The Definition of Economics
What is economics all about? Is it the study of money? Is it about trade-offs and scarce resources? Is it about inflation, unemployment, and government budget deficits? Is it about eliminating poverty?
All of the above are important topics in the study of economics.
The main objective of economic research is its ability to explain how we can most optimally achieve the highest standard of living. Thus:
Economics is the study of how we can best increase a nation’s wealth with the resources that we have available to us.
How Can We Best Increase Our Nation’s Wealth?
There is substantial disagreement over how a country can best achieve optimum wealth. Some economists support considerable government involvement, price controls, and government rules and regulations. Others believe that government involvement should be minimal and limited to tasks including the provision of a legal system, military, police and fire protection, and providing certain public goods. Many believe that a combination of moderate government involvement and private initiative works best.
Among other issues, there is controversy about the role of profits, consumer spending, savings, capital formation, compensation and income distribution, and unions. Should we more heavily tax profits to more equally distribute the wealth in our country? Should we encourage spending and discourage saving to stimulate economic growth, or should we do just the opposite? Should we limit CEO compensation? Do unions raise real wages or only nominal wages, and are they beneficial or harmful to our economic growth? These are important economic issues, which we will elaborate on throughout the text. Let’s define some important concepts first.
Marginal Benefit and Marginal Cost
When you make choices as a citizen, a business person, a student, or a government official, you make them, assuming you are rational and you make decisions voluntarily, by comparing marginal benefits and marginal costs. You will choose an activity (for example, going to school, accepting a job, or buying or selling a product), as long as your marginal benefit is equal to or greater than your marginal cost. When you choose to enroll in a college, you expect that your marginal benefit (a diploma, a better job, or higher earnings) will be at least as great as your marginal costs (the value of your time, your expenses on books, tuition, and other costs). When you buy a car, you make that decision because your expected marginal benefits (freedom to travel without having to rely on others to provide rides, status, and ability to accept jobs further away) are at least as great as your marginal costs (price of the car, gas, insurance, and maintenance). A firm will make a specific number of products based on its marginal benefits and marginal costs. It will choose to increase production as long as its marginal benefit (marginal revenue) is at least as great as its marginal cost.
The Difference Between Macroeconomics and Microeconomics
Macroeconomics includes those concepts that deal with the entire economy or large components of the economy or the world. The nation’s unemployment rate, inflation rates, interest rates, federal government budgets and government fiscal policies, economic growth, the Federal Reserve System and monetary policy, foreign exchange rates and the balance of payments are typical topics discussed in macroeconomics.
Microeconomics includes those concepts that deal with smaller components of the economy. Demand and supply of individual goods and services, the price elasticity (sensitivity) of demand for goods and services, production, cost functions, business behavior and profit maximization in various industries, income inequality and income distribution, and the effects of protectionism (tariffs, quotas, and other trade restrictions) on international trade are topics covered in microeconomics.
Macroeconomics looks at the bigger picture of the economy. Microeconomics looks at the individual components of the economy.
If macroeconomics is like studying a forest, microeconomics is like studying the individual trees.