What is economics?

By Abi Tyas Tunggal 15 March 2018 4 min read


  • Economics looks at the most efficient distribution of resources to people;
  • Macroeconomics looks at national production and international trade;
  • Microeconomics looks at individual and business production;
  • Scarcity is the tension between our limited resources, and our unlimited wants and needs.

Before we get into the nitty gritty, it's important we first outline the underlying concepts of economics.

We like to think of the economy as a machine that exists to produce and provide for people, by providing the goods and services we need to live and hopefully, do what we want to do.

A growing economy is usually driven by one of two things:

  • The population is growing; or
  • The population is geting richer.

The size of an economy is measured by metrics like Gross Domestic Product (GDP), a measure of the value of all goods and services produced by a country in a year.

So next time you hear that there is an increase in GDP, just think that the economy is growing. An economy with a stagnant or worse, a shrinking GD,P is not something to look forward to for most of us.

Economic systems

An economic system as the way things are produced and then allocated to people. If we step back and look at early agrarian societies, individuals tended to produce everything they needed and wanted at a household level.

If you needed food, you grew food. If you needed a house, you built it, and if you needed clothes, you sewed them.

Economics call this a self-sufficient economic system, with little division of labour and little specialisation. Agrarian societies were largely based on reciprocal exchange between family members. The idea of private property likely didn't exist because what you had was produced by your family anyway.

What happened next was economies based on social classes like feudalism. Feudalism was a system where a small percentage of the population, the nobility, owned all the land and leased small parts of it to peasants to live and work on, leading to peasants handing over much of their output back to the nobility in the form of rent and protection.

Then along came capitalism and the industrial revolution. Capitalism is the current economic system for most of us. It's a system where business owners (capitalists) produce goods and services for sale to make profit and not for personal consumption. Capitalists run their businesses by hiring workers in exchange for wages, and workers don't own their tools nor the end product.

This is effectively the opposite of what happened in agrarian societies.

While capitalism seems natural today, it's a strange idea. You make something with your own hands, but if you take it home, you're stealing because you created it on company time, with company tools.

Capitalism has led to deep specialisation where we prefer to exchange our time for money, and money for finished goods rather than plant our own food in our spare time. We're relying on the market to allocate and distribute the goods and services we need and want, rather than creating them ourselves.

This means private property is at the centre of any capitalist economy. You may have heard of socialism and communism, so we'll touch on them briefly here.

Socialism is a system where workers own the business and share the profits. Contrast this to a capitalist system where a business owner retains private ownership of the business and hire workers in exchange for wages. Socialist economies produce goods for profits and use the markets to distribute their goods and services like capitalists.

A communist economy is one where private property ceases to exist, and rather than using the markets to organise production, communists have a central planner who distributes goods and services based on need. In practice this has turned out to be a hard, if not (practically) impossible task.

Although, these humans are exercising their right of self determination through self-government.

What is scarcity?

Scarcity is the tension between our limited resources, and our unlimited wants and needs. If you've ever looked at your bank account and realised you don't have enough money to buy those flights you wanted, you already understand scarcity.

As individuals, we have limited resources like time, money, and skills. Countries have limited resources, too, like its natural resources, capital, labour force, and how technological advanced they are.

If scarcity didn't exist, economics wouldn't matter. Everyone would be able to get whatever they want, whenever they wanted it.

But because our resources are limited, economics does matter. Most of us want more than we can afford. We make decisions about what goods and services we buy and produce, and which ones we can go without.

The same is true for businesses, governments and any other economic actor.

Again, economics is the study of how we make decisions and how we allocate our scarce resources most efficiently.

The macro and the micro: Macroeconomics and Microeconomics

Generally there are two ways to study any system, at the macro level (top down) and at the micro level (bottom up), economics is no different.

Macroeconomics looks at the economy on a national and international level. This means looking at GDP, the total output of a nation, and how the nation allocates its limited resources of land, labour, and capital.

We also look at international trade, fiscal and monetary policy, inflation and interests rates, national unemployment, and more. A good rule of thumb is if it affects a lot of people, it falls under the realm of macroeconomics.

Microeconomics looks at the individual and their firms within an economy. That means looking at human behaviour to find how people and firms react to changes in price, and why they demand goods at one price point, but not at another.

Think of microeconomics as a way to explain how and why different goods are valued differently, and why individuals make the financial decisions they do, and how all these individuals come together to affect the macroeconomic environment.

While macro and microeconomics are different, understanding one will help us understand the other, and hopefully lead us to make better, more informed decisions when we're allocating our own scarce resources.

What is economics?