Advanced Economics/Foundations of Economics

Societies have needs and wants. Needs are things necessary for survival, such as food, shelter, or water. Wants are things not necessary for survival but we still may wish to own, such as a car, telephone, or Spider-Man suit (for whatever reason). Those needs and wants are satisfied by resources.

Resources, which are not limited natural resources (as we shall see), are utilized to produce various goods or services, in order to satisfy the needs and wants. Since resources are limited while demands for them is unlimited — a person can need and want an infinite number of things simultaneously — a conflict of what best satisfies these needs and wants arise. Do we need more cars or computers? More "butter or guns"? Are suits, in the economic sense, better than dresses? These situations are where economics come into play.

What is economics

Economics is a social science that studies the choices leading to the best allocation of limited resources, to satisfy unlimited demands of consumers. Social sciences study people and their interactions in society, such as psychology, sociology and history.

Scarcity and choice

Scarcity is a situation in which resources are insufficient to meet the demands of consumers. If there wasn't scarcity, people wouldn't have to make choices. And in turn economics, being the study of choice people make, would not exist. In economics, the term "scarce" is used slightly differently from the ordinary use. For example, it may seem that the number of cars in London is not scarce at all, but since cars have a price they are relatively scarce; not all individuals who want a car can afford it. The relationship between scarcity and price is explained in the next section: opportunity cost.

Opportunity cost

Opportunity cost is the cost of the second best alternative forgone as a result of making a choice. This simply means, the value of what you give up to get something else. For example, imagine you have a $10 gift card to spend on either tomatoes, lollies or coffee, which you like in that order (coffee > lollies > tomatoes). Then, when you buy the coffee the opportunity cost is the lollies (the next best alternative).

What you forgo isn't necessarily always expressed in monetary terms. It could be time, labor, health, or anything associated with losing the second best alternative. Subsequently, social media, in terms of economics, is definitely not free. For every hour devoted for it, an hour that could have been devoted to another activity — for instance, editing this course for the better — is given up.

As previously mentioned, anything that has opportunity cost is relativity scarce; thus, it must have a price since it cannot be supplied indefinitely. Priced goods are classified as "economic goods," such as cars, houses, and products. On the other hand, some resources don't have an opportunity cost associated with them; consequently, they are classified as "free goods", such as the air; we don't give up anything to breath it, so it doesn't have an opportunity cost for which reason it doesn't have a price.

The three basic economic problems

Since resources are relatively scarce, choices have to be made. Choices, the central theme of economics, give rise to three fundamental questions that every economy must answer.

• What to produce and in what quantities. With the available resources, what should be produced and how much of it? Do we produce a million cars the next year, a new operating software for the three major OS platforms, or electric cars?
• How to produce. There's plenty of ways to produce goods and in various combinations of production. Do we use more human labor and less machines, or vice versa? Do we adopt a new technology in the production line or recruit more workers?
• For whom to produce. There are billions of people on the planet all of which are sectored into numerous classes. With the good and services produced, do we distribute them among college students, PhD. experts, hospitals, companies, schools, actors, and so on.

Resources and factors of production

We have seen that resources are used to produce goods. Those resources could be human labor, machines, oil reserves and so on. When they are used in production of goods, they are collectively referred to as "factors of production", and are classified into four broad categories:

• Land: all natural resources, including all that is under it and above the land. For instance, oil reserve, forests, agriculture and non-agriculture, rivers and lakes, to name a few.
• Labor: all human labor — mental or physical — contributed to the production of goods or services. For example, the efforts workers — police officers, teachers, plumbers, or construction workers and so on — exert cognitively and physically that contribute to producing a good or a service is labor.
• Capital: a produced factor of production used, in turn, to produce good and services through human capital and physical capital. Physical capital is stock of manufactured resources, such as machinery, airport, tools, factories, and electricity generators. Human capital is value of workforce. Capital factor is also referred to as "capital good" or "investment good". Unlike land, capital goods can be increased through labor.
• Management (or entrepreneurship): a skill or ability possessed by some individuals that makes them organize and take risks to innovate new goods and services. Management or entrepreneurship involves managing and organizing the three above factors to create new goods and services. Because entrepreneurs face unclear outcomes in hopes of making a profit, it's considered risky.

Production possibilities model

 Guns or butter production possibility curve

Production possibility curve (PPC) or Production possibilities frontier (PPF) is a curve that shows the potential output for an economy of two goods with fixed technology and similar factors of production. For example, let's consider the classic question "guns or butter" charted in figure 1, where the economy has to choose either to produce food or guns. If the company decides to allocates most its resources for the production of guns, then it will not produce much "butter" (Point B). If it produces mostly food, then less guns will be produced (Point C). If the produce on point C, then the economy is allocating for the production of both goods. These choices are decided by societies. Some countries need more national security over food security, while others need the reverse. For the economy to produce in the PPC, two conditions must be met:

• Resources must be fully utilized and nothing of them are wasted.
• Resources must be utilized efficiently. If there's an alternative way that best produces the desired goods and is not employed, then there is a productive inefficiency. For the economy to be efficient, it must produce goods at the lowest cost possible.

In reality, no economy is ever able to reach PPC, because it can't meet the two condition, and hence it produces on inside PPC, i.e. point A. And, as you might have guessed, it can't produce outside PPC either, i.e. point X, unless PPC expands to accommodate the point through introducing more resources.

The PPC illustrates several economic concepts, to name some we've seen so far there's opportunity cost, scarcity of resources (the fundamental economic problem that all societies face), and the three basic economic problems (what, how, and who to produce for).

Utility

Utility is a measure of pleasure and satisfaction derived from consuming a good or service. Utility is two types:

• Total utility: The total satisfaction of a client after the depleting a certain quantity of goods or services. For example, the calculated total utility from drinking two cups of coffee.
• Marginal utility: The additional satisfaction drawn from consuming one more unit of a given good or service. For example, the satisfaction of user after eating one more sandwich. Note that, as the consumers dissipate more units, marginal utility tends to decrease and possibly becomes a negative — or redefined as "disutility." For instance, eating a lot of sandwiches might at some point sicken the customer, and from then it becomes a "disutility."

Microeconomics and Macroeconomics

Microeconomics is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms, whereas macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, including regional, national, and global economies.

Macroeconomics study aggregated indicators such as GDP, unemployment rates, national income, price indices, and the interrelations among the different sectors of the economy to better understand how the whole economy functions. Microeconomists analyze the market mechanisms that establish relative prices among goods and services and allocate limited resources among alternative uses. Microeconomics shows conditions under which free markets lead to desirable allocations. It also analyzes market failure, where markets fail to produce efficient results.