Economic Definitions

August 22, 2017

Economics as a field

Economics is a social science, meaning the atomic objects of economic field are people and their interactions.
Economics differs from other social sciences in a way that it explains economic phenomena using methods and techniques from natural sciences.
Formally, economics is defined as social science that studies the choices that individuals, businesses, and governments make as they cope with scarcity and the incentives that influence those choices.

Generally, economics is divided into two major subfields: microeconomics and macroeconomics.
Microeconomics studies how individuals interact with each other and how that affect an equilibrium.
Macroeconomics studies the aggregate effect of individuals on a national level.
These definitions are not strict and there is a thin line between what subfield a particular situation should be qualified in.

Individuals (or agents) almost always behave in the pursuit of self-interest.
There is also a notion of social interest - situation in which the society benefit from economic actions.
In most cases, we ask ourselves a question, would certain interactions of agents acting in self-interest be optimal to society and if not how can we improve it?
In this course, most choices will be made about goods and services that get "consumed" by individuals.

Choices always imply we face a tradeoff (choice between getting $1 mil and 1 cent is obvious!).
Agents make rational choices. Rational means they act in self-interest and maximize their own "utility" or benefit (or minimize their cost).
Rationality, however, is subjective.
Cost is not only something you pay to acquire benefit. It also implies the opportunity cost - a cost incurred by making alternative choice.

Frequently, economic choices are made about quantities. To choose a quantity, we compare it with "neighboring" quantities, one more or one less.
We would call it marginal quantities. Marginal benefit - benefit we get from getting one extra unit of a good. Marginal cost - cost we should pay to get additional unit of a good.
These definitions define incentives - a penalty or a reward that encourage/discourage a certain choice. Incentives change!
When we look at the data, sometimes we can see that some incentives influence the choices of multiple individuals. We say that the choices are correlated. Correlation, however, does not imply causation!

Policy making in economics can be qualified as a normative or a positive statement.
Normative statement tells us how the economy ought to be. Example: "Price of gasoline should be 10 cents a gallon, so that people will benefit by lower transportation cost".
We can agree or disagree with this statement, but we cannot test it. We have the current situation, but we cannot compare it with anything as it does not have a counterfactual.
Positive statement describe the current state of events. Example: "Prices of gas is high because of collusion and concentrated market share in oil market".
We can verify this statement by conducting an analysis and tell whether it is true or not.

What do we produce?
Goods and services (radio spectrum, pollution quota, etc.)
How do we produce?
Several factors of production are used: land, capital, labor, capital, and entrepreneurship.
For whom do we produce?
For the very same individuals, who get rent from land, wages from labor, interest from capital, and profit from entrepreneurship.

We learned several important definitions related to the study of economics.
We analyzed essential elements of economic analysis and showed the answers to questions of what, how, and for whom we produce goods and services.
We studied two approaches to policy making in economics.