ISSN 2201-1064
Vol. 2 January 2014
THINKING ECONOMICS
Author: Mohan Dhall, © Mohannah Education
The nature of economics
There are several important concepts that shape an understanding of the field of economics. These
concepts and their related assumptions are very important and students will need to keep them in mind
throughout their study of economics.
Greed and self-interest
The first basic premise or basic assumption in economics is that all people are greedy and act out of selfinterest. This means that all people at all times make economic decisions that emphasise personal wealth.
It also means that where a person can get more (goods and services) for the payment of less money they
will do so.
By extension, this greed and self-interest is often framed in terms of ‘wants’ or ‘desires’ as opposed to needs.
It is said that all people have unlimited wants and can never have their unlimited wants satiated. They will
always desire more than they have. Businesses in their marketing these days refer to meeting the ‘wants and
needs’ of people as though wants and needs are interchangeable terms.
Thinking Economics Insight 1
Needs
Wants and needs - Are people greedy…?
A need is something that a person cannot live without. Starting from nothing at all, needs include: air,
food, water and shelter. However, if this is all a person had then they would be able to survive. But, is
‘survival’ living? Arguably not, thus needs can also be extended to include things like ‘warmth’ (energy),
love, transport and education. Some of the basic human rights are also often characterised as basic
needs – such as a right to nationality and freedom of belief.
Wants and desires
Wants are defined as anything desired but not needed. Clearly needs are things we desire to be fulfilled.
Wants are said to make the difference between survival and quality of life. Thus wants are things like a
well-appointed home; a nice car and access to entertainment are often classified as wants.
In economics wants are generally thought of as being unlimited and people deemed to be insatiable
(incapable of becoming satisfied). However, is this true…?
Unlimited…?
Another term for ‘unlimited’ is infinite. It means without boundary or limitation, unending and
unceasing. So, are human wants and desires unlimited? The answer to this lies in how we view
people. Are people inherently greedy? That is, it is human to be greedy? Do we have unlimited
wants that we can never satisfy? Clearly this characterisation is not true. Though most people
want more than they currently have it is highly unlikely that a person will experience a situation
of unending dissatisfaction and need for more and more and more.
Greed and self-interest are also assumed to be a basic premise of the decision-making of businesses
or firms. That is, business decision-making will be based around the need to maximise wealth
and profits. The increase in wealth of companies is actually motivated by the owners of firms
who are individual people and expect to maximise their personal income and wealth. In this
way the self-interest of business-owners translates to a profit-maximising motive.
The emphasis or focus on profit-maximisation means that decision-making in businesses
will also emphasise the lowest costs where possible, as costs take away from profits. Thus,
within firms there will be decisions made that focus on increasing the income of the
firm whilst lowering the costs or expenses the firm incurs.
Rational choices
A second basic premise is that people are rational in the decisions they make. Being rational
means that decisions are based on logic and reason rather than on emotion, a ‘hunch’ or a
feeling. It is further assumed that business decisions are also made through the application of
rational thinking. This means that when faced with competing alternatives, business decisionmaking will apply logic and analysis to make the ‘best’ decision (most profitable, or least costly)
in the circumstances.
Thinking Economics Insight 2
Do people and businesses make
rational decisions?
This is an important question in the study of economics. After all – it seems obvious. Surely
people think about a situation, consider all alternatives and then calmly make their choices.
Surely a calm, cool mind is brought to economic decisions? The theory of rational economic
choices assumes that people always maximise their economic benefit. But consider this example
that is designed to ‘test’ this assumption of people:
A father and mother are separated and there are three children. While the parents were together the
father did most of the parenting and also all most of the income-earning. Now they are separated it
would be in his economic interest for the children to live mostly with him. However he decides that
even though he could dispute where the children live, it would be better if they lived with the mother
even though this will cost more in terms of Child Support payments. He decides that less conflict is
preferred and that this decision will be most harmonious.
Here the rational and the emotional overlay. However, the economically rational decision is not, in the
father’s view, the best. In this example the genders could be reversed with the same outcome.
In the market people are often swayed by emotion rather that reason. For example, I think that I would
like a $500 phone even though the $200 phone has all of the same practical functionality (but not the
branding).
Similarly, businesspeople often face competing economic decisions, all of which are subject to an
element of risk or speculation. In this context, where there are ‘unknowns’, a completely rational decision
may not be possible. Thus, both on an individual level and on the level of the firm, decisions may be
made that are not rational.
Moreover, many business people will take a risk when deciding which economic decision to make –
where there are competing choices. Risk is a term that means a decision has unknown consequences
at least one of which could lead to loss. In this way, business people have to decide between choices
where possible outcomes vary from financial success to financial losses.
Is every dollar of equal value...?
People generally like to save money. If items are discounted they may buy more of the item. So, if
a soft drink is discounted from $4 to $3 then a person may opt to buy more. However, would they
travel to make a saving? In travelling they incur a cost and thus reduce the amount of the saving.
Thus the perception about saving may be more important than the actual saving.
Also consider this
If I could save $20 on a $70 tank on petrol then would I also we likely to travel from store to store
seeking a $20 saving on a $1,200 bed? Is one lot of $20 worth more than another lot of $20? Is
the issue the relative saving: $20/$70 compared to $20/$1,200?
Is it the case that some $20 notes are worth more than others???
Scarcity
A third fundamental economic premise is that resources are limited. This means that as they get
utilised they can become scarce (rarer). Scarcity means that all resources can be exhausted.
Of course, some resources can be replenished. For example, fish stocks can renew if fishing
is stopped in a particular area for a period of time. Thus, resources can be divided into
those that are exhaustible (non-replenishable or non-renewable) and those that can be
inexhaustible if they are managed in a particular way (capable of replenishment, or
renewable).
Thinking Economics Insight 3
Replenishable or not…?
All resources may be replenishable over time. However, resources like crude oil, that
is used to make fuels such as petrol, take thousands of years to make through natural
processes. Since people tend not to live so long and since the use of resources changes
over time with changes in technology then resources that take thousands of years to
manifest can be considered non-replenishable.
However, fuels can be created in laboratories when scientists replicate the heat and pressure
that creates the breakdown of natural substances. The only problem is that in creating fuels
this way the cost is far greater than the cost of using the existing resources.
Sacrifice
If people have unlimited desires and wants, and if they have limited means then they will have to
prioritise the things they want most. That is, they will focus on the things they desire most and the things
they desire less will have to wait. In this way people have a hierarchy of wants and satisfy those deemed
to be most desirable.
In allocating money to particular things that they desire, people sacrifice temporarily or permanently the
other things that they desire. As it turns out, a person who does not have a desire satisfied immediately may
find that their desires or preferences change over time. Thus, what a person really wants at one time, they
may not want at another time. This change in preferences over time is an important consideration.
Thinking Economics Insight 4
Changes over time
Do we constantly desire or want the same things through our life? Clearly not – even though we all
have preferences. As a child the things we wanted will differ from what we want as adolescents and
later as adults. Due to this, when our desires cannot be satisfied immediately then it is possible that
the desired thing will not be wanted a short time later. Growth, insight, inquiry – these types of factors
increase personal awareness and shape our wants. How much money we have to spend also shapes
the way wants are realised or satisfied, and also the order in which they are satisfied.
Government
Compromise and delay…..Now or future and government priorities
From an economic perspective, what is not spent now can be saved and then spent later. This means that
money allocated to the satisfaction of current desires will not be available for satisfying future desires. A
government, whose economic role is to manage the economic affairs of the nation, is faced with similar
choices – money spent now, cannot be spent later. Thus, decisions about how much is spent and on what
are very important. It means that decision-making for governments, like individuals and business, can be
constrained by what is most necessary.
Like an individual, a government has some things it must spend money on and some things it can opt
or choose to spend money on. However, since a government has the responsibility of managing the
nation’s resources there are some priorities that must be funded otherwise the economy will suffer. In
order to determine what to spend and how much there are key economic questions that a government
must answer.
Key economic questions
All governments must ask some fairly basic questions which will determine how they allocate
resources, what is spent now and what can be delayed until the future. These fundamental
questions are:
What should be produced within an economy?
How much production should there be?
How should production be done?
How should the things produced be distributed?
What should be produced?
Every nation has an endowment of its own natural resources to a greater or lesser extent.
For example, Australia has large volumes of natural resources such as minerals and metals.
Similarly, Fiji has large sugar plantations and Hawaii has sunshine and beaches. Malaysia, an
oil producing economy, has recently made a change to ‘what should be produced’.
Thinking Economics Insight 5
Malaysia and palm oil
production
Malaysia is well-known for its crude oil processing. It has access to large oil reserves. However,
a recent increase in global demand for palm oil – an essential ingredient in many cosmetics,
personal cleaning products and foods, has caused a shift in production. Large-scale plantation of
palm trees in Malaysia for the production of palm oil has changed ‘what is produced’. Malaysia has
a natural environment and soil that encourages the growth of palm trees. Thus, the government
has encouraged the plantation of palm trees in order to take advantage of the increased global
demand for palm oil.
How much to produce?
A decision needs to be made about how much (what volume) of the various things produced should be
actually produced. This is because there is a limited capacity to allocate resources to production. Thus, there
is no use allocating resources for the production of goods and services in volumes that is unnecessary or
wasteful.
The question of ‘how much’ changes over time. Globalisation has meant that in most nations there has been a
rationalisation of what is made and how much is made. This means that national economies have had to make
decisions about what will sell best to a global market and what will not sell because other nations can produce
the same things for less.
A government can shape the ‘how much?’ question by taxing production to make it more costly to producers
and final consumers or it can offer financial incentives to encourage producers to make and offer to the market
particular goods and services.
How should production be done?
The way things are produced has changed over time. Technological advances have meant that there have
been improvements in how effectively resources can be used. Since wastage adds cost to firms then the least
wasteful production is likely to be the most profitable. A good example of the effect of technology can be seen
in the way books and reading materials are produced (see Thinking Economics Insight 6.
Thinking Economics Insight 6
Reading changes in markets…
The advent of advanced technologies has meant that the way people obtain information and the way
they interact with information is changing. Increasingly, the print media (books, magazine, journals,
newspapers) is being replaced with electronic media. This means that ‘production’ methods have
changed. Clearly there is a huge difference in the way an e-book is created and distributed than a
tangible hard cover textbook. The transition to e-books means no paper is used but more e-readers,
which use other resources to create, need to be made.
Governments can shape the ‘how should production be done?’ question by encouraging the
investment in technology. This can be done through the provision of grants or tax breaks that make
the acquisition of technologies affordable.
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