Chapter 1
What Does Economics Study? And Why Should You Care?
In This Chapter
Taking a quick peek at economic history
Observing how people cope with scarcity
Separating macroeconomics and microeconomics
Growing the economy and avoiding recessions
Understanding individual and firm behaviour
Getting a grip on the graphs and models that economists love to use
Economics is the science that studies how people and societies make decisions that allow them to get the most out of their limited resources. Because every country, every business and every person deals with constraints and limitations, economics is literally everywhere.
For example, you could be doing something else right now instead of reading this book: exercising, watching a film or talking with a friend. The only reason for you to be reading this book is that doing so is the best possible use of your very limited time.
In the same way, you hope that the paper and ink used to make this book have been put to their very best use. Similarly, we all hope that every last tax pound that the government spends is being used in the best possible way, and not being dissipated on projects of secondary importance.
Economics gets to the heart of these issues, analysing individual and firm behaviour, as well as social and political institutions, to see how well they perform at converting humanityâs limited resources into the goods and services that best satisfy human wants and needs.
Considering a Little Economic History
To better understand todayâs economic situation and what sort of policy and institutional changes may promote the greatest improvements, you have to look back on economic history to see how humanity arrived at its current situation. Stick with us: we make this brief survey as painless as possible for any history haters.
Pondering just how nasty, brutish and short life used to be
For most of human history, people didnât manage to squeeze much out of their limited resources. Standards of living were quite low, and people lived poor, short and rather painful lives. Consider the following facts, which didnât change until just a few centuries ago:
Life expectancy was about 25 years.
More than 30 per cent of newborns never reached their fifth birthdays.
Women had a 10 per cent chance of dying during childbirth.
Most people had personal experience of horrible diseases and/or starvation.
The standard of living for one generation was no higher than that of previous generations. Except for the nobility, everybody lived at or near subsistence level, century after century.
In the last 250 years or so, however, everything changed. A process of rapid innovation led to the invention or exploitation of electricity, engines, complicated machines, computers, radio, television, biotechnology, scientific agriculture, antibiotics, aviation and a host of other technologies. Each of these items enabled humankind to do much more with the limited amounts of air, water, soil and sea available on planet earth.
The result was an explosion in living standards, with life expectancy at birth now well over 60 years worldwide and many people able to afford much better housing, clothing and food than was even imaginable a few hundred years ago.
Of course, not everything is perfect. Grinding poverty is still a fact of life in a large portion of the world, and even the richest nations have to cope with pressing economic problems like unemployment, persistent poverty or lack of access to resources.
But the fact remains that the modern world is a much richer place than it has been in the past, and we now have sustained economic growth in most nations, which means that living standards have been rising consistently year after year. Identifying the institutions that led to higher living standards
The obvious reason for higher living standards, which continue to rise, is that human beings have recently figured out lots of new technologies, and we keep inventing more. But if you dig a little deeper, you have to wonder why a technologically innovative society didnât happen earlier.
The ancient Greeks invented a simple steam engine and the coin-operated vending machine. They even developed the basic idea behind the programmable computer. But they never quite got around to having an industrial revolution and embarking on a path of sustained economic growth.
And despite the fact that every society has had its share of really smart people, it wasnât until the late 18th century, in England, that the Industrial Revolution got started and living standards in many nations rose substantially and kept on rising, year after year.
So what factors combined in the late 18th century to accelerate economic growth so radically? The short answer is that the following institutions were in place:
Democracy: Yes, we can overstate this one. However, it does make sense to consider that youâre more likely to invest if your investment is protected by the rule of law instead of depending on the whim of a tyrant. Also, the governments of the democratic era have been better at incorporating the views of the merchants and manufacturers who have created the wealth that we now enjoy.
The limited liability corporation: Under this business structure, investors would lose only the amount of their investment and not be liable for any debts that the corporation was unable to pay. Limited liability greatly reduced the risks of investing in businesses and, consequently, led to much more investing.
Patent rights to protect inventors: Before patents, inventors usually saw their ideas stolen before they made any money. By giving inventors the exclusive right to market and sell their inventions, patents gave a financial incentive to produce lots of inventions. Indeed, after patents came into existence, the world saw its first full-time inventors â people who made a living inventing things.
Widespread literacy and education: Without highly educated inventors, new technologies donât get invented. And without an educated workforce, the invented products canât be mass-produced. Consequently, the decision that many nations made to make primary and then secondary education mandatory paved the way for rapid and sustained economic growth.
Institutions and polic...
