Chapter 1: Introduction to Economics

1.1. Meaning of Economics

As you start your class in economics, you are getting yourself into a wide field that has been here with us for at least a century. But what is economics, really? So first things first, let us learn the meaning of economics.

Meaning of Economics from Early Economists

Economics has multiple definitions. There is no best definition for economics, but economists have agreed on standard ways of defining economics after looking at the definitions of dead economists like Alfred Marshall, John Maynard Keynes, Adam Smith, Karl Marx, and Paul Samuelson.

Let has start with Adam Smith’s definition. Smith defined economics as ““an inquiry into the nature and causes of the wealth of nations.”

This definition of economics by Adam Smith has received a lot of criticisms. Some say that Adam’s definition is limited in scope as it deals only with wealth. Others say that Smith unnecessarily laid a lot of emphasis on material wealth rather than the wellbeing of the whole society of beings.

How can we possibly look at the scarcity of resources if we only focus on how nations create wealth? Well, we have to look further towards a simple and best definition of economics that most economists will agree with, but we won’t leave Adam Smith behind.

Alfred Marshall gave another peculiar definition of economics. Marshall said that economics is a field of social science which involves the study of wealth and mankind. Simply put, he defined economics as the study of man in the ordinary business of life.

Modern Definitions of Economics

Paul Samuelson built a modern definition by bringing together ideas from the early economists. His definition brings out the meaning of economics as: “the study of how people and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future among various persons and groups of society.”

What a mouthful definition. Can we get something simpler for a diploma student? Well, first digest what Samuelson says by breaking it down into the following elements:

  • People and society (known as economic agents)
  • Resources (money or otherwise)
  • Scarcity
  • Human wants (Samuelson calls it alternative uses)
  • Products and services
  • Distribution
  • Consumption
  • Time – now and in the future

These are the key elements that you need to consider when defining economics and other terms used in economics. Basically, you arrive at a comprehensive definition of economics by weaving these concepts together.

The dictionary definition of the term states that economics is the “branch of knowledge concerned with the production, consumption, and transfer of wealth”

Investopedia suggests that “Economics is a social science concerned with the production, distribution, and consumption of goods and services.”

Vancouver Island University defines economics as “Economics is the study of the use of scarce resources to satisfy unlimited human wants.”

Economics as a method of study is the process of trying to solve the economic problem. What is the economic problem? The economic problem is to match limited resources with unlimited wants and needs.

Therefore, economics is simply the study of how people allocate scarce resources to production, distribution, and consumption, both individually and collectively with an aim of satisfying the unlimited human wants.

This definition can clearly be illustrated by the figure below:

So, when defining economics don’t forget to mention the following items: scarce resources, production, consumption, unlimited human wants, and individuals/groups.

1.2. Scope of Economics

Economics is a social science that studies how people allocate scarce resources to satisfy their unlimited wants and needs. The scope of economics in simple terms refers to the areas that the broad economics topic covers. It should not be confused to the economies of scope, which relates to the advantages of producing related goods together to reduce production costs. The economies of scope is very broad, as it encompasses many areas of human activity. Here are some of the main areas that fall within the scope of economics:

  1. Microeconomics: This branch of economics focuses on the behavior of individuals and firms in the market. It examines how prices are determined, how markets work, and how individuals and firms make decisions about what to buy, sell, or produce.
  2. Macroeconomics: This branch of economics focuses on the economy as a whole. It examines the overall level of output, employment, and inflation in the economy and the role of government in promoting economic growth and stability.
  3. International economics: This branch of economics focuses on the economic relationships between countries. It examines how international trade, investment, and finance affect national economies and how governments can promote international economic cooperation.
  4. Public economics: This branch of economics focuses on the role of government in the economy. It examines how governments raise revenue, allocate resources, and regulate economic activity to promote the public interest.
  5. Development economics: This branch of economics focuses on the economic development of countries, especially in the developing world. It examines the causes of poverty and underdevelopment, and the policies that can be used to promote economic growth and reduce poverty.

Overall, the scope of economics is vast, and it encompasses many different areas of human activity. The above branches and scope of economics contain several other subtopics that cover the basic concepts of economics. Particularly, microeconomics and macroeconomics are the two major scopes or branches of economics that are widely studied in economics classes. Economics provides a framework for understanding how people make choices, how markets work, and how governments can promote economic growth and stability.

1.3. Human Wants

In economics, human wants refer to the basic needs that human beings need to function normally this include; food, shelter, clothing and air. Things like radio, education, watches, and vehicles are not very basic. They are meant to have an individual have a happy and comfortable and luxurious life. Wants that can be satisfied by providing goods and services re known as economic wants. When goods and services are provided to satisfy human wants, they lead to creation of utility – the enjoyment or usefulness that the consumer gets from using goods or services. The different types of utility include:

  • Form utility – This is created through changing the form of a raw material to a finished product. It is usually done during various manufacturing processes. The finished goods are in a better form for use than the raw materials.
  • Time utility – this type of economic utility is created through warehousing or storage
  • Possession utility – This is created through trade or exchange, which leads to the transfer of ownership from the seller to the buyer.
  • Place utility – this type of utility is created through distribution. After goods have been produced, they must be moved to the places where they are required for use.

Characteristics of Human Wants

Human wants have several characteristics. Some of them are:

  • They are many, numerous and unlimited.
  • They continually change with time and other factors.
  • Some are repetitive e.g. supper, lunch etc.
  • Wants are competitive
  • Wants are complementary-Used together e.g. shoe polish and a shoe.
  • Wants are habitual that they always occur e.g. toothpaste, perfume etc.
  • Wants are universal-Everybody wants them.

Types of Human Wants

They are classified into two groups.

  1. Basic human needs: This are things one cannot do without e.g. food. They always come at the top for the scale of preference and failure to satisfy them one can lead a miserable life or even die.
  2. Secondary human wants: they are things one can do without. They help one lead a happy meaningful and comfortable life e.g. TV set, radio, cars, education, sodas etc.
  3. One must satisfy basic needs before attaining secondary wants. Since the resources to satisfy human wants are scarce, one has to select on what wants are to be satisfied first and which can wait.

Characteristics of basic wants.

Basic wants are the goods that human beings require for survival. Without them, an individual will not survive or live normally. Some of the characteristics of basic wants include:

  • One can’t do without them.
  • They are felt needs
  • Can’t be postponed
  • They are satisfied before secondary wants.

Difficulties in Satisfying Human Wants

Although human wants are there to satisfy man with lives requirements, it is not always possible to have them this is because;

  • They are too many and new ones keep cropping up.
  • Resources to satisfy them are never enough (limited).
  • They are repetitive hence people will always strive for more resources.
  • They continually change with time and other factors like age and gender.
  • Some are habitual making life unbearable without them.
  • Due to scarcity of resources, a problem of deciding which want to satisfy first with scarce resources arise.

1.4. Economic Resources

Economic resources are ingredients that are available for providing goods and services in order to certify the human wants. A resource must be scarce and have money value.

Characteristics of economic resources

  1. They are scarce in relation to their uses
  2. They have a monetary value.
  3. They have alternative uses
  4. They are unevenly distributed
  5. They have utility
  6. They can be combined to produce goods and services.
  7. They are transferrable from one place to another

Types of Economic Resources

There are three main ways of classifying economic resources namely:

  1. Natural Resources: They are also called the gifts of nature and are held in trust by the government for the citizens. They include; forest, river, mountain, minerals and lakes.
  2. Artificial Resources: They are created by people through various production activities e.g. machinery,tools,roads,railway,airport,dams,bridges,h.e.p,harbours,soaps,books.
  3. Human Resources: They are mental/physical efforts offered by people to the production society. These efforts cannot be separated from their providers e.g. teaching, health services, mechanics, carpentry, engineers etc.
  4. Man Made Resources refers to anything created by man to assist in further production such as tools, equipment’s, roads and buildings etc.

1.5. The Concept of Scarcity and Choice

If the resources available are not enough to produce goods and services to satisfy all the wants then they are said to be scarce. As a result, individuals and society cannot have all the things that they want. Since resources are limited, choices have to be made. The choice to satisfy one want implies others are forgone. Individuals have to make choices e.g. consumers with their limited income and unlimited wants have to choose how they spend their income. An individual may choose to buy a bicycle to commute to work instead of buying a car if they do not have enough money to buy the car. In this case, they are foregoing a car and choose a bicycle due to the scarcity of resources.

Importance of Scarcity

Although scarcity may deny an individual the opportunity to access all the goods and services they need, it may also have a positive economic benefit for individuals and society. Some of the benefits of the scarcity of resources include:

  1. Makes people to work hard
  2. Stimulates usage of available resources
  3. Increases a person’s focus on their expenses and avoid misuse of resources
  4. Allows prioritization of choices to ensure that households and individuals focus on the most important things.
  5. It boosts creativity by making people to be more open-minded and seek new information or new ways of doing things in a better way.

Opportunity Cost refers to the value of benefit expected from the best second alternative forgone. It is based on the fact that resources being scarce have competing alternative uses. The choice to satisfy one alternative means that another is forgone. The value of the second best forgone alternative is the opportunity cost.

1.6. Economic Systems

An economic system refers to the way in which different societies solve the three different basic economic problems which are: which goods should be produced and in what quantities? How should various goods and services be produced?  How should various goods and services be distributed? To answer this question, various political and economic structures have been put in place. The major economic systems include the free market system, planned economic system, and mixed economic system.

1) Free Market Economy

A free market economy refers to a system where decisions about allocation of resources are made by individuals on the basis of prices generated by forces of market prices of demand and supply.

Features/Characteristics of a Free Market System

  1. Private property individuals have the right to own or dispose off their property as they may consider it fit.
  2. Freedom of choice and enterprise Individuals have the right to buy or hire economic resources, organize them for production purpose and sell them in the market of their choice. Such persons are referred to as entrepreneurs.
  3. Self interest in the pursuant of personal goals. The individuals are free to do as they wish and have the motive of economic activity in self-interest.
  4. Competition There is a large number of buyers and sellers such that each buyer and seller accounts for but is insignificant to influence the supply and demand and hence prices.
  5. Reliance on price mechanism: This is an elaborate system of commerce in which numerous choices of consumers and producers are aggregated and balanced against each other. The interaction of demand and supply determine prices.
  6. No government intervention hence no price controls, taxes and subsidies.
  7. There are property rights provided and enhanced by the government through copy rights patents, trademarks etc. e.g. on innovating and inventing one is protected from absorption and thus you enjoy the benefits.
  8. There is excessive advertising.

Advantages of a Free Market System

  1. There is the matching of demand and supply. Production takes place in response to demand hence a balance between what is produced and consumed. No wastage.
  2. There is flexibility of the market in responding to changes in demand and supply conditions thus variety products are offered.
  3. There are no resources wasted in planning as no planning is required
  4. Consumer sovereignty and competition gives rise to a wide variety of goods and services giving consumers a wide range to choice from.
  5. Higher rates of economic growth due to the incentive available for hard work which is motivated by profits.
  6. No wastage of resources on unrealistic projects because investment decision are based on profits.
  7. The costs associated with government bureaucracy are highly reducing encouraging entrepreneurship in the economy.
  8. Better quality products are produce due to innovation and inventions
  9. Intensive innovation and invention is prevalent due to competition.
  10. Affordable prices of products.

Disadvantages of a Free Market Economy

  1. Income inequality the ability of some people and firms to acquire excessive market power leads to greater inequality in income and wealth.
  2. There is likelihood of developing Monopoly powers whereby one firm controls the production and distribution of commodities.
  3. The price mechanism on its own cannot allocate resources to production of public goods e.g. schools, security etc.
  4. Instability in economy and unemployment. This is due to trade cycles, recession, depression, recovery and boom.
  5. The inability to deal with structural changes caused by wars, natural calamities among others.
  6. Inadequate provision of merit goods. Merit goods are goods of importance to the community such as health, education, security among others
  7. Due to excessive advertising consumers are likely to make irrational choices at the expense of moral life/health
  8. Over-exploitation of resources

2) Planned Economy

A planned economy, also known as command or controlled economy, refers to an economic system where the crucial decisions are determined a body appointed by the state. The body takes up the role of mechanism which prevails in a free market economy.

Features of a command economy

  1. Leadership and control of economies. All important means of production (resources) are publicly owned such as land, power generation, housing among others.
  2. Rationing of certain commodities if supply of such fall below demand.
  3. Existence of production targets for different sectors of the economy. The government determines how resources are allocated through planning.
  4. Fixing of prices and wages
  5. Occasional existence of restricted labor market in which workers take up jobs assigned to them.
  6. Government decides what is to be produced, how it will be produced and for whom to produce.

Advantages of a Planned Economy

  1. Avoids economic instability
  2. Minimize negative externalities
  3. Makes adequate provision of public and merit goods ie education, health and safety.
  4. Facilitate the shift of resources in pursuant of grand schemes such rapid industrialization
  5. Puts checks on monopoly power which are controlled by state monopolies (Parastatals).
  6. Ensures there is full employment.
  7. Low inflation rate is being experienced.
  8. Minimum waste of resources.

Disadvantages of a Planned Economy

  1. There is wastage of resources in production because consumers demand is judged in advance without the use of price mechanism.
  2. The cost of gathering information for planning is expensive to the state.
  3. There is no individual incentives and initiative for hard work and innovation.
  4. The power of consumer sovereignty is curtailed.
  5. There is no incentive for hard work and this discourages the suppliers
  6. Some resources may end up being underutilized
  7. Difficulty in estimating demand due to different time frames i.e. Decembers and end month and sometimes during certain occasions such as valentine demand tends to rise.

3) Mixed Economy

A mixed economy refers to an economic system where resource allocation is determined by the state-i.e. the government and price mechanism. Both the government and private sector have a role to play in resource is widely adopted in many countries and results varied depending on nature of the economy. The government normally intervenes when the private sector of market fails to allocate resources effectively as long as the objective of the economic growth and development is achieved.

Advantages of a Mixed Economic System

  1. Optimal utilization of a nation’s resources
  2. Relatively wider tax base
  3. Consumers are protected from consumption of harmful products
  4. A considerable degree of consumer sovereignty.
  5. High quality products and services due to competition
  6. More equal distribution /allocation of resources.
  7. Relatively stable prices.

Role of Government

  • Checking quality of products.
  • Offering government subsidies
  • Offering import and export tariffs.
  • Ensuring price controls
  • Foreign exchange market
  • Taxation by ensuring there is redistribution of income through a system of taxation.
  • To create a framework of regulations and rules to ensure fair competition thus promoting competition between firms both small and big ones.
  • Government intervention can prevent market failures in price mechanism.
  • Stabilization of the economy.
  • The government is able to maintain competition by controlling monopoly power.