An introduction to economics terms and concepts

 

 

INTRODUCTION

A simple and most widely quoted definition of economics is that given by the British Economists, Lionel Charles Robbin (1898 – 1984):

Economics is the science which studies human behaviour as a relationship between ends and scare means which have alternative uses.

In the above definition, the word ‘ENDS’ refers to human wants usually classified as goods and services.  The word ‘MEANS’ refers to productive resources otherwise called factors of production.  In every society, the productive resources are combined in different ways to produce different types of goods and services.

Economics is described as a science subject based on the way economists study and explain human behaviour concerning how best to allocate scarce resources among competing uses.  The economists adopt scientific method in which theories of human behaviour and developed and tested against the facts in a way similar to the practice in the pure sciences like Chemistry and physics.  However, economics is more appropriately placed within the social sciences because its subject matter, human behaviour in the production, distribution and consumption of goods and services can neither be controlled in the laboratory nor be predicted with absolute accuracy.

BASIC ECONOMIC CONCEPTS

A number of basic concepts or terms lie at the heart of economic science.  The most important ones are explain in this section.

Economy

The word is used to refer to a particular system of organisation of economic activities i.e. production, distribution, exchange and consumption of all things required to satisfy human wants.  Goods and Services

In economics, the term goods refers to material or physical things which can be seen or touched and used to satisfy human wants.  Examples include food items, cars, shoes, wristwatch, industrial equipment and machinery’s, etc.  Goods are classified in different ways.  One classification is economic goods and non-economic goods.  Economic goods are those goods which have prices and their production requires scarce resources having competing uses.  On the other hand the term non economic goods refers to things that are unlimited in supply and can be obtained free-without paying a price.  Examples on non-economic goods are stream water, gutter sand, sunshine, air, bush trees, etc.

Economics activities other than manufacturing or primary goods production are referred to as services.  Examples are banking, shipping, legal, insurance, tourism, medical care, etc.  But it is also common in economics to use the term goods to refer to both material goods and services which, in this case, is regarded as non-material goods.

 

Resources

These are things which are combined in numerous ways to produce goods and services required for the satisfaction of human wants.  Such things are alternatively referred to as factors of production, and can be classified as:

1.Natural resources: all free gifts of nature such as arable land, water, minerals (such as limestone, good etc), fishing ground, forests, hydroelectricity and solar energy potentials etc.  Natural resources are collectively referred  to as land in economics.

  1. Human resources: human efforts in the production process which consist of various mental and physical ability and skills. The term labour is used for human resources.
  2. Capital: man-made resources such as roads, dams, buildings, equipment’s and machines which help in the production of other goods that satisfy human wants directly or indirectly.
  3. Entrepreneurship: the person (in case of one-man business) or the business owners/managers who co-ordinate the other factors of production to produce and market goods and services and possibly invent and innovate.

Utility

This is the economist’s term for the satisfaction and need fulfilment that people derive from the consumption use of material goods and services.

Stock and Flow

The term stock refers to a variable which has no time dimension e.g. 1,000 bags of cement stored in a warehouse pending sales, which can occur anytime.  On the other hand, if a variable has time dimension, it is called a flow.  In other wards, the term flow refers to the quantity of an economic variable measured over a particular period of time.  It follows that 1,000 bags of cement produced or supplied per day by a cement company is a flow

Ceteris Paribus

The Latin phrase meaning “all other things being equal”.  The ceteris paribus assumption is more commonly used in economic theory to isolate the effect of a change in one variable or influencing factor.  This implies that “all other variables or determining factors are held constant”.  Economic theories are simplified and their validity enhanced with explicit or implicit use of ceteris paribus.

Rational Behaviour

As used in economics, behaviour in which economic agents i.e. individuals, firms and government do the best they can under given circumstances.  For example, the assumption of consumer rationality implies that the average consumer in his purchasing decision will always prefer more to less, or the basket of goods that will give him the maximum utility given his money income and the unit prices of the goods.  The assumption of rationality permits us to explain and predict how people will act under specific conditions.

MICROECONOMICS AND MACROECONOMICS

Traditionally economics is divided into two main branches: microeconomics and macroeconomics.

  1. Microeconomics

Microeconomics is concerned with specific segments of the economy, particularly the behaviour of individual consumer and firm and of groups of firms in industries.  As a branch of economics, it examines how resources are organised, controlled and rewarded in various economics activities, as well as how relative prices of goods and services are determined.  The main topics falling within microeconomics include the theory of price and wage determination, the theory of consumer behaviour, the theory of production and welfare economics.

  1. Macroeconomics

Macroeconomic is the study of the economy as a whole.  In macroeconomics; emphasis is on aggregate economic variables such as the economy’s level of employment, total output and income, total money supply, overall government spending, the levels of taxes, investment and saving, and so on.  It follows that macroeconomics explores the problems of unemployment, inflation, external disequilibrium. Sluggish economic growth, general poverty and inequality in the macro economy.

BASIC ECONOMIC PROBLEMS

The fundamental economic problems facing every society are discussed in this section

Scarcity

Economic scarcity means that people do not have as much as they desire.  The problem of scarcity arises as a result of the fact that, at any point in time, the productive resources available in any society are limited, whereas human wants are unlimited.  It follows that the amount of goods and services that can be produced are limited and inadequate to meet human wants.

Therefore, every society must resolve four fundamental economic questions.

  1. What is to be produced? Every society must determine in some manner what goods and services and how much of each to produce during any given period of time.
  2. How is the output to be produced? Each firm must decide how to combine the inputs to achieve optimal resources allocation i.e. the manner of combination of factors of production in order to produce quantum of goods and services.
  3. For whom to produce? That is, for which category of consumer is the goods being produced. Is it for the young, the old or for both categories?
  4. How to facilitate future growth? The resources must be utilized at a rate that would enhance future production possibilities.

Scarcity is the most fundamental economic problem facing every society.  If resources are not scarce, goods and services would not be scarce and there would be no need to economise.  Consequently, there would be no need to study economics.

Choice

Choices become necessary as a result of scarcity.  Making a choice implies giving up something in order to get something else.  The concept of choice relates to all the three main economic agents in the economy.

  • An individual consumer must choose among types of goods and services, between present and future consumption because of his limited money income.

 

  • The firm must choose what to produce and how to produce within constraint imposed by its limited resources.
  • The government must decide what public goods and services to provide for the people given its limited revenue as projected in the budget documents

ECONOMIC SYSTEMS

An economic systems describes the mechanisms by which scarce resources are allocated in society, both for production and distribution, the nature of the relationship between the individual and society and the role of government in allocation of resources and the direction economic activity (Donnelly, 1991)

Types of Economic System

The three main types of economic system – capitalism, socialism and mixed economy are explained in this section.

Capitalism

This type od economic system, otherwise called free market, free enterprise or laissez – faire economy is based  on private ownership and the freedom of individuals and firms to conduct their economic activities without interference from the government.

(a)  Features

The main features of capitalism are:

  1. Private ownership: Private individuals and firms own the means of production and goods in the economy.
  2. Freedom of choice: Individuals as consumers are free to spend their money income on those goods they consider desirable to satisfy their wants. This idea is called consumer sovereignty  and it influences what the producers will produce at any point in time.  Hence the statement in the market – economy consumer is the king”.

Similarly, the firms are also free to produce any good they want and which they are capable of producing.

  1. Limited role for government: The functions of the government are limited to provision of enabling environment, rules and regulations for private economic activities to thrive.
  2. Competition: Individuals and firms freely compete for goods and resources.

Therefore, in pure capitalism, the fundamental questions of what to produce, how to produce and for whom to produce are resolved by price – mechanism i.e. the interplay of the forces of demand and supply.

(b)         Advantages

  1. Optimal allocation of resources: Producers engage their resources only on those goods which appear to yield maximum profits.

 

  1. Greater output and higher income: There is increase in production and productivity leading to increase in income, saving and investment.
  2. Increase in efficiency: The presence of competition leads to a better use of resources to obtain cost advantage.
  1. Progress and prosperity: Intense competition promotes invention and innovation thereby bringing economic growth and prosperity.

(C )         Disadvantages

  1. Emergence of Monopoly: cut – throat competition may force small firms who could not cope to shut down while the big firms may merge and monopolise the market charging exorbitant prices.
  2. Inequality problem is worsened: the rich who own resources and control production are favoured while the poor become more impoverished.
  3. Inefficient production: more resources are allocated to the production of frivolous goods that are desired by the rich who have the means while the basic necessities required by the poor are in short supply.
  1. Economic depression and unemployment: excessive competition and unplanned production leads to excess supply, low price level and cut in the number of workers

Socialism

It is otherwise referred to as the command or centrally planned economy.  The economics of former Soviet Union, Cuba, a number of Eastern European countries and China are often cited as ready examples.

  • Features

The main features are

  1. Public Ownership: means of production are owned entirely by the central government.
  2. Public Allocation and Distribution: Prices of goods and services are fixed by the agencies of government. In order words, the fundamental economic questions of what to produce, how to produce and for whom to produced are solved by the government.
  • Advantages
  1. Greater economic efficiency: the government ensures that resources are allocated to those sectors where they can be used most productively.

Therefore, production efficiency is greater than under capitalism.

  1. Absence of Wasteful Competition: Duplication of goods and services or use of resources on extensive advertisement campaign is avoided.
  2. Less Inequality of Income: Every member of the society is taken care of within the limits of their relative capabilities and the overall resources of the state.
  3. Exploitation of Private Monopoly if avoided: State monopoly exists only to promote overall welfare of the people.

( c) Disadvantages

  1. Misallocation of Resources: Resources allocation is based on trial and error and selfish interest of the ruling class leading to underproduction of goods required by the poor majority.
  2. Loss of Consumers’ Sovereignty: Consumers are restricted to only the goods and services dictated for production by the state.
  3. No Freedom of Enterprise: Every person is employed by the government and there is tendency for underemployment misallocation of human resources.
  4. Waste of Resources: Central Planning requires large bureaucratic structures which waste resources.
  5. Poor Quality Product: The absence of competition weakens the drive for producers to improve on products’ quality.

Mixed Economy

It is an economic system which combines features of both capitalism and socialism.  In a mixed economy therefore, there exist private and public ownership of productive resources.  In those areas where the private individuals and firms are dominate, allocation and distribution of resources is done by price – mechanism.  But in those activities reserved for the government, central planning and administrative fiat decisions are used to solve fundamental questions on allocation and distribution of resources, goods and services.

The state intervention, however, is considered necessary to remedy the defects of the market economy earlier identified.

In the real – world, all economics are mixed, but the extent to which one mixed economy differs from another depends largely on how the government interprets its role in the economy.

  • Advantages
  1. Best allocation of resources. A mixed economy combines the good features of both capitalism and socialism. Therefore, the resources of the economic are utilised in a way that ensures the adequacy of all types of goods and services and production efficiency increases,
  2. General Balance. The competition and cooperation between the public sector and the private sector favours the realisation of a high rate of capital accumulation and economic growth.
  1. Welfare State.  In a mixed economy, there is no exploitation either by the capitalist or by the state.  Government agencies are established to protect consumers’ interest, while legislative measures are adopted to reduce poverty and inequalities of income and wealth.
  • Disadvantages
  1. Non-cooperation between the private and the public sector. In real – life, public – private sector partnership to promote economic progress is hardly found.  Most often, the private sector is subjected to heavy taxes and restrictions that impact negatively on its performance, while the public sector is given subsidies and preferences.
  2. Inefficient public sector. The public sector of a mixed economy works inefficiently due to bureaucratic control, over-staffing of the personnel, corruption and nepotism.  As a result, resources are mis-utilised and the level of production is low.
  3. Economic fluctuations. Periods of economic prosperity and hardship alternating which are characteristic features of a capitalist economy are equally experienced in a mixed economy. This is a result of the improper mixture of the features of capitalism and socialism.

Functions of an Economic System

All economics perform the following functions

  1. Allocation of Resources: Every economy has to decide what and how much good and services to produce at any given time.
  2. Organisation of Production: Every economic system must decide what alternative techniques of production are more suitable to its circumstances.
  3. Distribution of Goods and Services: How the goods are shared among people is determined in every economic system.
  4. Economic Growth and Development: The mechanisms to grow the economy and raise average living standard at determined in each economy.
  5. Economic Stability: Every economic system had mechanisms designed to control fluctuations in the level of economic activity eg. Using fiscal and monetary policies.

THE METHODOLOGY OF ECONOMICS

This section addresses how economists organize their studies to make economic science a worthwhile field of human endeavour.

  • The Scientific Method

Economists adopt scientific method in their investigations of economic problems and economic relationships.  In this method, problems and identified and defined, information relevant to the problem are collected, organized and analysed leading to the establishment of an economic theory.

  1. An Economic Theory

An economic theory otherwise referred to as economic law, economic principle or economic model helps to explain human economic behaviours especially production, distribution, exchange and consumption, as well as to predict the likely course of future events.  An economic theory to a particular problem on certain assumptions.  The usefulness of any theory to a particular problem situation depends on how realistic the given assumptions are.

  1. Words, Graphs and Equations

In economic discussions, three types of language are used – verbal, graphic and mathematical.

  1. Verbal Statement: The use of words is often the easiest way to presentation. It has the advantage of making discussions in economics available to a wide audience.
  2. Graphs: Because of their visual appeal, graphs are used as a further aid to understanding economic discussions. Moreover, graphs provide a clear picture of the relationship between two economic variables.
  3. Equations: Complex relationships, especially three or more dimensional relations or more are expressed in mathematical language – algebraic statement or functional relationship. However, for ease of presentation, variables are often reduced to two so that they can be shown on graphs.
  4. Limitation of Scientific Method in Economics

The nature of the subject matter of economics i.e. human behaviour  imposes limitations in the use of scientific method in economics.  Measurements and controlled experiments, which are vital in the physical sciences, are rarely applicable in economics because people cannot be expected to behave as predictably as inanimate matter, which can be subject of controlled laboratory experiment.

  1. Positive and Normative Economics

Economics analysis can be divided into two – positive economics and normative economics.

  • Positive economics is concerned with describing and analysing the way things are or things will be if certain conditions exist. For instance, the statement, an increase in demand for a commodity will cause its price to increase when other factors influencing demand and supply condition remain unchanged is a statement in positive economics.  In other words, positive economics is an objective science, which provides explanations of the working of the economic system.

 

  • Normative economics, on the other hand, is concerned with what ought to be, particularly how economic problems should be solved. It is a subjective science dealing with those areas of human economic behaviour in which personal value judgements are made.  Normative economics gives rise to statements such as  ‘money supply should be reduced to lower inflation rate in the economy’