Chapter 1

What Economics Is and Why You Should Care

IN THIS CHAPTER

Taking a quick peek at economic history

Observing how people cope with scarcity

Separating macroeconomics from microeconomics

Getting a grip on economic graphs and models

Economics studies how people and societies make decisions that allow them to get the most from their limited resources. And because every country, every business, and every person has to deal with constraints, economics is everywhere. At this very moment, for example, you could be doing something other than reading this book. You could be grueling through your hundredth pushup, bingeing the hottest series on Netflix, or texting with that friend you reconnected with at your last reunion. You should only be reading this book if doing so is the best possible use of your limited time. In the same way, you should hope that the resources used to create this book have been put to their best use and that every dollar your government spends is being managed in the best possible way.

Economics gets to the heart of these issues by analyzing the behavior of individuals, firms, governments, and other social and political institutions to see how well they convert humanity's limited resources into the goods and services that would best satisfy needs and wants.

Considering a Little Economic History

To better understand today's economic situation and what sorts of changes might promote the most significant improvements in economic efficiency, you have to look back on economic history to see how humanity got to where it is now. Please stick with me. I'll make this discussion as efficient and painless as possible.

Pondering just how nasty, brutish, and short life used to be

For most of human history, people didn't manage to squeeze much out of their limited resources. Living standards were quite low, and people lived poor, short, and painful lives. (Forget about being able to microwave the Lean Cuisine you had delivered to your doorstep or have a video chat with your doctor about the peculiarity of your Tuesday-only food allergy.) Consider the following facts, which didn't change until just a few centuries ago:

• Life expectancy at birth was about 25 years.
• More than 30 percent of newborns never made it to their fifth birthdays.
• Most people experienced horrible diseases and starvation.
• The standard of living was low and stayed low, generation after generation. Except for the nobles, everybody lived at or near subsistence, century after century.

In the past 250 years or so, everything changed. For the first time in history, people figured out how to use electricity, computers, television and radio, antibiotics, aviation, and a host of other technologies, including artificial intelligence and genetic engineering. Each has allowed people to accomplish much more with the limited amounts of air, water, soil, and sea they were given on Earth. The result has been an explosion in living standards, with life expectancy at birth now greater than 70 years worldwide and many people able to afford much better housing, clothing, and food than imaginable a few hundred years ago.

Of course, not everything is perfect. Grinding poverty is still a fact of life in a significant fraction of the world. And even the wealthiest nations have to cope with pressing economic problems like unemployment and how to transition workers from dying industries to growing ones. But the fact remains that the modern world is much richer than it was in centuries past. Even better, most nations now enjoy sustained economic growth so that their living standards rise almost every year.

Identifying the institutions that raise living standards

The obvious reason for higher living standards is that humans have recently discovered lots of valuable technologies. But if you dig a little deeper, you have to wonder why a technologically innovative society didn't happen earlier.

The ancient Greeks, for example, invented a simple steam engine as well as a sophisticated mechanical computer that could calculate dates centuries into the future. They even developed a mechanical way of storing what today would be called a computer algorithm. But they never got around to having an industrial revolution or figuring out how they could raise the average person's standard of living.

Ancient Greece wasn't alone. Even though there have always been brilliant people in every society in history, it wasn't until the late 18th century, in England, that the Industrial Revolution started. Only then did living standards begin to rise substantially, year after year.

What factors combined in the late 18th century to so radically accelerate economic growth? The short answer is that the following institutions were in place:

• Democracy: Because the commoners outnumbered the nobles, the advent of democracy meant that, for the first time, governments reflected the interests of society at large. A significant result was the creation of government policy that favored city-dwelling merchants and manufacturers over landed nobles living out in the countryside.
• The limited liability corporation: Under this business structure, investors could lose only the amount of their investments rather than being personally liable for all of a business's debts and liabilities. That reduction in risk led to way more investing - enough, in fact, to pay for factories and railroads and steamships.
• Patent rights to protect inventors: Before patents, inventors usually saw their ideas stolen before they could make any money. By giving inventors the exclusive right to market and sell their inventions, patents provided a financial incentive to produce lots of inventions. Indeed, after patents came into being, the world saw its first full-time inventors - people who made a living by inventing things. (Hello, Thomas Edison, Alexander Graham Bell, and Grace Hopper!)
• Widespread literacy and education: After the Industrial Revolution began, many nations began to make primary education mandatory. They understood that without widespread literacy, there would be few inventors and little progress. In addition, an educated workforce made spreading and implementing new technologies much easier. Soon, middle school and high school were mandated, too, paving the way for rapid and sustained economic growth.

Institutions and policies like these have given people a world of growth and opportunity. We enjoy a material abundance so unprecedented in world history that the most significant public health problem in many countries today is obesity. (Maybe if we had to forage for our own Lean Cuisine.)

Looking toward the future

Moving forward, the challenge is getting even more of what people want out of the world's limited pool of resources. We must face this challenge because problems like infant mortality, child labor, malnutrition, endemic disease, illiteracy, and unemployment are alleviated by higher living standards.

Economists believe that many of the poverty-related problems found in less economically developed areas might be alleviated if those areas adopt some of the institutions that have helped already-developed areas reach high levels of material prosperity.

On the other hand, economists point out that developing areas should learn from the mistakes of the past. There's no need to blindly copy the "smokestack industrialization" and heavy pollution that characterized the economic rise of England, Japan, and the United States in the 19th and 20th centuries. Modern development can be clean and green.

To summarize, three interrelated and excellent reasons should motivate you to read this book and get a firm grasp of economics:

• You can discover how modern economies function. Doing so can help you understand how they've raised living standards and where they could improve.
• By getting a thorough handle on fundamental economic principles, you can judge the economic policy proposals that politicians and activists promote. After reading this book, you'll be much better able to sort the good from the bad.
• You'll be able to spout off some interesting factoids at parties. Hey, whatever it takes to get a date, right?

Framing Economics as the Science of Scarcity

Chapter 2 delves into scarcity and the tradeoffs that it forces people to make.

The fundamental and unavoidable constraint that generates a need for the science of economics is scarcity: There isn't nearly enough time or stuff to satisfy human desires.

To compensate, people have to make hard choices about what to produce and what to consume. If they do so wisely, they can at least have the best of what's possible, even though what they end up with will likely fall far short of everything they dreamed of.

The processes that people follow when attempting to deal with scarcity turn out to be intimately connected with a phenomenon known as diminishing returns, which describes the sad fact that each additional amount of a resource that's thrown at a production process brings forth successively smaller amounts of output.

Like scarcity, diminishing returns is unavoidable. In Chapter 3, I explain how people deal with diminishing returns to get the most out of...