What you should know: Economics

Todd Knoop, professor of economics and business 


One

There is no such thing as a free lunch.
Everything costs something in terms of money, time, or energy. The question is how we choose to use the limited resources that we have. Economics is the study of how individuals, societies, governments, and countries distribute and use scarce resources. As such, it is applicable to almost every decision made in everyday life.

Two

Markets distribute scarce resources most efficiently, except when they don’t.
Economists have long understood the power of markets and the incredible ability of prices to move resources to the places where they will be most productive. While the conditions under which markets work best were clearly laid out by Adam Smith, most of the history of economics since Smith has been focused on understanding the conditions under which markets fail to provide the best outcomes and what can be done—such as the use of public policy—to correct for these failures. These market failures can come from failures of competition, such as monopolies. Market failure can also come from activities that affect third parties uninvolved in trades, such as pollution (a negative externality) or research and development (a positive externality). Finally, market failure can come from a lack of good information (think the current global financial crisis and the collapse of financial markets when they learned they were operating under bad information).

One

Trade is not like sharing the back seat of the car with your brother or sister.
Trade is not a zero-sum game. If I get more, it does not mean that you have to get less. The beauty of trade is that it is mutually advantageous and makes everyone better off. This is true even if one of the individuals (countries) in the trade is more productive. This idea that every individual, as well as every country, can potentially benefit from trade is known as the Law of Comparative Advantage. This is one of the most powerful ideas in the entire history of human thought.

One

Countries can’t get rich by increasing labor and capital alone.
The Soviet Union tried this in the 1950s and 1960s, and it didn’t work out so well. More important than how many inputs you have is how you use these inputs. In the United States and other rich countries, more than two-thirds of our growth comes not from acquiring more inputs but through increasing productivity. Productivity is a function of many things: technology, invention, innovation, knowledge, experience, etc. Understanding the role that each of these factors plays in increasing productivity is a major objective of modern economic research.

One

Rich countries are the ones that have institutions that encourage productive, not destructive, behavior.
At some level, Bill Gates and Ghengis Khan are the same; both men earned their fame by starting out as entrepreneurs. The main difference is that during the 12th century pillaging was a much more profitable startup venture than setting up a yurt and starting your own business. People respond to incentives. The more institutions reward productive behavior that benefits society in general—as opposed to destructive behavior that rewards the individual at the cost of the many—the richer that society will be. These institutions are shaped by factors such as property rights, legal systems, political stability, and protection from corruption. They are also shaped by sociological, cultural, and religious factors that illustrate that economics cannot be studied in isolation from other academic disciplines.

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