BASICS OF ECONOMICS
Economics Online Tutor
FOR NEW STUDENTS, A LOGICAL PLACE TO START WOULD BE TO ASK: WHAT IS
ECONOMICS?  FOR THE ANSWER TO THAT QUESTION, CONSIDER THESE TWO
FACTS OF LIFE: HUMAN WANTS ARE UNLIMITED, AND RESOURCES ARE FINITE.  
THAT MEANS THAT NOT EVERYBODY CAN HAVE EVERYTHING.  THIS COMBINATION
OF UNLIMITED WANTS, LIMITED RESOURCES, IS CALLED SCARCITY.  SCARCITY, IN
ECONOMICS LINGO, IS NOT THE SAME THING AS SHORTAGE.  THE TERM
SHORTAGE IS A COMPLETELY DIFFERENT CONCEPT AND WILL BE ENCOUNTERED
ELSEWHERE IN THE STUDY OF ECONOMICS.  SCARCITY IS CALLED THE ECONOMIC
PROBLEM.  HOW INDIVIDUALS, GROUPS OF INDIVIDUALS, AND ENTIRE SOCIETIES
DEAL WITH THIS ECONOMIC PROBLEM IS WHAT ECONOMICS IS ALL ABOUT.  SO
ONE DEFINITION OF ECONOMICS IS THIS:

ECONOMICS: THE STUDY OF HOW PEOPLE CHOOSE TO USE THEIR
SCARCE RESOURCES IN AN ATTEMPT TO SATISFY THEIR UNLIMITED
WANTS.

ECONOMICS DEALS WITH THE ANSWERS TO THE WHAT, HOW, AND WHO
QUESTIONS:  WHAT SHOULD BE PRODUCED?  HOW SHOULD IT BE PRODUCED?  
WHO SHOULD IT BE DISTRIBUTED TO?


AS YOU WILL FIGURE OUT, IF YOU HAVEN'T DONE SO ALREADY, THE STUDY OF
ECONOMICS INVOLVES A CERTAIN KIND OF LOGIC, A UNIQUE KIND OF THINKING.  
THIS IS ONE OF THE THINGS THAT IS DIFFICULT TO DEFINE, BUT YOU WILL
RECOGNIZE IT WHEN YOU SEE IT.  THIS FORM OF THINKING IS CALLED
"ECONOMIC THINKING", OR THE "ECONOMIC APPROACH".


ECONOMIC THINKING INVOLVES THE CONCEPT THAT COSTS INCLUDES
UNINTENDED CONSEQUENCES. ECONOMISTS ATTEMPT TO INCLUDE THESE COSTS
IN THE DECISION MAKING PROCESS.  THIS LEADS TO A THOROUGHNESS OF THE
THOUGHT PROCESS NOT FOUND IN ALL SOCIAL SCIENCES.


WHEN YOU HEAR PEOPLE, ESPECIALLY POLITICIANS, DISCUSS ECONOMICS
ISSUES, YOU OFTEN HEAR THEM TALK ABOUT WHAT SHOULD BE DONE, OR WHAT
COURSE OF ACTION SHOULD BE FOLLOWED.  SUCH STATEMENTS ARE CALLED
NORMATIVE STATEMENTS.  NORMATIVE STATEMENTS ARE STATEMENTS ABOUT
"WHAT OUGHT TO BE".  OTHER KINDS OF STATEMENTS YOU MAY HEAR IN
RELATION TO ECONOMICS ARE CALLED POSITIVE STATEMENTS, WHICH ARE
STATEMENTS OF FACTS, STATEMENTS OF THE RESULTS OF STUDIES, ETC.  
POSITIVE STATEMENTS INCLUDE NO VALUE JUDGEMENT, WHILE NORMATIVE
STATEMENTS INCLUDE VALUE JUDGEMENTS.  THE ECONOMIC APPROACH
REQUIRES THE AVOIDANCE OF USING NORMATIVE STATEMENTS.  ONLY POSITIVE
STATEMENTS SHOULD BE USED IN APPLYING THE PRINCIPLES OF ECONOMICS TO
REAL-WORLD SITUATIONS.


THE USE OF NORMATIVE STATEMENTS IS ONE TRAP TO AVOID WHEN STUDYING
ECONOMICS.  FOR THE ECONOMIC APPROACH, IT MIGHT BE HELPFUL TO NOTE
THE THREE OTHER COMMON MISTAKES TO AVOID:


1. ECONOMICS INVOLVES THE STUDY OF HUMAN BEHAVIOR.  THIS SHOULD BE
DONE BY ASSUMING THAT PEOPLE'S BEHAVIOR IS GOVERNED BY "RATIONAL SELF
INTEREST" (MORE ON THAT LATER), INSTEAD OF THE BEHAVIOR BEING GOVERNED
BY IGNORANCE.  DON'T ASSUME THAT PEOPLE BEHAVE IN A CERTAIN WAY
BECAUSE THEY ARE TOO "STUPID" TO BEHAVE RATIONALLY.  INSTEAD, ASSUME A
RATIONAL REASON FOR BEHAVIOR.

2. AVOID THE FALLACY OF COMPOSITION.  THIS IS THE FALLACY OF SAYING THAT
WHAT APPLIES TO ONE, WILL APPLY TO MANY.  IT MAY BE SAFE FOR ONE DRIVER
TO GO THROUGH AN INTERSECTION WHEN THE LIGHT IS YELLOW, BUT THAT
DOESN'T MEAN THAT IT IS EQUALLY SAFE FOR MANY DRIVERS TO DO SO AT THE
SAME TIME.

3. JUST BECAUSE AN ASSOCIATION BETWEEN EVENTS CAN BE FOUND DOES NOT
MEAN THAT ONE EVENT CAUSED THE OTHER.  TWO THINGS HAPPENING TOGETHER
COULD BE A COINCIDENCE.  OR THERE MAY BE A PROVABLE STATISTICAL
CONNECTION BETWEEN TWO EVENTS.  BUT JUST BECAUSE THE EVENTS CAN BE
LINKED DOES NOT IN ANY WAY IMPLY THAT ONE CAUSED THE OTHER.


I MENTIONED THE TERM "RATIONAL SELF INTEREST".  THIS IS THE ASSUMPTION
THAT ECONOMISTS MAKE THAT STATES THAT THE CHOICES PEOPLE MAKE ARE
DONE RATIONALLY, BASED ON THE INFORMATION KNOWN AT THE TIME, IN AN
ATTEMPT TO MAXIMIZE THEIR SATISFACTION.  THIS SATISFACTION IS KNOWN IN
ECONOMICS LINGO AS UTILITY (THE TERM "UTILITY" WILL COME UP OFTEN IN THE
STUDY OF ECONOMICS).  "RATIONAL", IN THIS CASE, DOES NOT IMPLY THAT
EVERYBODY WOULD MAKE THE EXACT SAME DECISION WHEN CONFRONTED WITH
THE SAME CHOICE, USING THE SAME AVAILABLE INFORMATION.  DIFFERENT
PEOPLE CAN MAKE DIFFERENT DECISIONS AND STILL BE RATIONAL.  DIFFERENT
PEOPLE HAVE DIFFERENT GOALS, DIFFERENT ATTITUDES, DIFFERENT COSTS.

SOME ECONOMISTS USE THE TERM "BOUNDED RATIONALITY" INSTEAD OF
"RATIONAL SELF INTEREST", IN ORDER TO EMPHASIZE THE FACT THAT PEOPLE DO
NOT HAVE PERFECT KNOWLEDGE AT THE TIME THAT THEY MAKE DECISIONS.  BUT
THE TERMS ARE INTERCHANGEABLE.  ALSO, IT IS IMPORTANT TO NOTE THAT
"SELF INTEREST" IS NOT THE SAME THING AS "SELFISH".  PEOPLE WHO ARE
ACTING IN RATIONAL SELF INTEREST, AND ARE TRYING TO MAXIMIZE THEIR
SATISFACTION CAN VERY WELL DO SO BY HELPING OTHERS, GIVING TO CHARITY,
AND MAKING NUMEROUS SACRIFICES.
USING MATH IN
THE STUDY OF
ECONOMICS:

DIFFERENT LEVELS OF
ECONOMIC STUDY REQUIRE
DIFFERENT LEVELS OF
MATHEMATICAL
KNOWLEDGE.   THE
PURPOSE OF THIS SITE IS TO
TEACH BASIC ECONOMIC
CONCEPTS. WITH THAT IN
MIND,  AN ATTEMPT IS MADE
TO INCLUDE ONLY A MINIMAL
LEVEL OF MATH.  HOWEVER,
SOME MATH IS INCLUDED,
BECAUSE IT IS IMPOSSIBLE
TO GET VERY FAR IN THE
STUDY OF ECONOMICS
WITHOUT ENCOUNTERING
SOME MATH.  I AM USING
THE FOLLOWING RULE WHEN
IT COMES TO USING MATH IN
THIS SITE: SOME MATH IS
INCLUDED, BUT NOTHING
BEYOND LINEAR ALGEBRA.  
THIS WILL COVER THE
BASICS, AND MANY
STUDENTS ARE FAMILIAR
WITH THE USE OF SUCH
MATH.  FOR THOSE WHO ARE
NOT, MUCH CAN BE LEARNED
FROM READING THIS SITE:
JUST SKIP OVER THE MATH
PORTIONS THAT ARE NOT
UNDERSTOOD.  BUT MORE
CAN BE LEARNED IF THE
MATH IS ALSO FOLLOWED.  
ANY QUESTIONS INVOLVING
A HIGHER LEVEL OF MATH
WILL NOT BE ANSWERED
HERE.  ALSO, THE USE OF
STATISTICS, IMPORTANT IN
MANY AREAS RELATED TO
ECONOMICS, WILL NOT BE
USED HERE.
FIRM
BUSINESS FIRM
COMPANY
ENTERPRISE
BUSINESS

THESE ARE ALL TERMS
THAT REFER TO THE
SAME THING: THE
TERMS ARE
INTERCHANGEABLE

THEY ALL REFER TO AN
ORGANIZATION THAT IS
CONTROLLED BY ONE
MANAGEMENT
STRUCTURE AND
OFFERS GOODS OR
SERVICES FOR SALE IN
THE HOPE OF EARNING
A PROFIT
SOME GOODS ARE NOT PROVIDED SOLELY FOR CONSUMPTION PURPOSES: THEY ARE USED TO PRODUCE
OTHER GOODS.  THESE GOODS ARE CALLED RESOURCES, OR FACTORS OF PRODUCTION, OR INPUTS (THE
THREE TERMS ARE INTERCHANGEABLE).  ECONOMISTS CLASSIFY RESOURCES INTO THREE CATEGORIES:

LAND: THIS INCLUDES SUCH THINGS AS MINERALS, TIMBER, AND WATER, AS WELL AS THE ACTUAL LAND
ITSELF.

LABOR: THE PHYSICAL AND INTELLECTUAL SERVICES OF PEOPLE.  THIS INCLUDES TRAINING, EDUCATION,
AND PEOPLES' ABILITIES.  
ENTREPRENEURSHIP IS A SPECIAL CLASS OF LABOR, BUT SOME ECONOMISTS
HAVE CLASSIFIED IT AS A FOURTH TYPE OF RESOURCE.

CAPITAL: MANUFACTURED PRODUCTS SUCH AS MACHINERY AND EQUIPMENT THAT ARE USED IN
PRODUCTION.  CAPITAL IN THIS SENSE IS SEPARATE FROM FORMS OF FINANCIAL BACKING SUCH AS
STOCKS, BONDS, ETC.  THOSE KINDS OF ASSETS ARE KNOWN AS FINANCIAL CAPITAL, AS OPPOSED TO
PHYSICAL CAPITAL.  IN TERMS OF FACTORS OF PRODUCTION, CAPITAL ONLY REFERS TO PHYSICAL
CAPITAL.

THESE DIFFERENT TYPES OF RESOURCES PRODUCE EARNINGS OF THEIR OWN, AND THESE EARNINGS ALL
HAVE THEIR OWN TERMINOLOGY: LAND EARNS RENT, LABOR EARNS WAGES, AND CAPITAL EARNS
INTEREST.  IF ENTREPRENEURSHIP IS LISTED AS A FOURTH TYPE OF RESOURCE, THEN ITS EARNINGS
WOULD BE CALLED PROFIT.


THE STUDY OF ECONOMICS IS GENERALLY DIVIDED INTO TWO BROAD CATEGORIES: MICROECONOMICS AND MACROECONOMICS:

MICROECONOMICS IS THE STUDY OF ECONOMICS AT THE INDIVIDUAL LEVEL: THE INDIVIDUAL FIRM, THE INDIVIDUAL CONSUMER, THE
INDIVIDUAL WORKER.

MACROECONOMICS IS THE STUDY OF ECONOMICS AT THE LEVEL OF THE ECONOMY AS A WHOLE, OR AN ENTIRE INDUSTRY OR
SECTOR OF THE ECONOMY AS A WHOLE.  ECONOMIC SECTORS ARE CLASSIFIED AS THE CONSUMER, OR HOUSEHOLD SECTOR, AND
THE BUSINESS SECTOR.


ONE LAST NOTE ABOUT THE STUDY OF ECONOMICS: IT IS OFTEN TALKED ABOUT, AND JOKED ABOUT, THE FACT THAT ECONOMISTS
TEND TO DISAGREE ON ABOUT EVERYTHING.  SINCE ECONOMISTS, WHO ARE SUPPOSED TO THE EXPERTS IN THE FIELD, CANNOT
AGREE OR COME TO A CONSENSUS, THEN PEOPLE, AND ESPECIALLY GOVERNMENT OFFICIALS, OFTEN SUGGEST THAT THEIR OWN
INSTINCTS AND OPINIONS ARE JUST AS GOOD AS ANYBODY ELSE'S, INCLUDING THE SO-CALLED EXPERT ECONOMISTS.  THESE
PEOPLE OFTEN DRAW ERRONEOUS CONCLUSIONS BY MAKING THIS ASSUMPTION.  THE TRUTH IS, ECONOMISTS ACTUALLY AGREE
ON ALMOST EVERYTHING.  ONE THING THAT ECONOMISTS ALWAYS AGREE ON IS THE LOGIC OF ECONOMICS ITSELF.  BUT THE FEW
THINGS OPEN FOR DISAGREEMENT ARE THE ONLY THINGS THAT THE PUBLIC SEES REGARDING ECONOMIC THOUGHT.  SINCE THE
PUBLIC SEES ONLY THE DISAGREEMENTS, THEY FALSELY CONCLUDE THAT DISAGREEMENTS AMONG ECONOMISTS IS THE NORM.

THERE ARE VERY GOOD REASONS BEHIND THE DISAGREEMENTS THAT DO EXIST.  ECONOMIES ARE VERY COMPLEX.  THEY INVOLVE
LITERALLY MILLIONS OF INTER-RELATIONSHIPS AND TRANSACTIONS EVERY DAY.  IN ORDER TO BE ABLE TO DRAW CONCLUSIONS,
ECONOMISTS DEVELOP SIMPLIFIED MODELS TO EXPLAIN THESE RELATIONSHIPS ONE AT A TIME.  YOU WILL UNDOUBTEDLY RUN
ACROSS THE TERM "CETERIS PARIBUS", WHICH IS A LATIN TERM MEANING "OTHER THINGS BEING EQUAL".  THIS MEANS THAT
ECONOMISTS ASSUME THAT THE OTHER MILLIONS OF RELATIONSHIPS ARE IRRELEVANT TO THE STUDY AT HAND.  ONLY THE
SIMPLIFIED MODEL ITSELF CONTAINS ANY VARIABLES TO CONSIDER.  WHILE IN THE REAL WORLD, OTHER THINGS NEVER REMAIN
CONSTANT.  ISOLATING SPECIFIC RELATIONSHIPS DOES YIELD VALUABLE, STATISTICAL CORRELATIONS THAT AID IN THE
UNDERSTANDING OF HOW THINGS WORK.  REMEMBER, THOUGH, THAT THESE CORRELATIONS DO NOT PROVE CAUSE AND EFFECT.


ECONOMISTS HAVE USED MANY STUDIES TO CREATE MANY SIMPLIFIED MODELS OF THE COMPLEX WORLD.  SOMETIMES, THE
COMPLEXITY IS COMPOUNDED BY THE FACT THAT RELATIONSHIPS STUDIED TAKE TIME TO DEVELOP IN THE REAL WORLD.  BY THE
TIME THEY DO, OTHER  FACTORS WILL CHANGE.  THE RESULT OF ALL THE COMPLEXITY IS THAT DIFFERENT INTERPRETATIONS OF
THE CONCLUSIONS THAT CAN BE DRAWN FROM LOOKING AT DIFFERENT MODELS WILL EXISTS.  THIS IS ONE OF THE CAUSES OF
DISAGREEMENTS AMONG ECONOMISTS, AND HAS LED TO DIFFERENT ECONOMIC
"SCHOOLS OF THOUGHT".  THESE DIFFERENCES
OFTEN SHOW UP IN PUBLIC AS BEING ASSOCIATED WITH DIFFERENT POLITICAL PHILOSOPHIES.  IT DOESN'T MEAN THAT
ECONOMISTS CANNOT AGREE ON ANYTHING, AND IT DOESN'T MEAN THAT ECONOMIC STUDY IS NOT WORTHWHILE.


ANOTHER CRITICISM OF ECONOMISTS IS THAT THEY ARE NOT 100% ACCURATE IN THEIR PREDICTIONS.  BUT THEY ARE NOT
SUPPOSED TO BE 100% ACCURATE.  THAT IS NOT THEIR JOBS, AND THEY DON'T CLAIM THAT IT IS.  THEIR JOBS ARE TO STUDY THE
MODELS, THE EVIDENCE THAT THEY HAVE AT THEIR DISPOSAL, COMPARE THAT TO THE CURRENT AND COMPLEX REAL WORLD
SITUATION, AND DRAW CONCLUSIONS BASED ON WHAT THEY BELIEVE IS LIKELY TO OCCUR BASED ON THE INFORMATION THEY
HAVE AT HAND.  THESE ARE ECONOMIC FORECASTS, NOT QUITE THE SAME THING AS PREDICTIONS OF THE FUTURE.  BUT THE
COMPLEXITY OF THE REAL WORLD, COMPOUNDED BY THE FACT THAT FUTURE DECISIONS WILL BE MADE BY IMPERFECT HUMANS,
MEANS THAT "RESULTS MAY VARY" WHEN IT COMES TO FORECASTS ABOUT THE ECONOMY.
IN THE COURSE OF ECONOMIC STUDY, THE TERM "GOODS AND SERVICES" IS OFTEN ENCOUNTERED.  
SOME COMMENTS ABOUT TERMINOLOGY WOULD BE APPROPRIATE AT THIS TIME.  "GOODS" REFERS TO
PHYSICAL PRODUCTS, WHILE "SERVICES" REFERS TO NON-PHYSICAL PRODUCTS.  IN TERMS OF WHAT IS
AVAILABLE FOR SALE, AN EXAMPLE OF A GOOD IS A NEW CAR ON A CAR LOT.  AN EXAMPLE OF A
SERVICE IS A HOUSECLEANING SERVICE.  FOR MANY TYPES OF ECONOMIC ANALYSIS, THESE TERMS
ARE USED TOGETHER TO INDICATE THAT THE ANALYSIS APPLIES TO BOTH TOGETHER; THUS THE TERM
"GOODS AND SERVICES".  BECAUSE THIS IS USED SO OFTEN IN ECONOMICS, IT BECOMES SOMEWHAT
CUMBERSOME TO CONTINUOUSLY REPEAT THIS TERM.  SOMETIMES, TO AVOID THIS REPETITION,
ECONOMISTS AND ECONOMIC TEXTBOOKS MAY USE THE TERM "GOODS" TO REFER TO "GOODS AND
SERVICES".  THIS SECOND MEANING OF THE TERM "GOODS" MAY SEEM AT TIMES TO BE CONFUSING,
BUT THE CONTEXT THAT IT IS USED IN SHOULD ALLOW YOU TO KNOW WHICH MEANING IS BEING USED
IN EACH INSTANCE.

SOME OTHER TERMINOLOGY TO BE FAMILIAR WITH:

ECONOMIC GOOD: SOMETHING THAT WOULDN'T EXIST IN SUFFICIENT QUANTITIES IF IT WERE FREE. THIS COVERS THE VAST
MAJORITY OF EVERY GOOD.

FREE GOOD: SOMETHING THAT THERE WOULD BE ENOUGH OF IF IT WERE FREE.  IT IS VERY DIFFICULT TO FIND A REAL-WORLD
EXAMPLE OF A FREE GOOD.  SOME PEOPLE SAY THAT AIR IS A FREE GOOD, BUT IN SOME LOCATIONS, "CLEAN AIR" IS NOT FREE;
THERE IS A COST INVOLVED.

ECONOMIC BAD: SOMETHING THAT PEOPLE PAY TO HAVE LESS OF.  POLLUTION, FOR EXAMPLE.