1. What Economics Is

CH A P T E R 1

What Economics Is

Economics is an exciting fi eld.

Th e economics of old sought to uncover how the world works. It showed, or even proved, that there is a natural order to it. Th ere is structure to the apparent chaos. Th e economy has something of a life of its own: it has a nature. Th is means not only that we can study it and learn about its ways, but also that we are not free to tamper with it at will and cannot make it work in ways that we might prefer but that are not in line with its nature. Th ere are “laws” by which the economy works, and they are immutable. Economics over the past three centuries has been about identifying, learning, and understanding those laws.

Core to understanding the economy is recognizing that it is about human actions and interactions. In fact, the economy is people acting and interacting. It is little or nothing else. We tend to think of the economy in terms of resources, machines, businesses, and perhaps jobs. But that is a simplifi cation that is misleading. Th ose are important, but they are all means to ends. Th e economy is about using means to attain ends. To put it diff erently, it is how we act to satisfy our wants,

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to make us better off . Simply put, the economy is about creating value.

Our means are limited but our wants are not. We must fi gure out how to make as much as possible with the little we have. If we choose to pursue one end, then we cannot use the same means to pursue other ends as well. In other words, there is always a tradeoff . Every choice we make and every action we take means that we forego what we did not choose. Either you take the car for a drive or you stay at home. You cannot do both at the same time. You can use your money to buy one thing, or to buy another. Or you can save your money for another time. But the same money cannot be used both to buy something and be saved too. Your choice of one thing means you did not and cannot choose the other. By choosing one thing over another, by acting, we rank things’ value to us—we economize. Th e economy is all of us economizing.

The Economy

Th e economy is an unplanned order. It is what emerges when people go about their own business, when we act and interact as we see fi t.

Th e French nineteenth-century economist Frédéric

Bastiat captured this in a question: “How does Paris get fed?” Living in a large city, Parisians do not produce food but still have abundant access to it. Th e important question is how this comes to be. Aft er all, there is no central plan for what types and quantities of foods are to be off ered to Parisians and when. Th ere is no one telling farmers when and what to sow, which land to use for each crop, what tools to use or develop, or in

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what cities, towns, or market squares to sell their produce and at what prices. All of this just happens. Th e economy is a decentralized and distributed system where all people—farmers and city folk alike—make their own plans and decisions. Th ey do not simply carry out orders from some central command.1

Th e aim of economics is to understand how an economy, in all its shapes and forms, works: the nature and workings of the overall process of people making their own decisions, acting, and interacting as they see fi t. Th e economy lacks both plan and planner. It doesn’t even have a goal. It just is.

But people have goals. Th ey have needs and wants that they strive to satisfy using diff erent means. Some things are provided by nature, but most of them require that people exert eff ort to produce them. Th ese are the goods and services that satisfy whatever wants we have. Production is core to the economy: it is about providing as many means as possible to satisfy as many highly valued wants as possible.

The Economic Problem

Production is a problem. It is not simply a matter of how many resources are available. Th ere is no constant relationship between input and output. Very oft en more inputs can produce more outputs, it is true. But

1In many economies, the government plays a large role, which is oft en in the form of a central command. We will discuss this issue in Sec—tion 3. For now, we will be focusing on the economy itself—i.e., how things come to work out on their own and without central command or plan.

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with innovations we get more output per input—we increase productivity. Th is is even more obvious when we talk about the value of the output and not just the quantity. Value is never automatic. One can use a lot of resources to produce something that turns out to be pretty worthless. If I produce a painting, the expected result would be of little value regardless of my eff ort or how much paint I use. Th e same canvas and paint used by Vincent van Gogh would create something of much higher value. By placing his signature on my painting it would increase my painting’s value. But my signature on his painting would decrease its value.

Th e only relationship that exists between inputs and outputs is that inputs must be used to produce outputs. We cannot create something out of nothing.

Th e economic problem is not production per se but economizing production. It is about the issue that arises because we do not have more resources than we can fi nd uses for. In other words, resources are scarce. So it is incumbent upon us to fi gure out how our resources can be used to produce the best possible outcome (in value terms). We have become increasingly good at fi g-uring this out, especially in the last few centuries. For thousands of years, we made very little progress, but suddenly, with what is referred to as industrialization, nation aft er nation began lift ing itself out of poverty through breakthroughs in production. Th e interest in economics coincides with this development.

Hence the title of Adam Smith’s hugely infl uential treatise: An Inquiry into the Nature and Causes of the Wealth of Nations. Th e title brings attention to the two dimensions of national wealth (prosperity) that are still

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core to economics: the nature of wealth and its causes. Th e nature of wealth refers to how we should understand it, what comprises it, and how the economy as a system relates to the theory of value as personal satisfaction. Th e causes of wealth refers to the origins and the particular processes that brought this prosperity about. If we understand them properly, we can lift peo-ple out of poverty and create an ever more prosperous society.

Economics as the study of how the economy works is consequently also the science of how prosperity is created.

Economics as Understanding

To be an economist is to be a student of the economy as an ongoing process. Th e aim is to understand how it works and its nature. It is about fi guring out the nature and causes of those universal processes, mechanisms, and orders that we identify as the economy. From this we learn about prosperity and, importantly, how to produce more of it and make sure more people benefi t from it.

To form an understanding of how the economy works, we must be humble before the fact that it exists and there is an order to it—it has a nature. Th e task of the economist is not to predict the specifi cs of the future but to uncover the underlying processes that produce the economic outcomes that we can observe. In other words, we must develop a logic for understanding aggregate economic phenomena and behavior—an economic theory. Economics is a framework for how to 20 Per L. Bylund

think and reason about the economy, for making sense of what is going on. An “intuition,” if you will.

It follows that learning economics is fundamentally about gaining economic literacy so we can better understand the world we are part of. Th e real world, not the invented world we fi nd in formalized models. As Ludwig von Mises put it, “Economics deals with real man, weak and subject to error as he is, not with ideal beings, omniscient and perfect as only gods could be.” Yes, exactly.