The basic economic problem is one of scarcity - individuals wants are unlimited and the resources available to the individual are limited. So one can say scarcity lies at the root of the economics and because of this individuals, and then also various groups of individuals (households, firms, and countries) are faced with choices as how to to utilise their limited resources to satisfy their unlimited needs. These choices depend on the value that the satisfaction of each of their needs have for them - this need satisfaction acts as the incentive to behave in an economically rational way so as to optimise the value in utilising the resources. The rational decision maker will always attempt to meet the most pressing need first.
The study field of economics can be split into two relatively distinct fields:
- Microeconomics - The study of choices that individuals, households and firms make to optimise need satisfaction. How prices are formed in a market, how individual firms decide their quantities of output under different market conditions.
- Macroeconomics - The study of larger groups such as governments, countries and international trade - together with issues such as aggregate supply and aggregate demand, Economic Growth, sustainable economic development, the business cycle.
The major issues that define the area of the field of economics:
1) How do choices that are made result in decisions of. how, when, where and for whom goods and services are produced?
2) What is the relationship between individual choices in terms of individual self- interest related to the common good, social interest and sustainability?
Goods and services are the means that individuals use (consume) in their attempt to satisfy their needs.
For these goods and services to come into existence firms employ the factors of production that are owned by the households (Land - raw materials, Labour, Capital - machines, Entrepreneurship). These are remunerated by paying the households rent, wages, interest and profit). Households use this income in turn to pay for the goods and services - in this process a money-good flow comes into being - a circular flow of income (from supplying the factors of production) and spending (on the goods and services required to satisfy ones needs). Theoretically then income is equivalent to spending. If one adds up all income it would equal all expenditure (if there were no savings and no products were unsold).
A formal definition of Economics then: It is the social science exploring and studying the choices that need to be made when solving the problem of how the unlimited needs of people are and can be satisfied by the relative scarce resources available ( after been turned into usable goods and services by individuals firms and other organisations in society).
Economists study the resultant and accompanying phenomena of: Economic growth, unemploment, poverty, prices as well as concepts such as business cycles, government failures, markets and so on.
I have read the words "we all want everything" in an Economics textbook (ECONOMICS for South African students - Mohr, Fourie and assoc., p6) again today - what nonsense! I do not want the tiara worn by Marilyn Monroe, I do not want Ghandi's spinning wheel, I do not want Charlie Chaplin's walking stick... or a polka dot bikini or... I want a cold Castle to start off with and I want that the High Court does not lose my file...My wants are unique to me. Do not tell me what I want and I definitely do not want what you want (or your wife!). I do not want cigarettes - so do not say "we all want everything" - it is not true.
The textbook continues and says that choices between alternatives uses of resources are DIFFICULT choices to make - it does however not say why - it is because the choices are AT THE MARGIN. If I have just run 100kms in the blazing sun and someone offered me the choice between a Castle and a video titled "Mentally preparing yourself for an ultra marathon", I think the choice will be clear cut. Less clear if the choice was between the Castle and a Thai massage. Most choices are at the point where the marginal utility of the choices are small or non-existent (the benefit values are close) . That is why it is difficult to make them. This argument brings us to the concept of "opportunity cost". For every unit of value you have to spend - be it time, money, or any other measure of value, one has only one benefit that one can spend it on. When I drink my Castle, I have foregone drinking a nice cup of coffee, a cup of soup, tea or a whisky - even cycling or updating a website (at that very moment). Those are all the costs (foregone opportunities) that I had to "pay" do take my swig of beer. They were the opportunity costs.
The official definition (Mohr, p7) states: "The opportunity cost of a choice is the value to the decision maker of the best alternative that could have been chosen, but was not chosen."
Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (the one that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not necessarily restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.
The term was coined in 1914 by Friedrich von Wieser in his book "Theorie der gesellschaftlichen Wirtschaft". However, in 1848 Frédéric Bastiat described this concept in his essay "What Is Seen and What IsNot Seen"
To fully understand the concept of optimising the value of a choice you first need to fully grasp the concept of diminishing utility when consuming one product and then see how a rational person would optimise his/her total utility when faced with a choice between two products and a given quantity of resource (money value) available. You can read more of it in the handout titled "The law of diminishing returns"
Have a look at the handout below written by me for good definitions of "Economics" or click here.
C. M. Heydenrych 2013