, they will always be scarce in the face of these unlimited wants.

The fundamental question in economics has always been how do we maximize happiness? Economists maintain that while we must allow people to decide for themselves what makes them happy, we know that people always want more. Therefore, society needs to use its resources as efficiently as possible to produce as much as possible; and society needs to expand what it can produce as quickly as possible. This explains why economists emphasize the goals of efficiency and growth.

But does the concept of unlimited wants mean that someone will want an unlimited number of new coats, or an unlimited number of pairs of shoes? No, it doesn't. Along with unlimited wants, economists normally assume that the more you have of something, the less you value one more unit of it. So, unlimited wants does not mean we want an unlimited amount of a specific thing. Rather, it means that there will always be something that we will desire. There will always be new desires. Our desires and wants are fundamentally unlimited.

1.3 Opportunity cost

Since resources are scarce, if we choose to use them in one way, we can't use them in another. Choosing more of one thing implies less of another thing. In other words, everything has a cost, and the real cost of something is what must be given up to get it. This is its opportunity cost – the value of the next best alternative forgone.

It's a cliché that there's no such thing as a free lunch – there is always an opportunity cost. Even if someone else buys you lunch, there is still a cost. There is a cost to society for all the resources used to grow the food, ship it to the restaurant and have it prepared. Your free lunch even costs you something: it uses up some of your scarce time that you could have used to do something else.

1.4 Marginal thinking: costs and benefits

You are familiar with the margin on a page – it lies at the edge. And when someone describes a soccer player as being marginal they mean he is a fringe player, on the edge of inclusion. Economists use the word marginal in a similar way. Marginal cost is the cost at the margin – or to be more precise, the cost of an additional unit of output or consumption. Thus, the marginal cost of wheat is the additional cost of one more unit of wheat. Similarly, marginal benefit is just the benefit someone gets from having one more unit of something. We might measure benefit in hypothetical utils of satisfaction; or in dollar terms – the maximum willingness to pay for one more unit. As the science of choice, the core economic framework is remarkably simple: all activities are undertaken to the point where marginal cost equals marginal benefit. Why? Because at this point total net benefit is maximized. An example will help.

Imagine we are old-style Soviet planners, trying to determine the quantity of steel to produce. Let's assume that the marginal cost of producing a ton of steel increases the more we produce – so we draw it as the upward-sloping line in the upper diagram of Figure 1.1. Further assume that the more steel is produced, the less one more ton is valued – so the marginal benefit line slopes down. How many tons should we produce? If we produce only Q1 units, the marginal benefit of one more ton is $6, but the marginal cost is only $3. This means that the extra benefit of one more unit is greater than the extra cost of producing it. Therefore, we can improve society's well-being by producing one more ton. This remains true as we increase production to Q*. But we should not produce more than Q*. Beyond that point marginal cost exceeds marginal benefit, reducing total net benefit from steel production. Total...