BASIC ECONOMIC CONCEPTS
When you hear the word economics, you probably think of “big business”—large
corporations that run banks and petroleum refineries, or companies that make
automobiles, computers and, yes, even comic books. Economics does include big
business, but it also includes much more. Like other social sciences, economics has
its own vocabulary and uses terms such as recession, commodity, or utility. To
understand economics, a review of key terms is necessary. Fortunately, most
economic terms are widely used, and you will already be familiar with many of them.
Goods, Services, and Consumers
Economics is concerned with economic products—goods and services that are
useful, relatively scarce, and transferable to others. Economic products help us satisfy
our wants and needs. Because they are both scarce and useful, they command a
price.
Goods
Goods There are different types of economic products. The first one is a good—
a useful, tangible item, such as a book, car, or compact disc player, that satisfies a
want. When manufactured goods are used to produce other goods and services, they
are called capital goods. An example of a capital good would be a robot welder in a
factory, an oven in a bakery, or a computer in a high school. Goods intended for final
use by individuals are consumer goods. Any good that lasts three years or more when
used on a regular basis is called a durable good. Durable goods include both capital
goods, such as robot welders, and consumer goods, such as automobiles. A
nondurable good is an item that lasts for fewer than three years when used on a
regular basis. Food, writing paper, and most clothing items are examples of
nondurable goods.
Services
The other type of economic product is a service, or work that is performed for
someone. Services include haircuts, home repairs, and forms of entertainment such
as concerts. They also include the work that doctors, lawyers, and teachers perform.
The difference between a good and a service is that a good is tangible, or something
that can be touched, while a service is not.
Consumers
Consumers are the people who use goods and services to satisfy their wants
and needs. As consumers, people indulge in consumption, the process of using up
goods and services in order to satisfy wants and needs.
Value, Utility, and Wealth
In economics, value refers to a worth that can be expressed in dollars and cents.
Why, then, does something have value, and why are some things more valuable than
others? To answer these questions, it helps to review a problem Adam Smith, a
Scottish social philosopher, faced back in 1776.
The Paradox of Value
Adam Smith was one of the first people to describe how markets work. He
observed that some necessities, such as water, had a very low monetary value. On
the other hand, some no necessities, such as diamonds, had a very high value. Smith
called this contradiction the paradox of value. Economists knew that scarcity was
necessary for something to have value. Still, scarcity by itself could not fully explain
how value is determined.
Utility
It turned out that for something to have value, it must also have utility, or the
capacity to be useful and provide satisfaction. Utility is not something that is fixed or
even measurable, like weight or height. Instead, the utility of a good or service may
vary from one person to the next. One person may get a great deal of satisfaction from
a home computer; another may get very little. One person may enjoy a rock concert;
another may not.
Value
For something to have monetary value, economists decided, it must be scarce
and have utility. This is the solution to the paradox of value. Diamonds are scarce and
have utility, thus they possess a value that can be stated in monetary terms. Water
has utility but is not scarce enough in most places to give it much value. Therefore,
water is less expensive, or has less monetary value, than diamonds. The emphasis
on monetary value is important to economists. Unlike moral or social value, which is
the topic of other social sciences, the value of something in terms of dollars and cents
is a concept that everyone can easily understand.
Wealth
In an economic sense, the accumulation of products that are tangible, scarce,
useful, and transferable from one person to another is wealth. A nation’s wealth is
comprised of all tangible items—including natural resources, factories, stores, houses,
motels, theaters, furniture, clothing, books, highways, video games, and even
basketballs— that can be exchanged. While goods are counted as wealth, services
are not, because they are intangible. However, this does not mean that services are
not useful or valuable. Indeed, when Adam Smith published his famous book The
Wealth of Nations in 1776, he was referring specifically to the abilities and skills of a
nation’s people as the source of its wealth. For Smith, if a country’s material
possessions were taken away, its people, through their efforts and skills, could restore
these possessions. On the other hand, if a country’s people were taken away, its
wealth would deteriorate.
The Circular Flow of Economic Activity
The wealth that an economy generates is made possible by the circular flow of
economic activity. The key feature of this circular flow is the market, a location or other
mechanism that allows buyers and sellers to exchange a specific product. Markets
may be local, national, or global—and they can even exist in cyberspace.
Products Markets
After individuals receive their income from the resources they sell in a factor
market, they spend it in product markets. These are markets where producers sell their
goods and services. Thus, the wages and salaries that individuals receive from
businesses in the factor markets returns to businesses in the product markets.
Businesses then use this money to produce more goods and services, and the cycle
of economic activity repeats itself.
Productivity and Economic Growth
Economic growth occurs when a nation’s total output of goods and services
increases over time. This means that the circular flow becomes larger, with more
factors of production, goods, and services flowing in one direction and more payments
in the opposite direction. Productivity is the most important factor contributing to
economic growth.
Productivity
Everyone in a society benefits when scarce resources are used efficiently. This
is described by the term productivity, a measure of the amount of goods and services
produced with a given number of resources in a specific period of time. Productivity
goes up whenever more can be produced with the same number of resources. For
example, if a company produced 5,000 pencils in an hour, and it produced 5,100 in
the next hour with the same amount of labor and capital, productivity went up.
Productivity is often discussed in terms of labor, but it applies to all factors of
production.
Investing in Human Capital
A major contribution to productivity comes from investments in human capital,
the sum of people’s skills, abilities, health, knowledge, and motivation. Government
can invest in human capital by providing education and health care. Businesses can
invest in training and other programs that improve the skills of their workers.
Individuals can invest in their own education by completing high school, going to
technical school, or attending college.
Division of Labor and Specialization
Division of labor and specialization can improve productivity. Division of labor is
a way of organizing work so that each individual worker completes a separate part of
the work. In most cases, a worker who performs a few tasks many times a day is likely
to be more proficient than a worker who performs hundreds of different tasks in the
same period. Specialization takes place when factors of production perform only tasks
they can do better or more efficiently than others. The division of labor makes
specialization possible. For example, the assembly of a product may be broken down
into a number of separate tasks (the division of labor). Then each worker can perform
the specific task he or she does best (specialization). One example of the advantages
offered by the division of labor and specialization is Henry Ford’s use of the assembly
line in automobile manufacturing. Having each worker add one part to the car, rather
than a few workers assembling the entire vehicle, cut the assembly time of a car from
a day and a half to just over 90 minutes—and reduced the price of a new car by more
than 50 percent.
Economic Interdependence
The U.S. economy has a remarkable degree of economic interdependence. This
means that we rely on others, and others rely on us, to provide most of the goods and
services we consume. As a result, events in one part of the world often have a dramatic
impact elsewhere. This does not mean that interdependence is necessarily bad. The
gains in productivity and income that result from specialization almost always offset
the costs associated with the loss of self-sufficiency.
