What is Economics?

- Definition & Types

Economics involves allocating resources to meet peoples' needs and desires for goods and services. Explore
the definition and types of economics including microeconomics and macroeconomics and learn about
growth vs. sustainability.

Economics - Allocation of Resources

Meet Joe. He is a typical entrepreneur in the United States who is about to start a new
downtown coffee shop. We'll be following Joe throughout this lesson to see how economics
affects his life. Economics is about the allocation of resources available to fulfill people's needs
and wants for goods and services.

In a perfect world, we would have unlimited resources and everyone would have all their needs
and wants fulfilled. But, we don't live in a perfect world; resources are scarce or limited.
Consequently, not all wants can be fulfilled, and decisions must be made about the allocation of
resources. Economics is studying how everyone from an individual to an entire country makes
these decisions.

Joe lives in a market economy where most resources are held in the hands of individuals who
have the right to decide what to do with them. Like everyone else, Joe both consumes resources
in the economy and provides resources to the economy. For example, he supplies labor to the
economy, and he also buys resources, such as food, transportation and housing. Since he's
starting a coffee shop, he will have to obtain resources, such as espresso machines, grinders,
coffee beans, milk and cups. He'll also need electricity and water as well as labor from
employees.

Microeconomics
Since Joe wants to start a business, he'll be particularly interested in microeconomics, which is
the study of how consumers and businesses make economic decisions. One of the most
important concepts of microeconomics is the law of supply and demand. This law states that if
everything else stays the same, the price of a good or service will be high if the demand for it is
high and the supply of it is low.

On the other hand, if the demand for it is low and the supply of it is high, the price will tend to
be low. If the demand for java is higher than the supply, the price of a cup will go up. If the
demand for it is lower than the supply, Joe will have to cut his prices to make sales.

Some economists believe that the economy is guided by an 'invisible hand ' - a term coined by
English economist Adam Smith in his book The Wealth of Nations. Basically, the idea is that
buyers and sellers will make decisions based upon what's best for them - in their self-interest.
And, the sum of these interests creates the best result for an economy.

Let's look at the invisible hand at work. Joe will only buy a commercial-grade espresso machine
at a price that is worth it to him. Vinny, the vendor, will only sell his espresso maker to Joe at a
price that is worth it to Vinny. No one makes Joe buy what Vinny is selling. They each decide on
their own if it is in their best interests to do the deal. The price at which Joe is willing to buy and
the price that Vinny is willing to sell should be an efficient allocation of economic resources.

Macroeconomics
Joe will also be interested in macroeconomics. While microeconomics studies a piece of the
economy, macroeconomics studies the entire economy. It looks at economic effects in the
aggregate. A hint to the distinction between microeconomics and macroeconomics can be
found in their prefixes. 'Micro' means 'small' and 'macro' means 'big.' Macroeconomics looks at
the big picture.

Common areas of study include:

Inflation, which is an increase in the general price-level in an economy

Unemployment

Economic output, which is the aggregate output of goods and services in the economy

Business cycle, which is the ups and downs of an economy, including growth, recession, depression
and recovery

Fiscal policy, which is the government's decision on taxing and spending and its effect on an
economy

Monetary policy, which is a government's decision regarding money supply and interest rates and its
effect on an economy

International trade

Study of economic systems. Economists study different economic systems, such as free market
economies, command economies and mixed economies

As you can see, macroeconomics helps us understand how the economy as a whole affects our
lives. These macroeconomic matters affect everyone, but let's focus on Joe. Business owners,
like Joe, will be concerned with the unemployment rate and inflation rate because it will impact
the costs of labor. Inflation also affects the costs of goods and services needed for his business.

Government taxation and spending will also affect Joe's business. Taxes take money out of his
pocket, and government spending means there are more people working providing goods and
services to the government. These people will then have money to buy his coffee. The supply of
money and interest rates will affect the price of goods and the costs of loans.

Growth vs. Sustainability

A current discussion in economics is economic growth and sustainability. Economic growth is
simply increasing the economy's ability to produce more goods and services. Joe's coffee shop
adds to economic growth because more coffee, cappuccinos, lattés, mochas and espressos are
produced and sold. The more Joe sells, the more employees he must hire to keep up with
demand. He'll also need to buy more goods and services. He can also increase growth by
improving productivity - getting more goods and services out of the same or fewer resources
than he used before.

However, there is a significant question whether growth can go on forever. Resources are
limited - there's only so much oil, timber, water, metals and the like to produce goods and
services. Some of these resources cannot be renewed, and increases in productivity through
technology may have limits. Additionally, unfettered economic growth can have adverse
environmental consequences, such as pollution and depletion of nonrenewable resources, like a
rainforest.

Some advocate for a sustainable approach to economic development where economic growth
takes into account the impact on the environment, so that economic growth is sustainable over
time. Joe can contribute to sustainable growth. For example, he can use recycled paper for his
disposable coffee cups, purchase organically grown coffee beans and implement water and
energy conservation policies at work.

Lesson Summary
Let's review what we've learned. Economics is the study of efficiently allocating resources to
fulfill the needs and wants of people. The study of economics is divided into two primary
subdivisions. Microeconomics is the study of the economic decision making of businesses and
consumers, while macroeconomics is the study of the economy as a whole.

Economic growth is an increase in the output of goods and services produced in an economy.
Economic growth may be limited by a finite amount of resources and technological limits.
Sustainable economic growth is an attempt to create economic growth in a way that is
sustainable and limits the damage to the environment.

Learning Outcomes
Upon completing this lesson, you will be able to:

Define economics and market economy

Distinguish between microeconomics and macroeconomics

Identify common areas studied in macroeconomics

Explain the importance of sustainable economic growth

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