Very Easy Economics:A rudimentary guide to an economist’s most basic assumptions

If you aren’t an (aspiring) economist, the odds are low that you are reading this article. However, if you fit into the category of countless individuals who have an interest in the subject, but are afraid of diving into the textbooks, university courses, and countless magazine subscriptions: you’re in the right place. Neo-classical economics is complicated from afar, but it all stems from five basic assumptions: scarcity, trade-offs, self-interest, costs vs. benefits, and graphical modelling. From there, economists can create further assumptions that lead to a deeper understanding of our most basic behaviours. At its core, economics is hardly the science of complex international trade patterns or alleviating wealth inequality, but rather the natural progression of these basic assumptions into increasingly complex models which seek to understand, predict, and balance a multitude of problems in our world. As phrased by Levitt and Dubner in Freakonomics, economics is “an extraordinarily powerful and flexible set of tools”, a representation “of how [the world] actually does work”. I quote Freakonomics here not only because of its firm place in the centre of the university economics experience, but because of the way it tackles complex (and interesting) scenarios in the real world. Briefly, we will take a look at the five core assumptions of neo-classical economics in relation to daily life.

Scarcity and trade-offs

Humans want an infinite number of things, some real and others unreal. We confront this reality every time we exercise our imaginations. We begin, then, with scarcity: the simple idea that, despite our infinite wants, we exist in a closed environment with finite resources. If only a limited number of our wants can be achieved, and the rest discarded, then we assume that trade-offs must be made. Because you can’t have all of A and all of B, you are limited to a combination of some A and some B that is possible with these finite resources. Imagine for a moment that there is a baker in a bakery who can make you any pastry you could ever ask for. His capacity to bake you pastries would be limited by scarcity, in the same way a firm in an economy may be. You may want a dozen croissants, three chocolate cakes, and a fruit pie, but the baker’s pantry could never hold enough goods to do so, he would not have a kitchen equipped for such a large order, and working alone on such a request could never be completed within the baker’s schedule. While you could wait for the entire order to be filled over the several days, in order to fulfill all of our desires, the earliest pastries would go stale or spoil long before. Because of these limitations, it becomes necessary to make trade-offs. You can have a dozen croissants, or the cakes, or the pie...six croissants and one cake is also possible, but you cannot order a pie with anything else. This is a rendition of the ideas of equivalency and production possibilities that economists deal with on a number of scales.

Cost-Benefit Analysis for Utility

Now imagine that the old baker passes away, and he’s succeeded by his daughter. This daughter is like her father, in that she can make the same goods, but she is unlike her father in that she does not bake her goods upon request, allowing a customer to order pastries by the slice, rather than the whole thing at once. On the morning that the baker is selling croissants, chocolate cake, and fruit pie, you walk in hungry for a bit of everything behind the counter. Now, unburdened by the constraint of what the baker can produce (assuming you only desire the goods already baked), you are confronted with the idea of utility. Utility is an economist’s analog for happiness a consumer derives from consuming. We, as consumers, derive utility from expending a resource in exchange for a good we will consume. This resource is generally money spent on things like t-shirts and cookies (for example), but might also be time out of our work day to spend with friends or watching TV. Think back now to a time you spent watching TV on the couch -- with every episode watched, you gained a certain amount of utility in the form of enjoyment. The utility derived by each additional unit consumed is known as the marginal utility. Despite enjoying watching TV, you eventually stopped to go do other things. This happens because every sitcom episode we watch or cookie we eat (assuming every unit is identical, which in this case they likely are) naturally gives us less satisfaction than the previous unit(s): this is what economists refer to as the law of diminishing marginal utility. Returning to the bakery, if you only have $20 in your pocket for pastries, you do something that humans do unconsciously hundreds of times daily: a cost-benefit analysis. You ask yourself how much utility you’d get from that additional slice of cake… or if your money would be better spent on an extra couple croissants, or maybe another slice of pie. The scope of cost-benefit analyses goes beyond walking through supermarket aisles or picking an outfit in the morning, though. We calculate in our minds the tradeoffs when choosing which parties to attend, which field to study, which person to marry. The outcomes of these analyses are used to maximise our utility and be as happy as possible, and are driven out of self-interest.

Self-interest and Models

Assuming humans act out of self-interest is not to say that we are inherently selfish, but rather that we seek to maximise our own utility above all else, that we’re happiest when we do things that benefit ourselves. Naturally, however, we understand that we are not the only ones affected by our actions, and this understanding leads us to conclude that the utility of others can, in fact, benefit the individual, and thus we can measure utility on an economy-wide scale. The things that drive us to make broader-scale utility decisions are incentives: the idea of spending money we earn on a chocolate cake or working hard during the week to be able to relax on the weekend are just a couple that are familiar to all of us. Economists, for the most part, study the world using different terms for very familiar concepts. Being happy, weighing your options from a limited pool of choices, and making decisions from those options are not foreign concepts to the vast majority of human beings. We can see quite clearly that economics at its most basic level is simply the study of daily life. From these assumptions, economists seek to break down and simplify the modern world, creating models along the way to explain, analyse, and predict real-world situations.

Of course, there are plenty of layers you can add on, allowing economics to branch out into a complex academic field with firm roots in these core assumptions. Some models add to the list of assumptions, but overall the study is simply a litany of the same underlying rules. Shifts in market supply and demand, changes in international exchange rates, policy decisions, and many more seemingly-complex economic phenomena all begin with the choices individuals make over seemingly-trivial matters like which brand of mustard to buy. This is not a guide to informed decision making, but rather a highly simplified guide to economic assumptions: a toolbox to be applied to future problems and endeavours. Hopefully, for our economic dilettantes, this has provided you with a better appreciation and understanding of the world around you and your place in it.