Introduction to Economics: Decision Making, Scarcity, and Efficiency

The Nature and Scope of Economics as a Science

• Definition of Economics: Economics is defined as the social science of decision making. It involves analyzing and describing how humans make choices in various contexts.

• The Scientific Nature of Economics: Critics often argue against the classification of economics as a science because it cannot provide answers to every question or because there are disagreements within the field. However, the field is considered a science because it meets the following criteria:

  • Methodology: It is a methodical discipline that utilizes the scientific method.
  • Experiments and Data: Economists conduct experiments, collect data, and perform rigorous data analysis.
  • Hypothesis Testing: The field involves creating hypotheses and theories that are then compared against empirical data.
  • Comparison to Other Sciences: Economics is comparable to biology; biologists are still learning and the field is incomplete, yet no one denies biology is a science because of disagreements or unanswered questions.

• Economics as a Social Science: While natural sciences (like physics, chemistry, and biology) are an inquiry into the natural world, economics is an inquiry into human nature.

  • Every economic decision has a social dimension.
  • No individual can satisfy all of their wants independently; satisfying wants requires contact and interaction with other people.
  • It is formally categorized as a social science, for example, under Category 4 of the Michigan Transfer Agreement (MTA).

• Heterodox and Traditional Approaches: The instructor highlights that the field of economics is currently changing. There is significant pushback against traditional, hierarchical ways of teaching the subject. The lecture aims to include heterodox approaches—alternative perspectives that challenge standard frameworks to show the full scope of what economics can be.

Human Nature and the Economic Actor

• View of Human Behavior: Economists operate under the assumption that humans possess two primary characteristics: they are purposeful and self-interested.

• Purposeful Behavior: To be purposeful means that actions are taken for a reason. Decisions are the result of a thought process where options are weighed and one is chosen based on available information.

  • Non-Randomness: Behavior is not arbitrary, random, or meaningless.
  • Non-Instinctive: Humans are not pre-programmed or driven solely by instinct like insects. For example, a bee does not decide whether to collect nectar; it is programmed to do so. In contrast, humans willfully choose one thing over another.
  • Rationality: The term "rational" is often used synonymously with "purposeful." It does not necessarily mean humans are hyper-calculating or "smart," but rather that they weigh pros and cons. The degree of care in this weighing process varies by the importance of the decision:
    • Minor decisions: Choosing a snack from the cupboard may involve minimal conscious weighing.
    • Major decisions: Choosing a major, getting married, or buying a house involves a formal weighing of pros and cons.

• Self-Interest: The goal of purposeful decision-making is the pursuit of self-interest, meaning an individual attempts to make their life better rather than worse.

  • Self-Interest vs. Selfishness: Being self-interested is not synonymous with being selfish. Individuals are in charge of their own preferences, and those preferences can include the well-being of others.
  • Altruism and Love: Acts of love or concern for family, community, or causes (social, economic, or environmental justice) fit into the self-interest model. When an individual chooses to care about another, that person's well-being becomes a factor in the individual's own well-being. Pursuing their happiness satisfies the individual's wants.
  • Malleability of Preferences: Humans can train themselves to change their interests. For example, food writer Jeffrey Steingarten posits that a person can develop a taste for any food by trying it $10$ times. The instructor used this method to develop a taste for Brussels sprouts.

• Meaningful Behavior as Data: Because behavior is purposeful and self-interested, an observer can interpret actions as meaningful data. If I observe you attending class, it tells me you perceive class to be better for your interests than the alternatives. While individuals may make poor decisions due to uncertainty or imperfect information, the starting assumption is that they do not knowingly act in opposition to their own interests.

Scarcity and Constrained Optimization

• Defining Scarcity: Scarcity is the fundamental reality that human wants are unlimited, but resources are limited.

  • Resources include time, money, talent, and friends.
  • Wants are biologically endless; even if satisfied now, the body will require more energy in the near future.

• Conflicting Wants: Scarcity leads to conflict between different individuals (e.g., two people wanting to live in the same house) and within the same individual (e.g., wanting to sleep in vs. wanting to get up and be productive).

• Mathematical Analogy (Constrained Optimization): Life is viewed as a series of optimization problems.

  • Goal: Maximize want satisfaction.
  • Constraint: Limited resources.
  • Analogy: A farmer with $400$ linear feet of fencing wants to maximize a rectangular grazing area. Without the constraint, the area would be infinite. The constraint (limited fencing) creates the challenge that requires a solution (calculus or pre-calculus application).

• Dynamic Decision Making: Humans do not just make isolated decisions for the current moment; they attempt to plot a path over time, known as dynamic constrained optimization. An example is attending college. In the short term, college requires giving up time and money, but individuals choose it for the long-term payoff (higher lifetime income), which is considered a "slam dunk" return in the United States.

The Central Economic Problem and the Four Questions

• The Central Economic Problem: This refers to how an individual or society satisfies as many wants as possible given limited resources. To solve this, an economy must answer four fundamental questions: What, How, Who, and For Whom.

• Question 1: What will be produced?

  • Opportunity Cost: Every decision to produce a specific good comes at the expense of producing something else.
  • Example (Government Spending): If the federal government increases the defense budget by $100,000,000,000$ ($100$ billion), there is an opportunity cost of $100,000,000,000$ worth of other goods (like education or healthcare) that are not produced. Even if the money is not taken directly from another budget line, it is money that could have gone elsewhere. No increase in production is free.

• Question 2: How will it be produced?

  • Efficiency: This refers to producing with no waste.
  • Economic Efficiency: A situation where no one can be made better off without making someone else worse off. Voluntary trades (e.g., trading a guitar for roller skates) move toward economic efficiency by making both parties better off without hurting others.
  • Productive Efficiency: Producing goods in a way that we cannot produce more of any one good without producing less of another. This involves using the right technology and natural resources.
  • The Peach and Apple Example: Peaches grow best in Georgia, while apples grow better in the North. Planting $500$ apple trees in Georgia and $500$ peach trees in Vermont is productively inefficient. By swapping the locations, society gets more of both fruits without increasing input—this is the "right way" to produce.

• Question 3: Who will produce it?

  • Labor Allocation: Productive efficiency also applies to human resources. Workers should do the tasks they are best suited for. Placing a great car-builder in a classroom and a great teacher in an auto plant results in less of both goods.
  • Comparative Advantage: Resources should be allocated to produce what they can at the lowest opportunity cost.
  • Comparative Advantage Example (Almonds and Wheat):
    • California is better at growing both almonds and wheat than Kansas.
    • However, California is "a lot better" at almonds and only "a little better" at wheat.
    • Growing wheat in California has a high opportunity cost because much almond production is sacrificed.
    • Growing wheat in Kansas has a low opportunity cost because very little almond production is sacrificed (Kansas is bad at almonds).
    • Efficiency is achieved when California specializes in almonds and Kansas in wheat.

• Question 4: For whom will it be produced?

  • Distribution: This involves how output is divided among the population.
  • Efficiency in Distribution: Satisfying as many wants as possible by getting goods to those who value them. For example, diapers should go to people with babies, and dog food should go to people with dogs. Splitting dog food equally among $330,000,000$ ($330$ million) people, most of whom do not have dogs, would be inefficient.
  • Markets and Willingness to Pay: Markets use price and willingness to pay to gauge preference strength. However, this is imperfect because wealth and access to credit can allow someone to outbid another even if they don't "want" the good more.
  • Fairness in Distribution: Some goods are distributed based on social justice or compassion rather than market bidding.
  • Fairness Examples: Education (distributed equally up to high school), healthcare, food, and housing.
  • Efficiency/Fairness Trade-off: While some believe fairness reduces efficiency, the instructor notes that providing essentials (like diapers to poor families) can actually enhance efficiency and social well-being.

Questions & Discussion

• Question from Ali: "Do you think solving too many problems creates more [problems]?"

  • Context/Example: Ali gave an example of working as a mechanic. A customer had a clogged catalytic converter. To "solve" the clogging and acceleration problem, the customer wanted to cut it off and replace it with a pipe. This solved the initial problem but caused a new one: the check engine light came on because the $O_2$ sensor was removed.
  • Instructor Response: This highlights the importance of the time dimension in decision-making. If individuals are shortsighted, they make decisions that solve current problems but create future ones. Dynamic constrained optimization requires thinking about the entire path rather than just the immediate fix. Sometimes use of resources to address a want creates further wants or secondary problems.

• Refining Physician Models (Instructor Dissertation): The instructor shared their doctoral research on physician decision-making regarding medications. The study assumed physicians were purposeful and self-interested. While physicians care for patient well-being, the data showed that in some cases, profit maximization drove prescribing behavior. Studying situations where physician and patient interests conflict requires the baseline assumption that behavior is not random.

• Proper Nouns and Specific Locations mentioned:

  • MTA (Michigan Transfer Agreement)
  • Henry Ford College
  • Jeffrey Steingarten (Food Writer)
  • Georgia (Peaches)
  • Vermont (Apples)
  • California (Almonds/Wheat)
  • Kansas (Wheat)
  • Bakersfield, California
  • San Luis Obispo, California