What is the nature of Economics?
Economics is a social science, which investigates what, how, why, and for whom goods and services are produced. As discussed in O level tutorials, The basic economic problem is that there are infinite(unlimited) wants but finite (limited) resources with which to satisfy them. Economics is meant to help us to choose between the competing demands placed on the limited resources that we have. Increasingly, economists are becoming more aware of the need to use renewable resources, such as wind and solar power instead of oil and gas for electricity generation. Following the Bruntland Report of 1987, economists are also increasingly aware of the role of sustainability. This means that we need to consider the needs of future generations as well as our own generation when we make our decisions regarding the use of resources.
Production possibility frontiers
Production possibility frontiers, or PPFs, help us to analyse the trade-offs that we must make as a result of the basic economic problem. They show the possible maximum combination of goods/ services that can be produced using the resources that we have available.
PPFs demonstrate the concept of opportunity cost — the cost of the next best alternative foregone. In the diagram above, the production of three more cows incurs an opportunity cost of four tonnes of wheat, ie we have had to give up wheat production in order to produce more cows because of our limited resources.
PPFs can also be used to demonstrate the concept of efficiency. Any point on the PPF is a
productively efficient point — we are using the factors of production (resources, including land, labour, capital and enterprise) we have to their maximum potential. Any point inside the PPF is inefficient — some of the factors of production are unemployed or underemployed.
Economic growth (an increase in the productive potential of the country) can be shown by an outwards shift in the PPF. Such a shift can be caused by an increase in the quantity or quality of the factors of production (eg, better educated labour, hi-tech capital, a new oil field discovery etc). Very occasionally, the PPF shifts inwards.
Another way in which economic growth can occur is via specialisation, or division of labour.
Adam Smith wrote about the division of labour in Wealth of Nations back in the 18th century. He said that by splitting the production of a good into a number of different tasks, and allocating each task to a different worker, then more could be produced as workers developed greater skill in performing their particular task with the use of specialist tools designed for just that task, thus leading to less wastage of materials and less time spent on their task. However, when this method was put into in the early 20th century, for example, with Henry Ford’s Model T production line, workers became so bored that they had to be paid high wages as compensation for the monotony of their work.
There are a number of approaches to organising an economy.
Free market economy: an economic system where all resources are allocated through the market forces of demand and supply, with no intervention by the government.
Command, or centrally planned economy: an economic system where all resources are allocated by the government, with no markets (eg ex-Soviet bloc, North Korea).
Mixed economy: an economic system where resources are partly allocated by the market and partly by the government (eg, most economies today).
From the point of view of efficiency, most economists would argue that free markets are the most efficient, in terms of using their resources in the best possible way to meet the needs and wants of consumers. However, when equity is considered, most economists would also argue that free markets lead to an unequal distribution of income and wealth, since owners of capital and entrepreneurs tend to accumulate the most income/wealth, and many people, such as the sick or elderly, are unable to work. As a result, most economies today are mixed economies, where markets allocate many resources, but governments intervene to different extents in order to ensure a minimum standard of living. They do this by raising revenue through taxes, and redistributing in the form of benefits and direct provision of services such as healthcare.
What is the difference between positive and normative economics?
Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic statements do not have to be correct, but they must be able to be tested and proved or disproved. Normative economic statements are opinion based, so they cannot be proved or disproved.
For example, the statement, “government should provide basic healthcare to all citizens” is a normative economic statement. There is no way to prove whether government “should” provide healthcare; this statement is based on opinions about the role of government in individuals’ lives, the importance of healthcare and who should pay for it.
The statement, “government-provided healthcare increases public expenditures” is a positive economic statement, because it can be proved or disproved by examining healthcare spending data in countries like Canada and Britain where the government provides healthcare.
The extent to which governments are involved in the economy is a normative issue, ie a matter of opinion, requiring a value judgment. Economic analysis tends to be more concerned with positive issues, ie statements of fact that can be tested against real-world evidence. For example, the USA has a predominantly private healthcare system, where people have to pay directly for their treatment, whereas the UK has a predominantly publicly-provided healthcare system (the NHS). To say that the UK’s approach is ‘fairer’ is essentially a matter of opinion, ie a normative issue. To say that the amount spent per head on healthcare in the UK is less than that in the US is a positive issue.