Economics Lecture One
This course requires more thinking than reading and writing. The length of the lectures and homework will be only about half the length of weekly history assignments. The extra time is for you to think more. You will have time to read and reread the materials, and think about them, in order to fully understand the concepts. Repeatedly ask yourself and others questions, and ask questions in class. Test yourself with your own examples. You may have to read and think about a concept in economics many times before you really understand it. But once you understand these concepts, you can use them your entire life, and this will help you in ways beyond money or business. This course will enable you to deal with problems and help you understand behavior by others, including politicians. Many of my students have told me that economics is the best course they ever took from me, and I teach many other topics.
Start working on the problems early in the week, so that you can ponder them a while before answering. Answers may not occur to you at first. It may be days after you read a problem, and while you're doing something completely different, when a light bulb turns on in your mind and you think, "Eureka" (I solved it!). Give yourself plenty of time for that to happen, by starting early on the problems. They are not difficult if you start early in solving them. If you get "stuck" on a problem, then you might find it helpful to look at similar problems and their model answers from the version of this course taught in 2007, which are posted along with lectures in this course online.
- 1 What Is "Economics"?
- 2 The Study of Economics
- 3 This Economics course is about far more than money
- 4 More Definitions
- 5 Scarcity
- 6 Transaction Costs
- 7 The "Invisible Hand"
- 8 Example of the Invisible Hand: "I, Pencil"
- 9 Assignment
- 10 References
What Is "Economics"?
Why should we even spend time on an economics course? Why is it important? How should we define "economics", the term itself?
It is often helpful to think about and improve the definition of an important word, as a way of increasing your understanding of it. For example, finding and improving definitions of the words "faith" and "forgiveness" can help improve our understanding of them. Let's work on identifying and improving the definition of the word "economics".
The Merriam Webster's Collegiate Dictionary (1994) defines "economics" (pronunciation is proper with either a long or short opening vowel, as "EE kuh nom iks" or "EH kuh nom iks") to mean:
- "a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services"
That definition has several terms that cry out for definitions of their own, such as "social science" and "goods and services," You might acquire a habit of having a dictionary handy to look up words when you need to.
Perhaps we can improve on that definition of economics. But let's first try to define what "goods and services" are, because they are found in the definition of "economics". At first glance, "goods and services" are the things and activities that someone is willing to purchase. Maybe you are not willing to pay for them, but someone is. Essential goods include food, clothes, cars, and books. We all pay in some way for those. The services that we need include help by doctors, dentists, teachers and barbers. A "good" is a tangible "thing", something you can touch; a "service" is an activity, like a taxicab driver transporting someone. Candy is a "good"; entertainment is a "service".
The meaning of "goods and services" extends beyond our basic needs. We do not need to go to a restaurant or a Yankees baseball game, or see a movie. We do not need to buy ice cream in order to survive. Sometimes people buy things like fancy clothes or cars in order to impress others. These are things that people want beyond what they need. And people work harder to obtain what they want for themselves, their children, and even to give to charity.
So the meaning of "goods and services" goes far beyond what people need, and includes anything they want and are willing to pay for. Note that not everything people want or need is something they are willing to pay for. We all want air in order to breathe, but we are not willing to pay for air. "Air" is not a "good or service." We all want friendship too, but that's not something that can be purchased. We all want the Yankees to win the World Series (well, not all of us do!), but we cannot directly buy that either. At most we can buy tickets in exchange for watching the Yankees play a game at their stadium. That "service" by the Yankees is a form of entertainment, like a music rock concert or a movie.
Now we are ready to define economics. We do not have to use the vague term "social science" as Merriam Webster's dictionary did. Our definition can simply be this:
- Economics is the study of the flow of goods and services.
Synonyms for "the flow" in this context include "market", "transactions", "making, buying, selling and consuming," and what Merriam Webster's dictionary said above: "production, distribution, and consumption."
You might try to improve our definition further. A weakness in our definition is its failure to recognize that some powerful concepts in our Economics course go beyond "goods and services," and include concepts like the value of time. Note that the word "economical" itself goes beyond "goods and services"; "economical" stands for minimizing waste in many different ways, such as avoiding wasted words. For example, the Latin language is described as being economical because it uses few words to say a great deal.
But that is enough about the definition of "economics"; armed with at least a working definition, let's begin to learn much more about it.
The Study of Economics
Each day there are billions of buying and selling transactions in the world. Think about how often, each day, someone in your family buys or sells something. Economics tries to understand those transactions, and what improvements are possible.
Most American families buy meat several times a week. If the price of meat is doubled, will more or less meat be sold? (Less.) We will be analyzing that type of change in purchases based on a change in price.
How we buy and sell things is almost as important as which goods we choose. Since nearly the beginning of the world, something called “money” has been the medium for buying and selling goods and services. The “money” itself has only the value that people assign to it. It can be made of a worthless material, such as green paper.
Money is not essential to a society. When we buy food, we could offer to work in exchange. Or we could grow our own food and trade the excess of our crop for the excess of someone else’s crop. This is known as “bartering”. American Indians lived well for long time without any money. So have many societies. A great deal of bartering still occurs today. The Amish are known to barter when they need services from outsiders.
But money makes transactions more efficient. Imagine loading up your shopping cart with groceries and then trying to barter with the owner of the store. You may not have any goods or services that the owner really wants. You may be a teacher, but he may not be interested in learning. Or you may be a professional football player, but he may not be a fan! Others are willing to pay to watch you play, but perhaps this grocer does not care how many touchdowns you can score. Both of you are then stuck, and you might as well unload your shopping cart and try another store.
Money solves this inefficiency. You accumulate dollars by doing work for someone who wants or needs it, and then use those dollars to buy the goods and services that you desire. The person or company who receives your dollars can then spend it in yet another way.
Money is sometimes a form of communication. Donating money to a political candidate or a charity makes a statement. Buying expensive clothes, a luxury car, or a showy house is like a form of speech too. One of the wealthiest men in history, Andrew Carnegie, wrote a book called the “Gospel of Wealth,” and then gave away his entire massive fortune before he died. Carnegie Hall, the first 39 branches of the New York Public Library, and Carnegie-Mellon University were just a few of his gifts.
When asked how much more money people want, many say they would be happy with 20% more money than they have. Remarkably, this answer is the same from the poorest to the wealthiest persons.
Freedom depends on the free exchange of money. Communism and other totalitarian systems rely on government control over how money is earned, saved and spent. Loss of this freedom inevitably results in the loss of the freedoms of religion and speech too. If we ever lose our rights to pick a job or career, then it would not be surprising if we lost our rights of worship also.
This Economics course is about far more than money
Economics has powerful insights that go far beyond money. Economics has teachings about the nature of time, marginal value, utility, and many other concepts that we will discuss throughout this course. One concept in particular, the "Coase theorem" (developed in 1960), is an economic insight that is powerful far beyond issues of money.
Learning economics will help you with your own purchasing decisions, planning for savings, choosing a career, and making business decisions. It will also help you use your talents to their fullest potential, minimize waste of your time, and avoid bad habits.
Here are two examples in the form of Latin phrases that have meanings beyond money:
- "caveat emptor" means "let the buyer beware" as he purchases something new. This concept is a helpful reminder of the dangers of harmful things like drugs and pornography, and harmful ideas too.
- "carpe diem" means "seize the day" and not waste a good opportunity. The present time is worth more than time in the distant future, when it is unknown what will be possible or even if the world will still exist as it does today. Show appreciation now, for example. The same principle of "carpe diem" can be seen in the Parable of the Talents (Mt 25:14-30) and the Parable of the Fig Tree (Luke 13:6-9) (the master gives the fig tree one more year to bear fruit, or else he'll chop it down)
Economics is special in how it focuses entirely on the present and future, and not on the past. For example, the price a good sells for does not depend on how much it cost in the past, but how much someone will pay for it now or in the future. This can be difficult for students to adjust to, as other school subjects like history are primarily about the past rather than the future.
For example, economics provides insights about the true nature of "time". In economics the value of the future is compared to the value of the present. There is no value to the past. When Christian values are superimposed on economics, the Christian faith in eternity makes the future far more valuable than the present; time spent worrying about the past is wasted time.
Economics also takes account of probability and risk, as in the famous aphorism "a bird in the hand is worth two in the bush." The two birds in the bush may fly away before you can put your hands on them. These insights go far beyond the concept of "money", and extend to many other aspects of life.
Economics is a relatively young subject or field, less than a few centuries old. There are still many advances to be made in economics, and much more value to be obtained from it. Perhaps some of the students in this class -- or your teacher -- will discover new economic truths during this course!
Economics is the single most likely course (other than a Bible course) to change a student's life for the better, as many former students have described. That is not simply because the student understands money and business better. It is because the logic of economics empowers students to recognize that hardships can be turned into blessings, that opportunities exist all around for everyone, and that the future can be made far better than the present. Economics, especially when combined with Christianity, is a logical subject that yields unlimited optimism and opportunity. Learn economics with an open mind and you will be forever glad you did.
Our “economy” is our overall system at a national level of earning, saving and spending money on goods and services. A booming economy has lots of job opportunities; a failing economy has lots of people out of work and unable to obtain a job.
“Macroeconomics” uses the Greek root "macro-", which means “big”. Macroeconomics is the study of the big picture of economics on the national level. It includes analysis of the total money supply of dollars, the Gross National Product (the total dollar value of all goods and services), and the national unemployment rate (the percentage of Americans who recently lost their job).
“Microeconomics” uses the Greek root "micro-", which means “small”. Microeconomics is the study of individual decisions about goods and services. It includes issues like how much a barber should charge for a haircut, or how much a grocery store should charge to sell a loaf of bread. Microeconomics includes the study of your decisions in buying a good or service. Our course here focuses on microeconomics more than macroeconomics.
“Net benefits” are total benefits minus total costs. For example, the net benefit of working at McDonald's is your salary minus your taxes and expenses in getting there and back each day.
“Opportunity cost” is the value lost in NOT doing something more valuable. Working at a job that pays only $5 per hour when you could have taken a different job at $12 per hour has an opportunity cost to you of $12-$5 = $7 per hour. Wasting three hours stuck in traffic has an opportunity cost of the money you could have been earning for those three hours, such as the minimum hourly wage times three hours.
“Marginal analysis” consists of looking at the costs and benefits of an incremental change, rather than the overall costs and benefits. For example, if you are already standing outside a grocery store, then the marginal cost of stopping in to buy a carton of milk is only a few minutes of your time plus the cost of the milk. But if you are sitting at home, then the marginal cost of buying a carton of milk is much greater: you must get into your car and drive all the way to a grocery store, which takes much longer and consumes expensive gas, in addition to the cost of the milk.
“Positive” statements in economics are testable claims of fact, without making any moral judgments. For example, the statement that “most public school students watch at least three hours of television a day” is a positive claim. It can be tested by doing a survey. The people are spending their time poorly, but it is a fact that they act that way. The remark that “fish live in trees” is also a positive statement. The statement is false, but it is still a positive (testable) statement. (Thanks to former Economics student Tim S. for making this insightful point on conservapedia.com).
In contrast, “normative” statements are judgments about whether something is good or bad. People should not watch as much television or smoke cigarettes. That is a normative statement. People should pray and read the Bible more often. That is also a normative statement.
We will use the word “rational”, as in “rational choice.” That means the choice or decision that maximizes the net benefit. A rational action, in economic terms, would be to accept the job with the highest net benefit (salary minus taxes and expenses). You may not actually want that job for other reasons, such as working for a company that hurts people (e.g., a casino in Atlantic City).
Finally, there is the concept of “redistribution”. That is the concept that government should try to even out the wealth in society, taking money from the rich and giving it to the poor. Redistribution inevitably causes a loss in total societal wealth. Redistribution is like a leaky bucket taking water from one pool and putting it into another, with water leaking out during the transfer. The leak in the bucket corresponds to the direct and indirect costs of the transfer, including salaries for people to do the transfer and disincentives to those affected by it (people will not work as hard if they know their property is going to be taken away).
The above concepts will become clearer for you as this course progresses.
The term “scarcity” in economics refers to anything that is not free. If a good or service costs something, even if only a penny, then it is "scarce" in economic terminology. Almost every good or service you can think of is "scarce" for the purposes of economics. There is a scarcity of gasoline, for example. Gas costs money because its supply (in refined form) is limited, and the high demand for the limited supply drives up its price. Drinking water is scarce too, because it does cost some money to obtain it. It is difficult to think of goods or services that are not "scarce" in economics. Here is a rare example of good that is not scarce: air. It does not cost money, not even a penny, to benefit from air. Its supply is almost infinitely greater than the demand for it.
Economics is about "scarce" goods and services, which is almost everything. Economists would say that television shows are scarce, while most of us would not ordinarily say that. Economists would say that junk food is scarce, while most of us would say there is too much it. Economists would say that fatty foods are scarce, even though that sounds odd. All these things cost money, and are not free (in the case of television, the "cost" to viewers includes the time they have to waste watching advertisements).
The reason for the broad definition of scarcity in economics is to include any good or service that can be bought and sold. If an item is so plentiful that everyone’s needs are fully satisfied, then there is no market to buy or sell it (e.g., ordinary air). Only those "non-scarce" goods are outside of the study of economics.
Goods that no one wants (i.e., there is no demand for them) are not scarce. For example, a new deodorant that smells like a skunk would not be a scarce good. You could charge nothing for it and your supply would still far exceed demand. Toothpaste that turns your teeth yellow would not be scarce either. How about hairspray that makes your hair fall out? If the price of a good is always and truly free, then it is not scarce.
Based on the above, can you define “scarcity” now in just four words? Here we go: scarcity consists of “wants greater than means.” If the "means" (availability) is greater than the "wants" (demand), then the good is free and it is not scarce. No one would pay anything, not even a penny, for it.
Based on our understanding of scarcity, we can now refine our definition of “economics”. “Economics” is the study of scarcity. If there is no scarcity, then everyone has what they want. There is no scarcity of air, so economics does not study the everyday uses of air. But there is a scarcity of land and oil, so we do study how they are bought and sold.
A Famous Dispute about Scarcity
There was a famous bet made in 1980 after the liberal Paul Ehrlich claimed that an increase in world population would cause greater scarcity in basic natural resources, such as copper, chromium, nickel, tin, and tungsten. A "classical" (conservative) economist, Julian Simon, predicted that people would seek and find substitutes for scarce resources, such as other materials, and that this would prevent greater scarcity and higher prices. The wager was that the liberal Ehrlich predicted that the price of these metals (also called "commodities") copper, chromium, nickel, tin, and tungsten would increase in price by 1990; the conservative Simon predicted their prices would not increase.
The classical economist Simon won the bet: the price of three of the five metals fell over that period and, when the price was adjusted for the effects of inflation, all five metals declined in their real prices. In the case of tin, its price fell from $8.72 a pound in 1980 to only $3.88 a pound in 1990. This was true even though the world's population increased by 800 million during that period.
Free market competition handles issues of scarcity extremely well, because it can find lower-cost substitutes over time, which drives down the costs to the public. For example, cheaper and better plastic was used instead of these metals during that period.
Beware of Exaggerated Scarcity
Beware of fake scarcity as a way of increasing price. The "collectors' edition," the "limited offers," and the "only one left," are all slogans designed to create the appearance of scarcity in order to create higher prices. People want things they think are scarce and limited in supply, such as gold, and are willing to pay more for it. Another example of an exaggeration of scarcity is when someone spends more time and money looking for something he lost -- because he exaggerates its value -- than the item costs to buy new. The lost item becomes very scarce in the mind of the person looking for it, but its real value is usually much less than that person thinks.
One of the most scarce things in the world is an original, perfect copy of the Gutenberg Bible - there are only 21 in existence today. Because it is so scarce, it is very valuable. But this is also an example of the mind exaggerating the significance of scarcity. Anyone can read and benefit from the Bible for free on the internet, or at a Bible study group. The owners of the scarce Gutenberg Bible probably never benefit from it by actually studying it. Owning a very scarce item does not guarantee any benefit from it.
Whenever we buy something, there are incidental charges known as “transaction costs.” These are the annoying burdens of time and money that interfere with our buying what we need or want. When you buy clothes, you have to spend time finding something you like. No one is going to pay you for that time you spend. You also have transportation costs. Then, when you finally find what you want, you have to pay extra for it to fund the salary of the sales clerk at the store. You may also have to pay sales taxes on the purchase (but not in New Jersey, which exempts clothing from sales tax!).
If you buy clothes over the internet instead, then you avoid some transaction costs but also take a risk that you might not like it when it arrives. Also, you have to pay for shipping when you buy over the internet, and the shipping costs are transaction costs.
“Transaction costs” are defined as the time, effort and added expense associated with the purchase of a good or service. Look around, and you will start noticing them everywhere. Almost nothing can be bought without all sorts of middlemen tacking on extra costs. Effort is also required by you when you buy almost anything. Some entire professions are built on transaction costs. Salesmen, for example, live off of transaction costs that are part of buying and selling goods. One could even describe health care as a “transaction cost” of living!
We will be referring to transaction costs throughout this course. They are one of the most basic concepts in economics. Often transaction costs are obstacles to the efficient purchase and sale of goods.
The "Invisible Hand"
Have you ever heard of the “invisible hand”? The most famous economist of all time, the Scottish philosopher Adam Smith, coined this term in his breakthrough tome called “The Wealth of Nations.” The “invisible hand” is the unseen force that guides individuals, who are acting to help themselves, to work in ways that benefit society. For example, the businessman who keeps his store open longer each day to make more money for himself ends up helping customers who need to buy his goods late at night.
When the early Jamestown settlers were on the brink of failure because no one was working, John Smith arrived and instituted a new rule: “He who does not work, will not eat.” Each individual then began working just to feed himself. The community soon became very successful. The invisible hand is the force that guides people to do work that is needed such that others benefit.
The opposite of the “invisible hand” is government control. In dictatorships like the former communist Soviet Union under Josef Stalin, the government dictates what people will and will not do. There is no “invisible hand.” The result is often disastrous. Tens of millions of people starved to death under Stalin’s rule due to his communistic government planning. Stalin may have even starved them intentionally.
Example of the Invisible Hand: "I, Pencil"
I am a lead pencil — the ordinary wooden pencil familiar to all boys and girls and adults who can read and write. ... I am a mystery — more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. ...
I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies — millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! ...
For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand — that is, in the absence of governmental or any other coercive master-minding — then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith. ...
The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society’s legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.
Read and, if unclear, then reread the above lecture. Complete the homework assignments at the level in which you choose to enroll in this course. You can change your mind later and shift from "honors" to "regular" or "regular" to "honors" if you like. Each week the "regular" portion will be about 6 to 8 questions, which all students should complete. The honors portion will be additional questions that the students enrolled in honors should complete.
For faster grading and feedback, you can post your answers using only your first name and last initial by following the link for the appropriate week at:
Alternatively, you can email me your homework answers. All homework is due within one week.
If you cannot figure out answers to this or any other homework assignment in this class, then try looking at the model answers to similar questions as posted here: http://www.conservapedia.com/Economics_Lectures
1. Give an example of a "good" not in the lecture, and an example of a "service" not in the lecture.
2. Imagine that your family has two options for dinner: eat at home, or go out to eat at McDonald's. Which option incurs more transaction costs? Identify two specific transaction costs. Which option is cheaper for your family, and why?
3. Define the concept of "scarcity" in your own words, and give an example of how an increase in scarcity for a good or service increases its price. Your example might be an item in a store (a good) or a special medical operation (a service), or anything else you can think of that is "scarce" in an economic sense. Extra credit: when do people exaggerate scarcity in their minds?
4. What is the “invisible hand”? Discuss what it is, using an example (which could be from the story in the lecture about the making of a pencil).
5. There are many parables by Jesus in the Gospels of Matthew and Luke (and one in Mark) which use familiar concepts of money and economics in order to teach a deeper, more profound spiritual point. Examples are at Matthew 13:18-23 and 44-46; Matthew 18:21-35; Matthew 20:1-16 and 21:33-46; Mark 12:41-44; Luke 7:36-50; Luke 12:13-21; Luke 14:15-24; Luke 15:8-10; Luke 16:1-13 and 19-31; Luke 18:9-14; and Luke 19:11-27. Pick one of these parables and explain both the economic point and the deeper spiritual point. Extra credit: why might the Gospel of Matthew have more economic parables than the Gospel of Mark does?
6. "Caveat emptor" or "carpe diem": pick one of these concepts and explain what it means to you.
Write an essay totaling about 300 words (rough approximation only) on one or more of the following topics (for example, your essay can be entirely about one of the questions below, or can address more than one of the questions below):
7. Please suggest an improvement to our definition of "economics", being as creative as you like, and explain why you think your definition might be better.
8. "Money is a good servant, but a poor master." Please explain.
9. Improve on this lecture's definition of scarcity, and/or discuss the Ehrlich-Simon disagreement.
10. (Based on a true story.) Imagine that you are riding on an airplane and need to finish a written project by the time it lands in order to earn a fee of $500. The passenger next to you, however, keeps interrupting you by complaining about how she lost a $5 bill in the airport before the plane took off. You keep telling her to forget about it, but she won't. She keeps bothering you so much that you cannot get your work done, which is worth far more than $5. What would make sense in purely economic terms for you to offer to get her to stop bothering you about it? Discuss the economics.
11. "There is no such thing as a free lunch!" Discuss the concept of (economic) scarcity in the context of that saying.
- Inflation tends to cause the prices (and wages) for everything to increase over time, such that a candy bar that costs $1 today may have cost only 10 cents in the 1950s. When comparing prices from different time periods, it is necessary to "adjust for inflation" to compare their "real" cost in the value of money at the particular time.
- The Gutenberg Bible was written in the Latin Vulgate.
- The full essay by Leonard E. Read is available from the Foundation of Economic Education ("FEE") at http://www.fee.org/publications/the-freeman/article.asp?aid=3308