Introduction to Economics

Economics: The Subject is in Vogue - But What Is It?

(Gary Rabbior)

Think about it - money has no real value in itself. You can't eat it, it won't keep you warm and it doesn't look particularly attractive as wallpaper. The value of money is in what it can do, or potentially do, for us when we use it to obtain goods and services.

Money is a medium of exchange - paper, coins and cheques - which is readily accepted in exchange for the goods and services provided. Money is a convenient way to compare the value of one thing with another and avoids the problem of determining, for example, how many hammers would be exchanged for a roast of beef. The old system of trading (bartering) became too complicated and therefore money was created to simplify the many, many exchanges of goods and services which take place in an economy.

So far so good. But as we all know something seems to have gone wrong somehow and the value of the dollar has been decreasing. Have a look at the change in your purse or pocket. The pennies are just about useless now and the nickel can hardly buy anything by itself anymore. What's been happening?

Consider the game of Monopoly. The number of properties, hotels and motels are fixed. Under the rules everyone receives a certain amount of money and one of the players, the banker, handles the money transactions involving the bank. Now, suppose we alter the game somewhat by doubling the amount of money each person gets and the amount of money in the bank. What would happen to the game?

You, and all other players, would receive more money. But what is its real value to you? Your wealth will actually be represented by your property, holdings and your development (hotels, motels) on those properties. Your potential for wealth is exactly the same as it was before since the number of properties, motels and hotels has not changed.

What will change? When it comes time for you to try to strike a deal with other players for properties to establish monopolies, you will now have more money to offer. The price you are prepared to pay will likely increase. Therefore you will probably end up with the same property as in the other game but you will probably pay a higher price for it.

This is what happens when the amount of money in an economy is increased but the quantity of goods and services which we can acquire with our money remains unchanged. That is, inflation. The real value does not increase - you have the same properties - but the price (the money value) rises.

From the example, you can see that even though the amount of money is doubled, a person's real wealth is largely unaffected. Money is not the real representation of wealth. The real representation of wealth is the quantity of goods and services which our money can acquire.

If, at the same time that we doubled the money in the Monopoly game, we had doubled the number of properties, the players would have been able to use their new money to buy new properties - not just spend more money on the same properties. The increase in properties represents an increase in the potential wealth that players in the game can acquire. It is properties they are trying to obtain. Money only enables them to get property. Any player who simply kept the money and did not acquire any properties is not going to survive a Monopoly game. Properties, then, are the focus of the game's activity. In the same way, the study of economics focuses on the goods and services produced by an economy.

The purpose of any economic system is to provide goods and services for the people in the society. People have certain needs (or necessities) such as food, clothing and shelter. Without these, basic survival would be a problem. There are other goods and services which one might call wants (or luxuries) - items which are not needed for survival but which make life easier or more enjoyable. Together this represents a large quantity of goods and services which people in a society would like produced.

The problem a society faces, as can be readily perceived, is that not enough goods and services can be produced to satisfy our collective needs and wants. This would be acutely obvious if prices were not established for goods and services. Think of the shortage of cars that would occur in our society if they were free to anyone who wanted them.

Therefore, the wants and needs of our society exceed the capacity of the economy to produce goods and services. Why? The capacity of an economy to produce goods and services is limited by the resources we have at our disposal. There are natural resources such as minerals, land and forests. In addition, we have the resources which are manufactured to enable production - e.g. factories, machines. These are referred to as capital resources. The natural and capital resources are going to sit idle unless labour is utilized to combine the two to produce goods and services. Labour is required in many forms such as doctors, machinists, computer programmers, managers and on and on.

Hence, there are three major categories of resources:

natural (land)
capital
labour

The major problem facing cur economy then is the following:

The resources our society can use to produce goods and services are limited relative to the quantities of goods and services we need and want. (Economic problem - limited resources versus relatively unlimited needs and wants).

That is the major concern of economics - how to use our limited resources to produce goods and services to satisfy our needs and wants. The limitation of resources imposes constraints on production - we can't produce everything we need and want.

This means our society has to make decisions. If we had unlimited forests we could use a tree for any purpose and not worry because there would always be other trees available. But since we know that isn't always going to be the case (because we have a limited quantity of forests) thought has to be given to how our trees are used.

Why? Because as soon as we choose to use a tree for one purpose (e.g. as lumber for a house) we lose the opportunity to use that tree for another purpose (e.g. pulp for paper for newsprint). Therefore, because our resources are limited, we must make decisions about how we are going to use them. When we use a resource for one purpose, we lose the opportunity to use it for something else.

We can summarize at this point:

We have needs and wants which we seek to satisfy.
The economy has resources to use to produce goods and services - natural, capital and labour.
The resources are limited relative to our needs and wants.
The limited resources impose constraints on the ability of an economy to produce.
Therefore, there are alternative ways we could use each resource.
Once a resource is used for one purpose we lose the opportunity to use it for another.
Therefore, decisions have to be made about how to use the limited resources to produce goods and services.
This means our society, and Canadians individually, continually make trade-offs, giving up certain goods and services to use resources to produce others.

Economics then, is the study of how a society uses limited resources to produce goods and services to satisfy needs and wants.

A society will establish a type of economic system to produce goods and services. There are a variety of systems which a society might establish but every economic system will have to address three major concerns:

What goods and services to produce?
Haw to produce the goods and services?
How the goods and services produced will be distributed to those who need and want them?

In conclusion, remember that money is vital in our economy since we use it to acquire goods and services. But money is only as valuable as the quantity of goods and services we can receive for it. Twice as much money and the same quantity of goods and services will only mean higher prices. Our standard of living will be affected by the goods and services our economy produces - not how much money we can produce.

Gary Rabbior is the Executive Director of the Canadian Foundation for Economic Education.