Basic Principals of Economics

Understanding economics can seem to be a daunting task, but by learning the basics on this subject a strong foundation will be set for future learning. High school courses often scare students away from the study of the economy because of the over compounded material and unanswered questions. When understood, economics is fascinating and a great conversational topic. The following is a brief overview of economics and some key terms associated with this subject matter.

By definition, economics is the study of how to best allocate scarce resources among competing uses. So if you were looking at this from a government stand point, resources would be output according to the country's needs and best interests. In America many resources are available; however sometimes our wants exceed our resources because of scarcity. For example, time may be a limited resource when preparing for an exam. A student must decide what they are willing to sacrifice in order to have more time to study, and this would be opportunity costs. Opportunity costs are the most desired goods and services that are given up in order to obtain something else. Other activities that may take up this scarce resource may be watching television or even sleeping, and they must be given up in order to gain more time. Choosing which opportunity costs to give up is economics.

Resource inputs used to produce goods and services are called factors of production, which consist of land, labor, capital, and entrepreneurship. With so many resources available there are countless combinations of goods and services that can be produced in a given time period and this is called production possibilities. The expansion of production possibilities increases output (Gross Domestic Product) and results in economic growth. Investments made by land owners or business owners are a key factor in economic growth. Usually business owners invest according to the market mechanism. The market mechanism is simply the use of market prices and sales to signal desired amount of output. If a product is selling quickly and maintaining a fair market price companies may invest more money to produce more of that product. Contrary to some belief, the United States government has learned that leaving the market mechanism alone is usually best for the economy. Laissez faire, which means leave it alone, is non-intervention from the government in the way goods and services are priced and sold. There are organizations of the government that may enforce laws that protect consumers, such as The Federal Trade Commission, but the government does not set prices. If the government does step in to intervene and fails, this is then called government failure. When there is a kink in the market mechanism, market failure may result. Market failure is an imperfection in the market that prevents optimal outcomes.

The production possibility curve is used to describe the many variations of resource input and production output to help select the best mix. To find an optimal mix in an economy there are three basic questions that must first be answered: what to produce, how to produce, and for whom to produce. A production possibility curve shows combinations of final goods that can be produced in a given time period with available resources and technology. This curve will answer the first basic economic question of what to produce. To understand the possibility curve we must first decide how much of each good could be produced and how many resources, or factors of production, are available. The more resources available, the more output can be produced. There is no one single point on the curve that is right for every nation at all times; the curve is forever changing to accommodate needs.

America is a mixed-economy which means market and non-market signals are used when deciding how to best allocate goods and resources. Externalities are non-market symbols that the economy may follow when producing goods or services. For instance, a company may save money by dumping waste in a nearby water way than disposing of it safely; however the resulting pollutants are an externality. Externalities are costs imposed on innocent third party victims. This is where the government does step in to make sure that even though the market mechanism allows for a company to use all of their resources to successfully produce goods, some of their resources must be used to prevent harm on others. These factories must use their own time and money to ensure that environmental laws are followed. Today, with the growing concern of global warming, many factories are going above and beyond laws regulated by agencies such as the Environmental Protection Agency. They are spending more of their own resources to prevent pollution, and this for them is an opportunity cost. These companies are giving up money and for social concerns.

Companies that choose to produce ethically are answering the second economic question of how to produce. Their goal is to find an optimal method of producing goods and services. Factors these producers take into account consist of, but are not limited to, efficiency, social concerns, and internal affairs. They must take consider the effects their production choices and products have on their consumers. If there is a negative effect, such as too much pollution, consumers may not purchase their goods. At the same time they must maintain efficiency while keeping their employees safe and happy.

The third economic question is for whom to produce and the answer to this can differ greatly from nation to nation and company to company. If the "whom to produce" question is not properly answered and executed the market may fail to distribute goods in the best possible way. In a communist nation goods are distributed based upon needs rather than the democratic nation's method of every person being productive and contributing to the economy. Living in a communist country means that if you need bread, you will receive bread with no input needed on the economy. The downfall is that when members of that community receive everything they need without contributing to production they will have no reason to contribute and production can quickly come to a halt.

There are pros and cons to every economy, but what works best in some places will not work in others. The key is to find the best optimal mix. Whether relying solely on the market mechanism or regulations by the government, the economy must be made up of well thought out and executed planning. Investors are what make the economy stronger, and they invest based upon what the market mechanism shows needs to be produced. Basic questions that must be answered by producers are what to produce, for whom to produce, and how to produce. Living in a mixed economy means that other signals, aside from those of the market mechanism, are used when deciding how to best allocate resources.

I hope this brief overview of economics answered some questions and sparked new interest in the topic. I am looking forward to discussing more about economics in future articles.