The Fundamentals of Economics

Economics is the study of how individuals, businesses, and societies (run by a governing body) handle scarcity. The principles of economics provide a foundation for good decision making for all three groups.

There are two branches of economics: macroeconomics and microeconomics. Microeconomics is the study of how individuals or individual businesses allocate resources. Macroeconomics looks at how the economy as a whole works.

Individuals, businesses, and societies have

• unlimited wants; and
• limited resources (land, money, labor, time, and so on).

Because wants are unlimited and resources are limited, decisions need to be made about how to use the available resources. Something must be given up to get or achieve something else.

• Trade-offs are ALL the alternatives that are given up when a choice is made about how to use resources.
• Opportunity cost is the most desirable alternative that is given up when a choice is made.

Any decision that involves a choice between two or more options has an opportunity cost. Going to a restaurant involves time and money. That time can’t be used to study for a test, and that money can’t be spent on going to a concert. Every choice has a value. The final choice has more value than another choice that was available.

People go to work or to school because they are self-interested. They seek personal gain. The reward, or incentive, for going to work is a paycheck. The reward for going to school may be a better job with a bigger paycheck.

• Decisions are influenced by incentives, which can be rewards or punishments.
• Self-interest is the prime motivator in decision making.
• In general, people take action when the benefit is greater than the cost.

Adam Smith, the father of modern economics, reasoned that the best economic benefit for all can usually be accomplished when individuals act in their own self-interest.

To summarize, there are five major economic assumptions:

• Individuals, businesses, and societies have unlimited wants and limited resources (scarcity).
• Choices must be made due to scarcity. Every choice has a cost, or something that was given up to get it (trade-off).
• Everyone reacts to incentives and their own self-interest.
• Everyone makes decisions by weighing the benefits and costs of every choice.
• Real-life situations can be explained and analyzed through models and graphs.