Introduction to Economics

Alfred Marshall, a highly influential early economic thinker, provides a definition that is still relevant today: “Economics is a study of man in the ordinary business of life. It enquires how he gets his income and how he uses it. Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the study of man.” [3]

Why is Economics Important to Me?

At its most basic level, economics is all about choice, whether that choice is made on an individual or a collective basis. The choices you make about how to run your organization have a profound impact on its success. For example, when should your organization provide a new product or service? Who will buy your product, and why will they choose to do so? Where should the raw materials or labor to develop that new product or service come from? How much should they cost? Understanding economics can help you get to grips with these complex questions and, ultimately, give your organization the best possible chance of success in today’s economy.

A Brief History Lesson

Classical economic thought developed in the late 18th century when a group of Economics pioneers, including Adam Smith and David Ricardo, began to develop new theories about commerce and the development of market economies. Smith’s classic book The Wealth of Nations helped establish economics as a field of study in its own right. [4] Smith argued in support of economic freedom and the idea that the economy will prosper with limited government interference (known as laissez-faire), free competition and free trade between markets.

As the stock market crash of 1929 plunged the world economy into turmoil, two men emerged with competing claims on how best to restore equilibrium. First up was John Maynard Keynes, the father of Keynesian economic theory. He believed that governments had a duty to spend in order to improve economic performance. A significant departure from popular economic thought, Keynes argued that optimum economic performance could be achieved by influencing demand through government policy, namely increased public spending and taxation, rather than through the free market philosophy favored by the classical school of economics. His ideas are outlined in the key book The Economic Consequences of the Peace. [5]

Keynes’ rival was an Austrian economics professor, Friedrich Hayek. His view was the polar opposite. He considered any attempts to intervene in the economy pointless and potentially dangerous. Hayek’s book The Road to Serfdom offers a strong argument against economic planning. [6] In it, he ‘warned of the danger of tyranny that inevitably results from government control of economic decision-making through central planning.’ [7]

Keynes and Hayek had many heated public debates about the virtues of the free market versus government intervention, and their arguments are still relevant today.

Recent interest in economics has focused on the field of behavioral economics, which looks at the intricacies of human behavior and how our decisions are not always as rational as we believe them to be.

While the previously held ‘rational man’ assumption can be a powerful tool for looking at behavior, it has many shortfalls that can lead to unrealistic economic analysis and policy-making. Leading authors in this field include Daniel Kahneman and Dan Ariely.

Fields of Economic Study

The study of economics can be broken down into a number of core areas:

Microeconomics

This concerns all the individual elements that combine to make up an economy - the behavior of individuals, households and businesses. Microeconomics considers issues such as the process by which households decide on what and how much to consume and whether to save, as well as how individual organizations set prices for their products and services. Microeconomics also considers whether markets have enough competition and how the labor or employment markets function.

Macroeconomics

This is the study of the economic ‘big picture’ - analyzing economy-wide issues such as economic growth as well as changes in inflation and unemployment levels. Although economists generally separate themselves into distinct macro and micro camps, macroeconomic issues are the product of all the microeconomic activity in an economy. [8]

Macroeconomic Policy

Top-down policy by governments and central banks is intended to maximize economic growth whilst keeping down inflation and unemployment. The main instruments of macroeconomic policy are changes in interest rates and money supply, known as monetary policy. Changes in taxation and public spending are known as fiscal policy. The fact that unemployment and inflation often rise sharply, and that growth often slows or GDP falls, may be evidence of poorly executed macro­economic policy.

Behavioral Economics

Behavioral economics takes human behavior as its starting point. As we have seen, previous areas of economic thought, such as classical economics, assume that people make rational choices in their own interests. Behavioral economics argues that this is not really the case and that people are often irrational in their behavior. Modern day behavioral economists, including Daniel Kahneman, Amos Tversky and Dan Ariely, have identified important areas of irrational human behavior, such as overconfidence, optimism, loss aversion and extrapolation. [9] An understanding of how people actually behave is essential when it comes to the development of economic policies.