Amer N. Raja
FUNDAMENTALS of ECONOMICS
The Aim & Scope of Economics:
The study of economics is aimed at finding the natural law governing an economy and its scope is to find the ideal principles for the working of an economy based on those findings.
There is no such Thing as Free Lunch:
It is the most fundamental law of nature that every thing has either monetary or non-monetary value. Though generally things have both monetary and non-monetary aspects, never the less for the purpose of simplicity and understanding we only consider monetary aspect of things in economics.
INVISIBLE HAND
This is the most vital as well as an extremely difficult idea to logically explain, and however absolutely impossible to mathematically prove it. Perhaps in order to understand it one needs to think beyond logic and one may comprehend it after one's own peculiar experiences. How the invisible hand plays it role in making financial shifts among individuals, groups and even among nations can be understood by studying natural phenomenon viz., the animal world, the plant world, the rotation of the solar system, the rain, diseases, wars, natural disasters etc. Moreover the mental state of an individual changes continuously and mysteriously which affects one's decision making and other faculties that results in changes in one's economic/financial conditions. Uncontrollable and unpredictable invisible factors beyond human control brought financial changes.
Defining Economics:
Economics deals with the efficient management (by the individuals & entrepreneurs) of scarce resources to satisfy unlimited human wants by applying science & technology in the market.
* Efficiency can be defined as doing things in a best possible manner. Basic Economic Problem:
Scarcity of Resources, Unlimited Wants & Choice:
It is a known fact that our resources (time, raw materials, land, human resources, machines, money etc.) are limited while our wants are unlimited and recurring therefore we have to make some choice among available alternatives to satisfy our wants.
Economic Resources:
Economic resources can be broadly divided into following four categories:
o Land & Raw Materials:
These are free gifts of nature. All things derived from nature are included in this category.
o Labor:
It consists of the contribution of human beings.
o Capital:
It consists of plant & Equipment.
o Mind/Entrepreneurial Ability:
Entrepreneurial ability refers to the ability to organize production and bear risks. Some people are more intelligent and have the gift of managing things better than others. It is due to their contribution that societies develop. Due to this reason we categorize this resource separately from labor.
Motivating Force - Self Interest:
It is the self-interest that makes us act. Here it is also very important to mention that economics cannot be separated from other fields of study. All knowledge is interrelated. Adam Smith, who has significant influence in formulating modern western economic thought, was a professor of moral philosophy, which deals with finding the ideal kind of life. It is a fact that every individual tries to gain best from his/her available resources to make one happy. It is assumed that individuals will follow his/her interest to make choice among different alternatives. It is also important to mention here that self-interest is entirely different from selfishness. As a general rule of life: "Enlightened Self Interest is the best interest".
*Selfishness is a short term while enlightened self-interest is a long-term phenomenon.
Logic & Logical Fallacies:
All interpersonal communication is based on logic. Likewise all human knowledge, that is experiences and views of all human beings since inception, is also communicated on the base of logic. Though logic fails at very minute as well as very huge levels, still because of human limitation in our interpersonal communication we are dependant on logic. Logic can be defined as a science of correct reasoning.
o Logical Errors/Mistakes:
Here we will mention the two main fallacies of logic that makes human knowledge erroneous. They are:
§ post hoc, ergo propter hoc fallacy (association as causation)
It occurs when one incorrectly assumes that one event is the cause of another because it precedes other.
§ Fallacy of composition
It occurs when it is incorrectly assumed that what is true for each individual in isolation is also true for an entire group.
Demand & supply:
In any economy prices of goods are determined by the interaction of demand and supply. All study of economics revolves around these two fundamental concepts.
o Demand:
Demand is a relationship between price & quantity demanded of a good in a given period of time while keeping other factors like tastes, preferences, status etc. constant i.e., considering only price as a determining factor.
o Supply:
Supply is relationship between price and quantity supplied of a good in a given period of time while keeping other things constant i.e., considering only price as a determining factor.
CORE ISSUES IN ECONOMICS:
Role of Government:
The proper role of government should be as minimal as possible. For efficient management, civil society is much more important and efficient than political society.
The market, by the interaction of demand and supply, not the state, should set wages and prices. Similarly monetary policy should also be set by interaction of market forces. Taxes levied by the government should be minimal. Lower taxes would provide the fundamental incentive for the entrepreneurs and individuals to work hard and to reinvest for greater profits that would consequently raise economic activity. The role of government should be as minimal as possible so government should do only those things private citizens can't do for themselves. The corruption level is extremely high in public enterprises and also the efficiency of public enterprises is much lower than that of private enterprises.
Government should control its expenditure and it should match expenses with revenue. Bigger government is the biggest problem. Therefore decentralization and only taking those tasks that private enterprise cannot perform; are highly desirable for efficient management.
Rules and regulations should be formulated with a view for maintaining justice among members of the society and law should be equal for all.
Tariffs and other barriers to trade should be completely abolished, gradually. Free trade can greatly and rapidly improve the general economic condition and consequently social condition of the society. In short, government governs best which governs least.
Entrepreneur & Entrepreneurship:
Entrepreneurship is a vital aspect for economic growth and development. Because of its importance this should be studied in depth. Entrepreneurs are gifted individuals who have the gift of managing resources and have keen foresight to visualize things much better than ordinary people. High growing economies provide viable environment and freedom for the entrepreneurship to grow that eventually led to the development and growth of economies.
Economic Growth:
An important element and field of study in economics is economic growth. Essentially the motive behind all economic activity is in raising the standard of living. We study that how standard of living is raised. Education plays a pivotal role in raising general standard of living in the long run. Capital formation results from prudently managing resources and by finding new ways to improve the present means of production by using new technology; that is a consequence of knowledge gained by acquiring education. Therefore capital formation is the key factor for economic growth.
Trade:
Exchange, monetary or non monetary, is an integral part of any human activity. Human exchange views/goods/services etc because they feel that they will gain by exchanging. However, in economics we are only concerned with monetary exchange of views/goods/services etc. It is wrongly assumed that our world is a zero-sum world where gain by some is loss of other. Factually and fortunately we are living in a positive sum world. If this had been the case then progress in our world would have never been possible. Never the less it does not entail that in all monetary exchanges both parties will equally gain. Moreover the value gained in an exchange between two individuals or groups can never be evaluated precisely by the third party because the value of an exchange is very different for different individuals.
Free and greater trade, free from force and coercion, would result in comparatively more fair deals and consequently the chances of greater gains by both parties are more realizable.
Competition:
Cooperation:
For the efficient management of the resources (time, skills, natural etc) human need to cooperate to make optimal use of these resources. Moreover most of the natural resources need to be transformed for use and to make them valuable. Groups need to cooperate to be successful. Cooperation juxtaposed with positive competition is an ideal combination for efficiency.
Specialization & Comparative Advantage:
Natural inequality among humans is a fact of life. Economics aims at efficient management; therefore to make best use of human resources different individuals specializes in those particular fields in which they can be better than others because of their natural abilities. Due to this reason some individuals have comparative advantage over others.
Information:
Information is very important for making informed rational decisions. However accurate information is impossible by any individual because of the human mind, because every human being is unique, and also due to unpredictable future. Information about market behavior is extremely diverse and ubiquitous. Therefore it is not possible for any individual to accrue the available information and our decisions about future at best are mere estimate with enormous possibilities.
Profit & Loss:
The expectant and prevailing profit and loss are the determining factors for the investments. It provides the criteria for the goods and services to be produced. Where in the short run demand of the products is the primary factor in stimulating the investment trends, profit or loss is the litmus test for products produced in the long run.
Trade Off:
It's a general principle that in order to gain something one needs to loose something. The most important resource for an individual, time is limited. Therefore no one can do all the things oneself, so a rational individual focuses one's time on those tasks where one can perform best. However it is quite impossible to precisely quantify the time one put in some particular activity is equal to the forgone activity/activities. Nonetheless for the purpose of understanding this concept economists assume that the price of engaging in some activity is equal to the cost of the other activity/activities one has forgone.
Price Theory:
Demand for and supply of products determines their prices in the market. It is wrongly asserted by the majority of the people that cost of goods determines the prices of the product. In actuality it is the marketing activities of the producers and the perception of the consumers about the products that determine the prices of the products. As a general rule higher the prices lower will be the demand and vice versa. However in some cases due to the nature of the product and the marketing efforts of the producers higher prices lead to higher demand.
Causality -- Cause & Effect:
Despite limitations of logic, causality is the most important phenomenon in understanding economic theory and practice. Excluding mega-microscopic and mega-macroscopic phenomenon, every cause has some effect and that effect is a cause of some other effect ad infinitum. Due to this cause and effect relationship in a world of numerous individuals and groups their actions has great impact on other elements in the economy. Despite the complexity of this relationship that is also chaotic, understanding this relationship can help enormously in making good estimates about the future and to form comparatively sound opinions about the market trends.
Labor Economics:
In this field we study that how wages are determined. Like all other markets the wages are set by the interaction of demand and supply. Higher wages can only be achieved by greater investment and economic activity in the long run. Employment and unemployment are also the key issues that we study in this field. Ups and downs in the economy are the facts that cannot be avoided. Higher consumption level asks for greater capital investments that will raise general wage level and results in lower unemployment.
Uncertainty:
No one knows the future. It's the fear of future that is an integral part of our lives and also an impetus for human activity. This factor of uncertainty gave birth to the idea of risk. There is always degree of risk in all human activities. As a general rule: "higher the risk, higher the reward". Uncertainty is also nature's law of rewarding and punishing the human actions. Moreover it is also a way of nature of teachingand making known new ideas to the new participants and making room for the new and efficient members.
Public Finance:
The filed of public finance is directly related with role of government. Bigger the government, larger the funds are needed to finance it. The accountability principle is of pivotal importance in public enterprises because the ownership of these enterprises has no personal owners. Moreover, fund should be received from those who get benefits from that service.
Money & Banking:
Banking in an economy is the determining factor for gauging its performance. Money is the medium of exchange that facilitates transactions among participants of an economy. Banks play the role of intermediaries. Interest rates and value of currency with relation to other international currencies is set by central banks. However ideally it is best that market forces of demand and supply determine them.
Consumption & Saving:
Raising the consumption level is key factor to all economic activities for reducing costs, creating employment, raising standard of living and eliminating poverty.
On the other hand, raising consumption greatly can result in undue depletion of resources in a given market and cause inflation. If this situation prolongs that would result in recession to depression. Therefore a sagacious policy of moderation is the ideal combination.
Marketing:
Marketing is the key for stimulating demand and consequently enhancing economic activity. Entrepreneurs have the sharp ability of marketing to understand the economic environment and knowing the customer demand ahead of time and finding new segments that would consequently raise general standard of living.
Cost & Production:
Every thing entails cost. Finding the best methods to produce goods at minimum possible cost is essential for firms to earn profits and compete successfully.
Technology:
Technology makes the difference between the present age and the previous one. The problems faced by humans in all times are quite similar yet the technology of their respective eras determines the mode of production as well as way of living. Technology is of utmost importance for understanding economics because by applying it we enormously reduce costs and even reach new markets that could not have been possible with out technology. Moreover it raises standard of living by simplifying the complex tasks.
Poverty:
The problem of poverty is the focal point in the field of economics. Ignorance is the main cause of poverty. The best way to eradicate poverty is by spreading knowledge.
Every thing entails cost. Finding the best methods to produce goods at minimum possible cost is essential for firms to earn profits and compete successfully.
Technology:
Technology makes the difference between the present age and the previous one. The problems faced by humans in all times are quite similar yet the technology of their respective eras determines the mode of production as well as way of living. Technology is of utmost importance for understanding economics because by applying it we enormously reduce costs and even reach new markets that could not have been possible with out technology. Moreover it raises standard of living by simplifying the complex tasks.
Poverty:
The problem of poverty is the focal point in the field of economics. Ignorance is the main cause of poverty. The best way to eradicate poverty is by spreading knowledge.
