(VOL. I) The Basic Principles of Modern Economics

[Papa Liam 960]

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THE BASIC PRINCIPLES

OF MODERN ECONOMICS

Volume I: Defining Economics

 

 

WRITTEN BY

Elibar'indor W. Halcourt

 

PUBLISHED BY

The Northern Geographical Society Press

 

SUPERVISORS
Dr. Otto Wittenbach
&

Dr. Tanith Vursur

 

12th of Tobias' Bounty

36 2E

 

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Abstract

This essay details the basic introductory principles to become familiarized with when considering the field of economics. It is my belief that much of the hesitancy for new scholars to begin studying economics is the lack of foundational literature, and that the low number of published works in economics is due to the general public holding a misconception of what economics actually is. Thus, this is the first of a three part series detailing the most fundamental, basic principles of economics, which I am writing in the hopes that more budding academics will embrace the discipline and construct more advanced theories. In this volume, we define the parameters of what economics actually is, as to give the reader a foundation to further study the relatively new field. Subjects covered include resource scarcity, rational choice theory, opportunity cost and markets.

Introduction: What is Economics?

The current volume of published works in economics is concerningly slim. Conventional wisdom dictates that the small quantity of economic literature is the consequence of economics not being a viable field to study. It would be my contention that economics is now more relevant than ever, and the reason that academics have not given it the recognition as afforded to history or anthropology is due to the lack of foundational texts, and the lack of understanding regarding what economics actually is. Economics is a discipline which has only recently been receiving the attention it deserves from advanced scholars, but it is by no means a new field. Literature in economic history dates back to the era of Aegis, where an institution known as the Aegean Academy -- regarded as the first attempt at a formal educational institution in history -- defined economics as the study of “trade commands and markets.” The intention of this program was to educate students to become savvy merchants, and prevent them from being scammed when making financial transactions. While this definition provides a useful practical application, it is not considered accurate by the parameters of today’s economists. 

It is difficult to come up with a single, coherent definition of what economics “is,” as we still regard it as an emerging field. However, if we were to create an all-encompassing definition, we could summarize the entirety of economics into the following; “Economics is the study of how rational decision makers interact with the concept of value.” You may note that this is a bit of a broad definition, but it is the only one which encapsulates every possible definition of how other economic scholars would describe the discipline. One scholar may define economics as, “the study of production, consumption, and wealth in a society.” Another may take the viewpoint that economics is, “the science of human choice in which a rational individual maximizes their own utility in a world in which resources are finite.” The next could just as easily defend the notion that economics is, “the study of how free agents respond to incentives.” On their face, there is nothing wrong with any of these definitions, as they are all correct in their own regards; economics is the study of all the above. However, the field of economics is not exclusive to any one of those definitions, and one cannot go unaccompanied by the others. All three supplementary definitions inform the original parameters outlined, in that economics is the study of how rational decision makers interact with the concept of value.

It is also worth noting what economics is not. There is a common misconception regarding economics, in that it is similar to the field of business or finances. In my experience, many scholars unfamiliar with the field of economics tend to refer to it as the fancier cousin of business studies. Whereas business teaches you how to operate and maintain various aspects of private industry in the market, economics is a social science which addresses the choices and behaviors of people participating in said markets. This is my contention with individuals who conflate economics with business; Business addresses the production of goods and services which are consumed, and economics addresses the behaviours of free agents in the market, including those consumers. There does exist an overlap between the fields, but it should be remembered that business is a professional practice whereas economics is an academic one.

 

Positive and Normative Statements

As with many of the social sciences, economics deals with both positive and normative statements. This serves as the foundation for analysis in the social sciences and economics, distinguishing between an indisputable fact and a subjective opinion. The normative statement addresses the analysis of a subject which is informed by personal opinion, ethics, values and morals. We cannot prove it right or wrong, because there is no definitive, objective truth regarding the statement. For instance, if I order a Carrington pale ale from the local tavern, I might say, “This pale ale is delicious!” This is a normative statement. I find the drink to be delicious, and nobody can dispute that statement, because it cannot be proven to be true or false. If I were to say, “This pale ale is in a glass mug,” that would be a positive statement, because we can deduce if the pale ale is actually in a glass mug or not. Even if a statement is incorrect, it is still positive, because we can prove that it is false. If I were to say, “This pale ale is in a wooden mug,” and the ale was indeed in a glass mug, that would still be a positive statement; I could just be proven wrong by the barkeep.

The reason I cite positive and normative statements is to detail how economics is not a “hard science” as some are often led to believe. Economics is, at the end of the day, a social science which often does not reach conclusions in objective truths, but rather uses analytical data to reach subjective, opinionated world views. Just because a discipline uses a wide array of quantitative methods does not mean that all of the data and conclusions we cultivate are cold, dead-set, objective truths. Very often, that quantitative data is merely used as an indicator to inform our beliefs.

 

Opportunity Cost

Opportunity cost serves as the foundation of behavioral economics. If there is one lesson I want you to take away from this reading, it’s this; opportunity cost is the next best alternative forgone. It measures the “next best thing,” the option you gave up in an effort to pursue the best option. 

For instance, on a given day, I could either take a jog for two hours or write for three. If I choose to go for a jog for two hours instead of writing for three, I sacrifice one hour of writing. The figures below demonstrates my options;

	Jog	Write
Elibar’s Options	2	3

 

 

For the sake of this example, let us assume that there are only two possibilities in this scenario; either I can write for three hours or I can jog for two. There is no middle ground. The red points on the graph are the only two options I have.

However, this is hardly how the real world operates. Surely, I can find a comfortable middle ground. To figure out what that middle ground is, however, I need to calculate what the opportunity cost for each individual unit is -- in this case, the unit being hours jogged or writing. If this were a diagram where each of the units had a 1:1 ratio, it would be easy to calculate; i.e. if my options were between three hours of jogging and three hours of writing. I’d be giving up one hour of jogging for one hour of writing, and vice-versa. In this example, we’ll have to exert a bit of basic algebra. To calculate the opportunity cost of pursuing a given option, you must divide the forgone option by the option pursued. For instance, if I decide to jog today, we would divide the forgone option (writing, three hours) by the pursued option (jogging, two hours).

 

Opportunity Cost for 

one hour of jogging 

3 / 2 = 1.5

 

In this example, for every hour I jog, I give up an hour and a half (1.5) of writing. Conversely;

Opportunity Cost for 

one hour of writing 

2 / 3 = 0.66

 

If I were to pursue writing instead, I would be giving up 0.66 hours of jogging (or two-thirds of an hour, for the fractionally inclined) for each hour I write. So then, let’s say that in our first example, we wanted to pursue only one hour of jogging instead of two. The rest of that time can be used to write. Because our opportunity cost for jogging is 1.5 hours, our graph now looks like the following;

 

As pictured above, in pursuit of one hour of jogging, I have sacrificed an hour and a half of writing. Opportunity cost is mayhaps the single most crucial economic concept for budding scholars to comprehend, as it demonstrates that we live in a world of scarcity and finite resources; and in that world of scarce and finite choices, people have to make decisions which maximize their utility, and optimizes the allocation of the resources available. This is what’s referred to as the rational choice theory.

 

Market Functions`

You may know markets as the congregation of shops and stalls in the centre of your town or city, and indeed, that is exactly what a market is in economics, as well. Markets simply refer to the systems and institutions by which parties exchange goods and services, may it be on Main Street or the international exchange of goods. Markets are not a uniform concept, they come in various styles, systems, and sizes. The economy of various halfling villages which reject the usage of mina are just as much of a market as the mixed-use economies of Orcish societies, who often assign value to both mina and snagas, and as is the classical market of Imperial exchange.

Markets typically include two major agents involved in the process of exchange; the consumer, who is buying the good or service, and the vendor, who is selling the good or service. There may be other actors involved in market exchanges -- think tax agencies, sales brokers -- but market transactions will always, consistently have a consumer (buyer) and a vendor (seller). 

Those are the actors in markets, and they manipulate two other major elements which determine the overall status of the marketplace, two elements which are rather intuitive to most; supply and demand. These two fundamental components of economic literature describe how the consumers interact with sellers, and how the price of the good interacts with it’s available quantity. We visualize supply and demand through this figure;

 

A major complaint from new economics students is that they understand the material, but do not understand the graphs used to explain that material. Graphs are tricky business for anybody unfamiliar with visualizing quantitative work, it can be a challenge to rewire your cognition in such a way that graphs make sense, but do keep in mind that these graphs are here to help you comprehend economic concepts. One notion that we ought to clarify immediately is that you should think of supply and demand as separate actors in the marketplace, just as you would distinguish consumers and sellers. Their movements will not have implicit impacts on their counterpart (although there will obviously be consequences of one falling and the other rising, but there is no law which explicitly states, “As demand rises, supply falls.” They are separate actors.) There are four major elements at play here, and it is of utmost importance that any budding economist understands each one. The two to begin with are price and quantity, represented as p and q respectively. Price refers to the compensation one party gives up to the other in exchange for the good being analyzed (this refers to the price the consumer is willing to pay the seller for a good). Quantity refers to the amount of that item which is actively purchased on the marketplace. 

Demand is the downward sloping curve; as the price of a good increases, the quantity decreases, and vice versa. This is known as the law of demand, and it correlates with the consumer’s desire to purchase goods. Think about the market for our aforementioned Carrington pale ale. At the price of five mina, the demand is relatively high, because many consumers are willing to pay a measly five mina for an ale. However, should the barkeep raise the price to fifteen mina per ale -- a terrifying proposition which I hope never manifests -- then less people will want to buy pale ales at that price; thus, the quantity decreases, and demand has fallen.

Then comes supply, the upward sloping curve on our graph. Supply resembles the amount of goods readily available, as provided by the sellers. As it is upwards sloping, the relationship between price and quantity is positive, as opposed to the inverse relationship according to the law of demand. As price increases, so will the quantity, as is the law of supply. Now, take the perspective of our barkeep. Suppose the price of the pale ale he’s selling rises, for whatever the reason (maybe the quantity of malt used to make the ale has decreased, so the malt farmer raises his prices, and the barkeep has to recoup his losses!) As a result, the barkeep has an incentive to produce more pale ale. This will increase the supply.

When the supply is greater than the demand for the good, we’re in a situation known as a surplus. When the demand outpaces supply, we’re in a shortage. The intersection on the graph, where both supply and demand meet, refers to the point where both are in perfect market conditions that are appropriate for the given good; they are at equilibrium. This is an important term to remember, as it means the market for that good has perfected itself. However, if demand rises, then the equilibrium price and quantity will rise, resulting in the entirety of the demand curve itself to shift right (as in, the actual line itself will move). When this curve shifts, however, the equilibrium price will still remain at the intersection of the line, but the value of the price and quantity will still have been altered. The inverse also holds true, where a decrease in demand causes the curve to shift left. Likewise, a decrease in supply causes the equilibrium to change to a higher price and lower quantity, as the supply curve will shift left. The opposite also holds true, where the increase in supply causes equilibrium to have a lower price and higher quantity, as the curve shifts right.

This concept can be intimidating at first, but forget the fancy terminology for a brief moment. These principles are intuitive, you know that as the price for a good increases then less people are going to be able to afford it. The visualization may be intimidating, but this is not a newfound idea to the well-read commoner. Remember, graphs are your friend, make use of them.

 

Theories of Value

Theories of value are competing ideas which contest the foundations of economic thought and principles. Although this veers into the bounds of political economy (the study of how production and trade interact with society’s governance and laws), it is still a series of concepts worth introducing in this first volume. This is to demonstrate that economics is, as clarified in the first section of this book, a social science where subjective morals and opinions are used in qualitative analysis. The theory of value-added is one that has to be comprehended before embarking on an individual economist’s thoughts. The value-added theory stipulates that each stage of production adds additional value to the final value of a produced good. Everything from the malt farmer, to the brewster, to the tavern’s sale of my pale ale adds some sort of value to that ale.

With this in mind, the theory which many in the mainstream descendant society adhere to is the subjective theory of value. Subjective-value theory stipulates that we cannot ‘calculate’ the actual value of a good through any inherent property, but rather that the good is valued differently by various consumers, and thus markets allocate the goods to those who need them most based on how much they value them. In other words, “you want this thing more than I do, but I want that thing more than you do.” This is the theory utilized primarily by Imperial, dwarven, and to a smaller degree, Orcish societies. Prominent contemporary economist Soren Q. Z. Haas-Lotherington is one of the most notable advocates of subjective-value theory.

The theory most critical of subjective-value theory is the labor theory of value, which takes the opposite stance, in that there are objective indicators which we can use to calculate the value of a certain good; primarily, how much socially necessary labor time was invested into the production of the final good. This theory differentiates the value of the good, which is calculated through how much labor was invested into said good, from the wages paid to workers, who’re paid on the merit of how much their employer and the owner of capital is willing to compensate them. Labor theory of value is practiced staunchly in halfling society, where they’ve forfeited the use of mina, and more recently it has made strides in Mali’aheral circles with modern economists like Tilruir Niënor Nullivari. Classical political economists who adopt the labor theory of value include halfling scholar Bernard Oakstool and the Imperial academic Bell Sano, prominent in the 1600’s. The labor theory of value has lost traction amongst critical scholars, but it has seemingly been making a quiet reappearance in non-human circles today.

 

Conclusion

Economics is a complex discipline. It is one that many scholars might find themselves unfamiliar with, even others in the social sciences, as it can make objective truth and subjective thought indiscernible from one another to the unread eye. But to scholars, economics is important because it can have a revolutionary impact, not only on the academic community but society at large. This is more than the study of how things are produced, or how stuff is traded. It is the study of incentives, scarcity, allocation, and how society assigns value to different elements of our various civilizations.