The Story of Economics
Economics is the study of how people use scarce resources to satisfy their unlimited
wants. People always try to maximize their utility (make themselves better off) and
businesses always try to maximize profits. Productive Resources (land, labor, capital,
and entrepreneurship) are scarce and we have to figure out how to use them. Of
course, you have to give up one thing to get another and anytime a person uses a
resource to make one thing they can’t make another thing with it at the same time. For
example, if I use a tree to make a pencil I cannot also use that same wood to make a
table. This is an example of a trade off. Any time you give up something to get another
there is a cost of time. The second best choice of what to do with your time is called an
opportunity cost. You worked with opportunity cost and trade offs when you planned
the dance and did the budget. When evaluating what choice is best it helps to use a
tried and true economic method like PACED (problem, alternatives, criteria, evaluation,
and decision). This is how economists evaluate problems.
Every society must answer the questions below. How it answers these questions
determines what type of economy it has: market or command. Each economy has
certain goals: freedom, efficiency, equity, security, stability, and growth.
What should be produced?
Every economy must decide what kind of things they will make with the productive
resources available. Will they use wood to make beds or chairs? Will they use corn to
make tortillas or corn starch? Will they do a little of both? They must make decisions
about how to use their resources. With every decision there is a trade off. In other
words they need to make the most of their available resources. In order to do this we
would make a production possibilities curve. When we make more of one thing we
give up making another thing. A trade off must be made. There is an opportunity cost
to making anything. Think about Goldilocks and the 3 bears or the gold for wilderness
assignment. When we use a production possibilities curve we can evaluate if a company
or economy is efficiently using its productive resources.
How should the goods be produced?
Economies must figure out how they want to produce the goods and services that they
want in the most efficient way.
Who should get the goods produced?
We would like to satisfy society’s wants but since there are limited productive resources
we have to decide how we are going to allocate these goods. Some allocation systems
include random draw, personal characteristic, performance based, willingness and
ability to pay, first come first served, fiat, voting, or a combination of any of these.
Different types of economies such as market and command have different kinds of
allocation systems. Command economies allocate resources by fiat or first come first
served while market economies allocate goods and services by willingness and ability to
1
pay. Think of the school cafeteria assignment when remembering these two types of
economies.
All of this is done to satisfy our unlimited wants. People always prefer more. This is
called the “pig principle.”
Market and Command economies are the two types of economies that we studied.
They answer the 3 questions in different ways. In a command economy, the
government makes all of the choices about how to use resources. The central planners
will decide what should be produced, how it should be produced and who should get it.
The resources are allocated based on the preferences of the government (fiat) and are
usually distributed according to a first come, first served method of allocation. In
Market economies individuals make all of the decisions about how to use resources.
People start businesses and use resources according to prices. For example, should we
use this tree to make a table or pencils? I simply need to look at which one I, as a
business owner, will bring me a greater profit. If I see that I can make a greater profit by
making pencils with the wood then I have an incentive to make them.
Finally, incentives are really important in a market or command economies. Market
economies tend to have a lot of incentives to encourage people to work and be
productive while command economies do not. People respond to incentives and
therefore do productive things in any economy. An incentive is a reward or punishment
for doing something. Changing incentives changes our behavior. Getting a speeding
ticket is an incentive not to speed. The possibility of earning college scholarships are an
incentive to do well in high school. The possibility of earning an additional 1 million
dollars over the course of your lifetime is an incentive to earn a college degree instead
of skipping college. The possibility of a pay raise if your students test well is an incentive
for teachers to give answers to students on standardized tests. Think about the parking
lot assignment that we did when you tried to put a car in a parking lot based on the
scenario I gave you. Each time you had a different incentive. Sometimes you parked
only small cars in the lot because you were rewarded for the number of cars in the lot.
Other times you were rewarded only if you had an equal number of each car size in the
lot. When incentives change so does human behavior.
2