Lesson summary: Introduction to Macroeconomics

If you want to sum up what economics means, you could do so with the following statement:

Individuals and societies are forced to make choices because most resources are scarce.

Economics is the study of how individuals and societies choose to allocate scarce resources, why they choose to allocate them that way, and the consequences of those decisions.

Scarcity is sometimes considered the basic problem of economics. Resources are scarce because we live in a world in which humans’ wants are infinite but the land, labor, and capital required to satisfy those wants are limited. This conflict between society’s unlimited wants and our limited resources means choices must be made when deciding how to allocate scarce resources.

Any economic system must provide society with a means of making choices that answer three basic questions:

What will be produced with society’s limited resources?
How will we produce the things we need and want?
How will society’s output be distributed?

Key Terms

Term	Definition
economics	the study of how individuals and societies choose to allocate scarce resources.
scarcity	the fact that there is a limited amount of resources to satisfy unlimited wants.
economic resources	also called the factors of production; these are the land (natural resources such as minerals and oil), labor (work contributed by humans), capital (tools, equipment, and facilities), and entrepreneurship (the capacity to organize, develop, and manage a business) that individuals and businesses use in the production of goods and services.
models	graphical and mathematical tools created by economists to better understand complicated processes in economics.
*ceteris paribus*	a Latin phrase meaning "all else equal".
agent	some entity making a decision; this can be an individual, a household, a business, a city, or even the government of a country.
incentives	rewards or punishments associated with a possible action; agents make decisions based on incentives.
rational decision making	an agent is "rational" if they use all available information to choose an action that makes them as well off as possible; economic models assume that agents are rational.
positive analysis	analytical thinking about objective facts and cause-and-effect relationships that are testable, such as how much of a good will be sold when a price changes.
normative analysis	unlike positive analysis, normative analysis is subjective thinking about what we should value or a course of action that should be taken, such as the importance of environmental factors and the approach to managing them.
microeconomics	the study of the interactions of buyers and sellers in the markets for particular goods and services
macroeconomics	the study of aggregates and the overall commercial output and health of nations; includes the analysis of factors such as unemployment, inflation, economic growth and interest rates.
economic aggregates	measures such as the unemployment rate, rate of inflation, and national output that summarize all markets in an economy, rather than individual markets; economic aggregates are frequently used as measures of the economic performance of an economy.

Models and graphs

Economics is a social science. This means that economists, in their study of human interactions, use models to simplify, analyze, and predict human behavior. Models include graphs and mathematical models.

The purpose of these graphs and mathematical models is to simplify the many interactions that occur in an economy. In their use of models, economists usually make the assumption, when analyzing the effect of a particular change on a market or on a nation’s economy, that all else is held constant. The term we use for “all else equal” is the Latin expressions, ceteris paribus.

Another assumption economists make is that economic agents are rational and have an incentive to make decisions that are always in their own self-interest. While in reality human beings often act irrationally, by assuming people, businesses, governments, and other agents are rational decision-makers, and by assuming ceteris paribus, economists attempt to establish laws and make predictions about how human interactions will affect society.

When thinking about economic problems, we can use either positive analysis or normative analysis. Positive analysis is objective, fact-based, and cause-and-effect thinking about problems. When economists disagree it is typically due to different normative analysis. When using normative analysis, the focus is on what should happen or how desirable one action is compared to a different action.

The study of economics is sometimes broken down into two disciplines: microeconomics and macroeconomics. Microeconomics examines the interactions of buyers and sellers in individual markets for goods and services, the competitive structure of markets, and the markets for resources. Macroeconomics examines the interactions and behavior of entire nations' economies, such as why recessions occur, what causes economic growth, and how countries can benefit from specialization and trade.

Common Misperceptions

Economics is not the study of stock markets, money, or how to run a business. Although many new students believe they will be learning about these concepts, economics is a social science that seeks to better understand and predict human interactions; unlike business and finance, which focus on how to manage a business organization and invest money in a way to earn the highest return for investors.
One essential assumption made in most economic analysis is that all humans are rational and will make choices based on what is always in their best interest. In the real world, obviously, people, businesses, and even entire societies can be highly irrational.
Just because a decision is "irrational" in the economic sense, that doesn't mean that it is inherently wrong, bad, or lesser than what an economist would call a "rational" decision. In fact, the field of Behavioral Economics seeks to understand better the many reasons humans choose to make economically "irrational" choices in their decision making.
One of the four economic resources that societies must decide how to allocate is capital. When people use the word capital in everyday conversation, many people are referring to money or “financial capital.” In economics, capital is defined as the already-produced goods (tools, machinery, equipment, and physical infrastructure) that are used in the production of other goods or services. A robot on a car factory floor is defined as capital in economics; money you borrow to start your own business is not.

Discussion questions

Victorian historian Thomas Carlyle once called economics the "dismal science" because he believed it obsessively focused on the scarcity of resources. What does the field of economics provide society that other sciences such as chemistry, biology and physics cannot?
Using at least three key terms from this lesson, explain how scarcity affects you in your everyday life.
What are the three basic economic questions? How have different societies that you know about or have studied in other classes attempted to answer these questions?

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