Principles of Economics in a Nutshell

Lorenzo Garbo, Dorene Isenberg, Nicholas Reksten

• Publisher: Routledge
• Year: 2020
• Print ISBN: 9781032295848
• eBook ISBN: 9781000043754
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Principles of Economics in a Nutshell provides a succinct overview of contemporary economic theory. This key text introduces economics as a social science, presenting the discipline as an evolving field shaped within historical context rather than a fixed set of ideas.

Chapters on microeconomics introduce concepts of scarcity and tradeoffs, market analysis (the Marshallian cross of supply and demand) and the theory of the firm and market structure. Chapters on macroeconomics begin with an explanation of national income accounting, followed by discussions of macroeconomic theory in the goods market and in the money market from both a Keynesian and Classical view. The text concludes with examples of how to expand upon core material, introducing the perspectives of feminist and ecological economics.

This book will be of great importance to students new to economics and is ideal for use on single-semester Principles courses or as a primer on economics courses in other settings. The text is fully supported by online resources, which include a set of analytical questions and suggestions for further reading for each chapter.

1

More than just the stock market

Introduction to economics

1.1 Economics as a social science as a social science

Social science, according to the Oxford Dictionary, is the scientific study of human society and social relationships. The traditional social sciences are: anthropology, economics, politics, psychology, and sociology; more recently, interdisciplinary fields such as women’s, gender, and sexuality studies, race and ethnic studies, humanitarian affairs, and so on, have been added to the more traditional list.

What distinguishes economics among these social sciences? The noun economics comes from the Greek oikos-nomia, which became oeconomia in Latin. Nomia in Greek means “distribution, arrangement, management” (think also about: astronomy, agronomy …), while oikos means “household”. Thus, economics originally meant “management of the household, of the place we live in”. This is a definition worth reflecting upon for a moment, as it may help you distinguish economics from adjacent fields of study: for instance, you may want to consider the fact that “management of the household” does not only imply making the household wealthier. Also, the emphasis of this definition falls on the household as a whole, and not on its individual components. This is quite different from what we experience in our highly individualistic society! In ancient Greece, the purpose of human existence was the enjoyment of a good life, and such an objective could only be attained within the community, that is, the polis (city-state). It was the community – and not the individual – that could achieve good social results, a prerequisite for well-being. Therefore, individuals were to conceive their conduct in economic affairs in light of their relations with each other and so with the community of citizens on which they depended. Here is how Aristotle (384–322 BCE) wrote about it in Politics:

Man is by nature a political animal. And therefore, men, even when they do not require one another’s help, desire to live together; they are also brought together by their common interests in proportion as they severally attain to any measure of well-being. This is certainly the chief end, both of individuals and of states. (III, 6)

Seeing then that the state is made up of households, before speaking of the state we must speak of the management of the household. … And there is another element of a household, the so-called art of getting wealth [chrematistike], which, according to some, is identical with household management, according to others, a principal part of it. (I, 3)

More than two millennia have gone by since then, and you may think that many aspects of human and social existence have changed. You may think, for instance, that today we are much less dependent on others in the pursuit of our own well-being (individualism). But … are we really? Where do you stand in regard to the possibility for human beings to achieve well-being un-collectively?

Let’s reflect further on the definition of economics given earlier, which may be rephrased as: economics deals with the use of the resources of the household with the objective of producing the greatest well-being for the household itself. A simple generalization of “household” to whatever environment we live in updates the definition of economics to a concept we can relate to more easily: the management of resources of a city, a state, a country, and so on, with the objective of maximizing the overall well-being of the corresponding population. This is where troubles begin: is there a unique definition of the well-being of a community, a definition we could all agree upon? And even if we could agree to consider just one definition of the well-being of a community, how likely is it that we would also agree on how and what to measure in order to evaluate it? How likely is it that we would also agree on what policies or strategies would improve it the most? Even people with fairly similar visions of the world are unlikely to share the same idea of well-being, to choose the same unit of measure and techniques in order to evaluate it, to imagine the same policies to improve it. Economists generally agree that the purview of economics is the management of resources with the objective of maximizing the overall well-being of the community, but often disagree –like everybody else – on the practical, concrete translation of the community’s well-being, on what and how to measure it, and on what to do in order to improve it. The next section of this chapter will provide you with some help in rationalizing the most common causes of divergence of opinion among economists.

Before we get there, though, let’s do some more work on our definition. Given the inclusion of economics among the social sciences, the study of the management of resources for the well-being of the community must be conducted according to the methods and principles of science: it has to be a systematic and methodical study. Again, scientific comes from the Latin scientia, which means knowledge, and scientific then means productive of knowledge. How does one then approach the study of economics according to a scientific method?

Francis Bacon, a British philosopher, in 1620 published a treatise entitled Instauratio Magna, which contains the very first full and modern description of the scientific method (Bacon in fact became later known as the founder of the scientific method). In its most basic form, such method consists of a strict sequence of methodological steps, that can be summarized as follows:

1. faithful record of natural phenomena;
2. derivation of aphorisms – system-free inferences of/from what one observed;
3. “negative instances” are used to eliminate faulty aphorisms, while aphorisms that are not negated by experimentation are gathered into generalizations that constitute “knowledge.”

A couple of examples should clarify.

• Example 1: a truthful aphorism
  • I observe water running through my bare fingers and wetting them.
  • I derive the aphorism that when water runs through my bare fingers, my fingers get wet.
  • Are there instances in which this does not happen, that can negate my aphorism? No.
  • Thus, I can generalize and say that water wets bare fingers.
• Example 2: a faulty aphorism
  • I observe that during a downturn of the economy (recession) there are more poor people around.
  • I make the inference (aphorism) that during a recession people become poorer.
  • Are there instances that deny my inference? Yes: during the last recession, for instance, the average compensation of CEOs increased.
  • My aphorism is faulty.

Summarizing, the conceptual sequence of the scientific method – and so also of economic analysis – consists therefore of: facts → theory → check of the validity of the theory against facts.

1.2 On the scientific character of economics, ideology, and perspectives

In the previous section we have already come across some causes of disagreement among economists. There is more. We just saw that economics, as a social science, follows the scientific method: there is fundamental agreement on that; but how scientific can economics really be? Can the study of economics, which has so much to do with the human experience and understanding of reality, the types of interactions, norms, structure of society, historical patterns, and so on, lead to scientific knowledge? Joan Robinson, a celebrated British economist, in Freedom and Necessity (1970, p. 119) wrote: “The methods to which the natural sciences owe their success – controlled experiment and exact observation of continually recurring phenomena – cannot be applied to the study of human beings by human beings.” Even if economists faithfully apply the scientific method, the outcome of their work may have to be taken differently from, say, the outcome of a chemical reaction that can be repeated ad infinitum in the same exact conditions. Thus, Robinson concludes that, “The function of social science is quite different from that of the natural sciences – it is to provide society with an organ of self-consciousness.” What could that mean?

The degree of certainty with which economists perceive the outcome of their work (that is, how scientific economists consider the outcomes of their work) tend to divide economists into different camps: it typically distinguishes scholars who self-identify as economists or as political economists, depending on whether the focus of their work and their vision of the discipline are restricted to what can be objectively measured (pure economic relationships), or whether they can only conceive economic relationships in contextual ways, within the political, historical, cultural, and social framework in which economic relationships take place.¹ Of course, the question of whether anything at all can be measured truly objectively remains open.

An additional and growing area of disagreement among economists has to do with the system of beliefs and moral values (ideologies) scholars abide by. The impact of ideology on one’s approach can be best appreciated through examples. Consider, for instance, the following passage, taken from Sismondi’s “On the Condition of the Work People in Manufactories” (1847 [1834], p. 196):

The most important of all questions in Political Economy [is] the share of happiness which wealth ought to diffuse among those who contribute by their labour to its creation. With us it is a fixed principle that social order ought never to sacrifice one class of men to another, and that, whilst admitting divers conditions, poor as well as rich, these differences are only protected for the common welfare of all, this inequality is only legitimate, because it secures, even to the humblest, a portion of comfort, which he could not find in savage life.

You may be convinced that some degree of economic inequality is necessary to maintain incentives for improvement, innovation; but can the degree of economic inequality become excessive? Would someone who holds beliefs similar to Sismondi’s, advocate for some form of redistribution of wealth (or income) from the higher to the lower economic echelons of society? Do you think that economic rights are fundamental human rights? Can you imagine someone holding a different set of beliefs?

Or consider the following statement by John Stuart Mill (1848, pp. 364–5), one of the most important philosophers and political economists of the nineteenth century:

Everyone has a right to live. We will suppose this granted. But no one has the right to bring creatures into life, to be supported by other people. … If a man cannot support even himself unless others help him, those others are entitled to say that they do not also undertake the support of any offspring which it is physically possible for him to summon into the world. … It would be possible for the state to guarantee employment at ample wages to all who are born. But if it does this, it is bound in self-protection, and for the sake of every purpose for which government exists, to provide that no person shall be born without its consent.

Do you share this ideology? Would someone who holds these beliefs advocate for a policy of taxation of the wealthy and subsidization of the poor? Of the children of the very poor?

Political or religious ideologies inform our moral priorities, determine what we think could and could not be infringed, and thus differentiate among the possible policies and strategies economists envision with the objective to increase the overall well-being of society. Most people, for instance, think that private property is sacred, and may think that taxation of one’s lawfully earned income is an infringement of the fundamental right to private property. In addition, taxation may decrease the incentive to improve one’s economic condition and may thus diminish buoyant economic perspectives for the whole country. We would all suffer from this, one would say. But when we see a growing, often mentally ill, homeless population on the streets of one of the wealthiest countries in the world, or full-time salaries that may be insufficient to put enough food on the table, we may want to consider whether there is a more fundamental right that would be infringed by not using some taxation to alleviate the suffering of a portion of the population.

Finally, economists may also disagree because they structure their reasoning on the basis of different economic paradigms or schools of thought, where paradigms are understood as “systems of thought” or “economic theories” that include the specific questions economists try to answer, what facts, institutions, and behaviors they consider as assumptions of their thought process, and the methodology followed in the development of their theories. Paradigms can be motivated by history, intellectual/scientific evolution, ideology, or by any conceivable combinations of the above, and thus yo...

Table of contents

• Cover
• Half Title
• Epigraph
• Title Page
• Copyright Page
• Contents
• List of figures
• List of tables
• Preface
• Chapter 1 More than just the stock market: introduction to economics
• Chapter 2 Not in the Garden of Eden: scarcity and tradeoffs
• Chapter 3 Led by an invisible hand: the market
• Chapter 4 Inside the magic box: productivity, costs, and profit maximization
• Chapter 5 Understanding the wealth of nations: national income accounting
• Chapter 6 In the short-run we are alive: macroeconomic theory and policy: the goods market
• Chapter 7 Money changes everything: macroeconomic theory and policy: the money market
• Chapter 8 The embedded economy
• Index