Economics is concerned with the optimal distribution of scarce resources within society. For example, economics is concerned with how individual decisions like how firms produce goods and which goods people buy. An important element in economics is concerned with the extent to which governments can intervene in the economy to improve economic welfare. Economics is also concerned with wider issues such as economic growth and unemployment – issues that affect the whole of society.
Supply and Demand
The most basic model in economics concerns how the price and quantity of goods and services is determined. For example, if demand for a good rose, we observe that this usually leads to a higher price. This higher price in turn encourages firms to supply more. This simple model helps explain a whole variety of different issues and topics. For example, we can use supply and demand to explain wage differentials. A lawyer can command a high wage because the number of qualified lawyers is very low. Cleaners tend to get lower wages because there are many more people with necessary qualifications.
Economics is concerned with decisions that agents (firms and consumers) make. For example, classical economics generally assumes that people wish to maximise their well-being; i.e. we assume firms wish to maximise profits and consumers wish to maximise their utility (happiness)
However, the real world is more complicated. Not all firms wish to maximise profits; they may seek to maximise market share or pursue other social / environmental objectives. Also people may not be rational but get caught up in irrational booms and busts (e.g. stock market booms, housing booms, dot com bubbles). Therefore there is a branch of economics known as behavioural economics.
Macro economics is a term relating to nation wide economic problems. For example, the rate of inflation in a country measures the average increase in prices. Higher inflation affects both savers and borrowers, and can influence living standards. Economic growth is another key factor that can determine living standards. Higher economic growth can lead to improved living standards and lower rates of unemployment. A recession (negative economic growth) can lead to the opposite. Macro economics
Government Intervention in the Economy
A continual debate in economics is the extent to which governments intervene in the economy. On the one hand, free market economists argue government intervention should be very limited (e.g. to protection of private property, national defence). The argument of free market economics is that governments tend to be inefficient, they don’t have the same incentives to produce what people want and need. If you leave it to markets, the ‘invisible hand’ automatically responds to changes in demand to provide goods that people want.
On the other hand, other economists argue that the free market actually creates many problems. In a free market we may have monopolies, inequality, under-provision of important public services. Therefore to improve economic welfare, there is a necessity for governments to raise tax and spend on public goods not provided by the free market. Markets vs Government Intervention
To some extent all major economies have converged on a similar model which may be termed a ‘mixed economy’. This is a combination of free markets (no government intervention) and state provision of goods. The old Soviet Union pursued a ‘command economy’ Communist, where government decided what to produce, how to produce and for whom.
The opposite to a Command economy is a pure free market, where there is no government intervention. Within the two are mixed economies. The extent of government intervention in an economy varies significantly from 17% of GDP (Hong Kong) to over 50% in Scandinavian countries like Norway and Sweden.
Further Issues in Economics
- Tax. Which goods should we tax? E.g. Carbon Tax, Petrol Tax, Cigarette Tax.
- Inflation. What is inflation? How is it measured? Is it bad?
- Government borrowing? Why do governments borrow so much and how does it influence the economy?
- Market Failure. What is market failure?