What is Economics

Economics is the study of the process that deals with satisfying unlimited wants using limited
resources. It examines how individuals and societies make decisions to meet their needs and
desires when resources are scarce.

Economists have defined economics in different ways:

 Adam Smith (1776): defined it as “an inquiry into the nature and causes of the wealth of
nations.”
 J. B. Say (1803): described it as the science of production, distribution, and
consumption of wealth.
 Alfred Marshall (1920): called it a study of mankind in the ordinary business of life,
focusing on the use of material means for well-being.

All these definitions show that economics is a science dealing with unlimited wants and
limited resources, focusing on how to use those scarce resources most efficiently.

Wants, Scarcity, Resources, and Choice Problem

Wants refer to the willingness of possessing something regardless of affordability. Human

wants are unlimited because people’s desires never end; as soon as one want is satisfied,
another arises.

Resources are the factors used to produce goods and services. Anything that cannot produce
goods or services is not considered a resource. Economists classify resources into four
categories—land, labour, capital, and entrepreneurial ability. These are also known as the
factors of production.

However, every country, regardless of its wealth, faces a limited amount of resources, which
creates the problem of scarcity. Scarcity means the lack of enough resources to produce all the
goods and services that people desire.

From this arises another problem called the choice problem. Since resources are scarce,
individuals and societies must choose which wants to satisfy first and which to postpone. It is
impossible to produce or consume everything at once, so both individuals and governments must
make choices and set priorities. Because scarcity gives rise to the problem of choice, these two
are called the twin problems of economics.

Three Interrelated Economic Problems

From the problems of scarcity and choice, three interrelated economic problems arise:

1. What to Produce.
2. How to Produce.
3. For Whom to Produce
What to Produce

The first problem directly relates to scarcity. Society creates demand for countless goods and
services, but due to limited resources, only a few can be produced. Individuals—at the micro
level—and the state—at the aggregate level—attempt to solve this problem by prioritizing
which goods and services should be produced first.

How to Produce

Capital-Intensive Technology:
A given amount of output can be produced using either capital-intensive or labour-intensive
technology. Capital-intensive technology uses a comparatively higher amount of capital than
labour.

Labour-Intensive Technology:
Conversely, labour-intensive technology uses a comparatively higher amount of labour than
capital.

Recommendations for Nations:

 Affluent nations with abundant capital should use capital-intensive technology to

improve production efficiency.
 Densely populated nations with abundant labour should use labour-intensive
technology, which lowers production costs.

For Whom to Produce

Goods Production Limitations:

No matter the production method, the quantity of goods and services produced is always
limited. The state must carefully distribute them, or some people may receive too much while
others get too little.

Insufficient Total Output:

In reality, output is not enough for everyone. Ignoring this limitation can cause chaos.

Distribution Fairness:
A fair society must focus on justice and efficiency in distribution because all economic
problems stem from scarcity.
Circular Flow of Economic Activity

In a simplified framework, the economy consists of only two sectors — the households and the
business firms. The households own all the resources such as land, labour, capital, and
entrepreneurship, while the business firms hire these resources to produce goods and
services.

Using the resources obtained from households, the firms produce goods and services, and the
households then purchase these goods and services from the firms. The households pay money
to the firms in exchange for the goods and services they consume. In return, the firms pay the
households rent, wages, interest, and profit as compensation for the use of their resources.

The flow of resources (such as land, labour, capital, and entrepreneurship) from households
to firms and the flow of goods and services from firms to households together form the real
flow. The monetary flow refers to the flow of money — the payments made by firms to
households for resources, and the spending by households on goods and services produced by
firms.
If households spend less than they earn, some goods remain unsold, though this is ignored here
for simplicity. In this model, households represent demand and firms represent supply, forming
the basis of microeconomics and macroeconomics.

Microeconomics versus Macroeconomics

Microeconomics studies the behavior of individual economic agents or variables.

Macroeconomics studies the overall behavior of the economy and aggregate variables.

Examples:

 Microeconomic concepts: demand or supply of a good, price of a good, income of a

consumer or producer.
 Macroeconomic concepts: aggregate demand, aggregate supply, price level, national
income.

Microeconomics explains how demand is created through the attainment of utility, using
cardinal and ordinal approaches. Other important topics include price elasticity of demand
and supply, production and cost theory, theory of the firm, market structures, factor
pricing, general equilibrium, and welfare economics.

Macroeconomics focuses on national income, consumption, investment, goods and money

market equilibrium, fiscal and monetary policies, economic growth, international linkages,
and inflation-unemployment relationship. It also studies techniques to stabilize inflation and
unemployment. Since it mainly deals with policies, macroeconomics is often called policy
economics.

Opportunity Cost

Opportunity cost is the next best alternative foregone when an economic decision is made.

Example 1: To produce 5 kg of rice, if a producer gives up the production of 6 kg of wheat, the

opportunity cost of producing 5 kg of rice is 6 kg of wheat.

Example 2: If an individual rejects a job offer to run a business, the opportunity cost of
running that business is the income that could have been earned from being employed.

Note: Opportunity cost is sometimes called implicit cost or invisible cost.

Production Possibility Curve

Production possibility curve (PPC) shows the combinations of two goods that can be
produced under a given technology by efficiently utilizing all of the resources of an economy.
Suppose the economy produces only two goods — food and cloth. Regular shape of a PPC has
been shown below.

In the above diagram:

 Point A shows that the economy produces 12 units of cloth by employing all of the
resources. In this situation, production of food is nil.
  The opposite occurs at point D, where all resources produce 6 units of food alone.
 Points B and C show positive combinations of both food and cloth.

By joining A, B, C, and D, production possibility curve (PPC) is drawn as a concave curve. If

technology improves, PPC shifts outward.

Concavity of PPC reflects increasing opportunity cost. Movement along a PPC exhibits
increase in output of one good and decrease in output of another good.

The underlying concept is known as marginal rate of product transformation (MRPT).

MRPT is the decrease in production of one good due to one unit increase in production of
another good, or vice versa.

The Production Possibility Frontier (PPF) shifts outward when an economy’s resources or
technology improve, allowing it to produce more goods and services than before. This
outward shift indicates economic growth, as the economy can now achieve higher levels of
production and satisfy more wants without sacrificing the output of other goods.

Economic Systems

Economic systems are classified according to who owns the factors of production. These
resources can be owned by private individuals, by society, or by the government. Based on
this, there are three main types of economic systems.

Types of Economic Systems

1. Capitalism
2. Command Economy
3. Mixed Economy

These are the three main types of economic systems, classified according to who owns the
factors of production.

Capitalism

Definition:
In capitalism, individuals own the factors of production. A person who acquires
more resources becomes wealthier and can dominate those with fewer resources.

Price Determination:
Market prices are determined by the interaction of demand and supply.

Key Feature:
The distinguishing feature of capitalism is free competition. Individuals compete freely without
interference from the government or any other authority.
Examples:
Canada, South Korea, Singapore, Germany, Great Britain, and the United States.

Advantages of Capitalism

 Provides individual freedom for all.

 Encourages innovation and creativity.
 Offers an incredible variety of goods and services to choose from.
 Rewards productive people.
 Provides consumer choice.
 Encourages competition, which can lower prices.
 Ensures a high degree of consumer satisfaction.

Disadvantages of Capitalism

 Can lead to inequality of wealth.

 May neglect social welfare needs.
 Not enough public goods such as education, health, and defense.
 Can result in unemployment.
 Risk of monopolies or unfair competition.

How Capitalism Answers the Big Three Economic Questions

1. What to Produce?
Capitalism produces goods and services that consumers demand.
2. How to Produce?
Businesses and entrepreneurs choose the most efficient methods of production to
maximize profit.
3. For Whom to Produce?
Goods and services are produced for those who can afford to buy them.

Definition:
In a command economy, there is no private ownership of property. All factors of production
are owned and controlled by the government. Karl Marx, the proponent of communism,
argued that capitalism causes deprivation because private ownership and free competition
increase the gap between rich and poor. Under communism, the government controls the entire
economy in the name of the people, aiming for a society with no class, no hierarchy, no
currency, and no personal property.

Examples:
The former Soviet Union is a classic example. The government decided how much food,
clothing, and machinery would be produced and at what prices. Factories followed state plans
rather than responding to market demand.

Advantages of a Command Economy

 1. Quick decision-making
2. Focus on social welfare
3. Full employment
4. Control over resources
5. Avoids wasteful competition

Disadvantages of a Command Economy

1. Lack of consumer choice

2. Inefficiency
3. Slow to innovate
4. Risk of corruption
5. Mismatch between production and demand

How a Command Economy Answers the Big Three Economic Questions

1. What to Produce?
The government decides what goods and services will be produced.
2. How to Produce?
The government plans production and instructs producers on what resources and
methods to use.
3. For Whom to Produce?
The government decides who receives the goods and services, often based on people’s
needs or national priorities.

Mixed Economy

Definition:
A mixed economy is an economic system that combines features of both capitalism and
command economy. In this system, private businesses are allowed to operate freely,
producing goods and services to meet consumer demand. At the same time, the government
plays an important role in regulating economic activities and providing essential services to
ensure social welfare and economic stability.

Example:
Countries like Bangladesh and India follow a mixed economy. In these countries, private firms
produce most goods and services, but the government controls key sectors such as health,
education, and infrastructure to protect public interests and promote balanced development.