INTRODUCTION TO ECONOMICS

Lesson 3

CONCEPTS, PRECEPTS. LAWS AND PRINCIPLES
SCARCITY

The concept of scarcity is central to economics. As we have seen some economists incorporate scarcity into their definition of the subject. The word scarce describes anything, material or immaterial, which is in limited supply, ie. its supply is not infinite. More realistically, scarcity in economics refers to all useful things, ie things which are capable of satisfying a human want, which are not in such supply that all who want them can have their wants completely satisfied. Air, for instance, in most circumstances is not scarce. In earlier times, timber in heavily forested, inaccessible areas was also so regarded. It is the factor of being or not being scarce which determines whether something is or is not an economic good. Goods which are not economic are of little or no concern to economists.


VALUE

When anything, whether material or immaterial, is both desired and scarce, then it has value. Both aspects are necessary; if something is not scarce [in the economic sense, as above] or if no one wants it, then that thing has no value. [ If it were desirable and possible to remove desire from the human condition, other than by death, then value would not exist.]

To find what comprises value or what it means [which is really only another way of saying the same thing] was once a major puzzle for economists. To say, as the dictionary does, that value means the worth of something is of little, if any, assistance. That diamonds, which were of little practical use, should be expensive, whilst water, which was essential to life, should be cheap was seen as a paradox Ėthe Paradox of Value.

Until the 1870s, economists generally took the view that value was intrinsic, that it was something within the thing, which was capable of being independently determined by everybody so as to arrive at some identical objective measurement, much as one could objectively measure the weight or height of something. Taking their cue from the physical sciences, economists postulated that the concept of value was akin to such concepts as mass and distance, and strove to discover the currency and units, which could be used to measure it. Reasoning that if value was within it must stem from the process of creation they focussed on inputs or costs of production. What they generally decided was that the value of something depended on the amount or cost of labour expended in its production- the Labour Theory of Value. This enabled to some extent an objective measure of value of a thing to be determined. Note that it was also consistent with the concept of a Just Price; the idea that there is a natural or fair price for all things, one which can be determined and which concept was [and is still] seen by many as desirable or consistent with morality.

Despite its widespread acceptance the Labour Theory of Value was largely seen as unsatisfactory. It tended to be inconsistent with reality; if there was no demand for something then no matter how much labour went into its production, it still could not command a value. Conversely such things as oak trees grew in value without any labour being expended at all. Pearls do not have value because people dove for them but rather people dove for them because pearls have value. The answer lay not in the production or supply but in the demand.

Resolution of the Paradox came in the 1870s when 3 famous economists, Jevons in England, Walras, a Frenchman living in Switzerland and Menger in Austria, separately formulated what is now termed the Theory of Marginal Utility. There was no single objective value of a whole class or category of things such as coal or stockings or bananas, which was applicable at all places and in all circumstances. Rather value was subjective and lay not in the thing but in the person desiring to use consume or possess it, who determines, given his or her own particular circumstances, how much he or she desires, not the genus or entire quantity of the thing, but a single, marginal unit of it.


COST

In Economics, the concept of cost is not simply a reference to an amount or quantity actually expended in achieving a result ie the explicit cost. Scarcity dominates human existence and forces us to make choices about what use should be made of resources. By definition, choice involves the selection of one option over another. To live is to make choices. Every choice made comes at a cost viz the opportunity forgone to have used the resources to achieve the next most desired alternative option. This is sometimes referred to as economic or opportunity cost. Thus if one has $1 and could use it to purchase 2 apples or 4 oranges the cost of a decision to buy 2 apples is 4 oranges. It is not just choices involving money that give rise to opportunity cost, but rather all choices. The cost of deciding to use a Sunday to go to the beach rather than a trip to the hills is the lost opportunity to have gone to the hills. This approach takes account of both explicit and implicit costs and given that the chooser is presumed to wish to maximise his return, reflects more accurately the overall cost position.

Occasionally when reading economic journals or the financial pages of the press one comes across the word Tanstaafl. This is somewhat of an in-joke. It is an acronym for There Ainít No Such Thing As A Free Lunch, an assertion attributed to the famous American economist Milton Friedman. In one sense it is cynical advice to the naÔve but in another it is reflective of the view that in economics all choices come at a cost.


LAW OF COMPARITIVE ADVANTAGE {COMPARITIVE COST]

This is one of if not the most famous of economic laws It was first formulated by the famous 18th century British economist David Ricardo. It is the theoretical basis for the benefits of trade and for the Division of Labour or increased specialization. It demonstrates that free trade between nations benefits both nations and that it pays for each nation to specialize in those areas in which it has the most advantage or the least disadvantage. Perhaps most importantly it shows that this holds true even if one nation has an absolute advantage over the other in all areas of production.

Ricardo explained the law by comparing, as an example, the cloth and wine makers of England and Portugal. This is best shown by a table;

Number of Labourers Required to produce 1 Unit
 

England

Portugal

Cloth 10 5
Wine 40 5


Portugal thus has an absolute advantage being able to produce both wine and cloth at less cost in labour than England. The first impression is that Portugal should produce both goods and export them to England.. In fact this is not the case; if England, for example transferred its workers from making wine, [where its disadvantage is greater], to making cloth [where its disadvantage is less], then it would increase the amount of cloth it produced by 4 units and decrease the amount of wine by 1. It would seem that Portugal would have nothing to gain by switching its workers from cloth to wine but in fact if it does it increases the number of units of wine produced by 1 and decreases the units of cloth by 1. The net result is that the overall number of units of cloth has increased by 3 and the amount of wine produced has remained the same. There is thus an overall benefit. And by concentrating on wine, where its superior performance is 8 times that of England, rather than in cloth where it is only 2 Portugal too is better off.

The law works also at a private level. It may be for instance that a surgeon is also a good gardener. Yet it pays the surgeon to concentrate on his surgery and hire an inferior gardener, since the time he saves by having someone else do his gardening is more than paid for by using the time saved thereby to perform work as a surgeon.


David Sharp
22/10/01