An Introduction to Economics

National Income already covers the specific concepts (GDP, GNP, real versus nominal income) used to measure an economy's output. This note covers the chapter that comes before it in the book's own sequence: what economics actually is, and the basic structural choices every economy has to make regardless of how its output is later measured.

Economics: the discipline of scarcity and choice

Economics is conventionally defined, following the British economist Lionel Robbins (1935), as the science of scarcity: the study of how societies allocate genuinely limited resources against wants that are, for practical purposes, unlimited. Two textbook definitions worth holding precisely capture the same idea from different angles: economics is "the study of how societies use scarce resources to produce valuable commodities and distribute them among different people" (Samuelson and Nordhaus), and, in a second, complementary framing, the study of "how individuals, firms, governments and other organisations within our society make choices and how these choices determine a society's use of its resources" (Stiglitz and Walsh). Both definitions rest on the same two ideas: resources are scarce, and a society must therefore make choices about how to use them efficiently.

This scarcity is exactly what gives rise to opportunity cost, the value of the next-best alternative given up whenever a choice is made. Because no individual, firm or government can pursue every possible use of a limited resource simultaneously, every economic decision, at every scale from a household's grocery budget to a national government's five-year spending plan, necessarily involves forgoing some other use that resource could have been put to instead. Opportunity cost is not a specialised or advanced concept in this framing; it is the direct, unavoidable consequence of scarcity itself, and it is the reasoning tool economics applies to essentially every question it asks.

Organising an economy: three distribution models

Once an economy has produced a given quantity of goods and services, it still faces a second, separate problem: how to actually distribute what has been produced to the population that needs it. Historically, economies have organised this distribution through one of three models. Under a state-controlled distribution system, the government takes sole responsibility for supplying goods and services, with no direct payment required from the consumer, the model historically associated with the former Soviet Union and Communist China. Under a market-based distribution system, goods and services are supplied and priced through the mechanism of demand and supply in an open market, the model historically associated with the capitalist economies of Europe and North America. Under a mixed (state-market) system, which developed out of the practical experience of running the first two models and is by far the most common arrangement in the world today, some goods and services are provided free or at a subsidised price by the state, while others are left to the market, with the exact mix shifting over time as an economy's own socio-economic composition changes. Sectors of an economy (primary, secondary and tertiary, an agriculture-industry-services split used throughout this reference book's later chapters) and the different types of economies (capitalist, socialist, mixed) that these distribution choices give rise to are the direct, practical application of this same organising question.

Quick revision points

• Economics is the science of scarcity (Lionel Robbins, 1935): the study of how societies allocate limited resources against unlimited wants. Samuelson/Nordhaus and Stiglitz/Walsh's definitions capture the same idea, resource scarcity and the resulting need for choice, from two angles.
• Opportunity cost is the value of the next-best alternative given up by any choice; it follows directly from scarcity and applies at every scale, from an individual to a national government.
• Three historical models for distributing an economy's output: state-controlled (government supplies directly, no consumer payment; former USSR, Communist China), market-based (price mechanism, demand and supply; capitalist Europe/North America), and mixed (state-market), the most common model worldwide today, with the exact state-versus-market mix shifting as an economy's own conditions change.
• Sectors of an economy (primary, secondary, tertiary) and the resulting types of economies (capitalist, socialist, mixed) are this same distribution-model question applied in practice.