What is Economics?

What is Economics?

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Economics, in one aspect, is the study of how individuals, societies,
and countries manage to deal with the problem of scarcity. Scarcity
is a problem within economics because the wants of people are
unlimited and the resources available to fulfil those wants are finite
(Sloman, 2001). The answer to scarcity is efficiency which Gowland
and Paterson (1993) described as the most benefit from a certain
amount of scarce resources. Within the economic system, there are
several types of economies, each generating a different level of
efficiency. It is said that an economic system that has allocative
efficiency, productive efficiency, and equity will be effective.
Along with the latter mentioned, the division of labour and
comparative advantage, when exploited also bring about the
effectiveness of a system.

Within an economic system there are two contrasting ideals: the market
economy and the planned economy. A free-market or laissez-faire
economy makes decisions on an individual level with minimal government
intervention. On the other hand of the spectrum lies the planned
economy where all economic decisions are made by the government
(Sloman, 2001). Both economies have their advantages and
disadvantages. In a free-market economy there is freedom of choice,
high incentives, and the belief in consumer sovereignty, yet, there
are problems such as inequality of income, macroeconomic instability,
and the chance of market failure. Likewise, though a planned economy
has advantages such as low levels of unemployment and equal
distribution of income, there is a loss of personal freedom and lack
of consumer choice. Many people feel that efficiency lies in the
free-market economy where one can easily answer the questions what
should be produced, how it should be produced, and for whom. However,
the problem with this ‘capitalist’ economy is that poverty and boom
and bust cycles reduce progress (Economic Systems: How Societies adapt
to Problems, 2003). “If you care about economic efficiency, you
should like free markets…But they would also believe the second one
should be qualified, in addition to its stabilisation and distribution
functions, governments will be needed to correct market
imperfections…” (Rhoads, 1999, p.66) Rhoads (1999) mentions how a
market economy leans towards more efficiency but needs the government
sporadically, a combination which makes the so-called mixed economy.
A mixed economy which leans towards laissez-faire, as in the case with
the U.S or the United Kingdom, is rather successful. On the contrary,
countries, such as Burma or North Korea, which slant towards a planned
economy, lack progress.

Along with allocative efficiency, how resources should be allocated,
productive efficiency, which production method should be utilised, and
equity, “specialisation and exchange are both necessary to have an
efficient economy” (Demmert, 1991 p.3). Specialisation comes in the

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form of labour division and exchange in the form of comparative

The theory of division of labour dates back to the time of Adam Smith
when he wrote, “The greatest improvement in the productive powers of
labour, and the greater part of the skill, dexterity, and judgement
with which it is anywhere directed, or applied, seem to have been the
effects of division of labour (1999a p.109). Smith (1999a) explained
the theory of labour division by giving the example of a pin factory
to clarify this theory. Smith (1999a) realised that if he employed 10
people, each performing 2-3 tasks, the total number of pins made was
4,000. Those same 10 people if specialising could make 48,000 pins a
day. The great increase of work is present due to three very
different conditions. One condition was that each worker was employed
to do one business, increasing the adroitness in fulfilling that
task. Secondly, the workers were saving hours by doing one type of
job. If they had to switch jobs they would waste time by going to a
different workplace and using different tools. Thirdly, with the help
of machines, workers could do the work of many (Smith, 1999a). As time
goes by, workers who concentrate on one trade, find cost-effective
methods of performing that task. Men are much more likely to discover
easier and readier methods of attaining any object when the whole
attention of their minds is directed towards that single object than
when it is dissipated among a great variety of things” (Smith, 1999a
p.114) Nevertheless, labour division can also bring down efficiency
and decrease output per person . Drawing wires for almost 20 years, a
worker has become an expert at his task, yet he can lessen
productivity. When one task is repeated day in and day out, the work
becomes monotonous, making the worker less motivated. Additionally,
if one part of the assembly line is missing the entire factory stops
production (Young, 2003). Furthermore, the effectiveness of
specialising depends on the nature of the market. If the market is
small, it is unwise to dedicate entirely to one aspect. For example,
a country carpenter must deal with every aspect of carpentry, from
making wagons to carving wood. On the contrary in large populous
cities the assistance of workers, who would specialise in one area of
carpentry, is required (Smith, 1999a). All the same, the benefits of
labour division do outweigh the minor disadvantages when compared.

Comparative advantage, often referred to as the “Ricardian Model”, is
another vital factor in every efficient economic system (Suranovic,
2003). Adam Smith defined comparative advantage, saying, “What is
prudence in the conduct of every private family can scarce be folly in
that of a great kingdom. If a foreign country can supply us with a
commodity cheaper than we ourselves can make it, better buy it of them
with some part of the produce of our own industry, employed in a way
in which we have some advantage” (Smith, 1999b p.33). Ricardo, as
shown by Griffiths and Wall (2001), further explained this theory
showing how a country could gain by specialising in those products in
which they were relatively more efficient. One can see that
comparative advantage is referred to in terms of international trade.
Nevertheless, comparative advantage is also used when talking about
two producers, Bill and Bob, who exchange. Comparative advantage is
interrelated with opportunity the cost of giving up the next best
thing. The efficiency brought about by comparative advantage can be
seen when comparing two countries, U.K and Japan.


With each country producing what they are relatively better the total
output and consequently the productivity increases (Comparative
Advantage and International Trade, 2003). Each nation has a
comparative advantage in something, even though it may not have an
absolute advantage. The problem with comparative advantage is that at
times goods which are efficient in producing can bring nominal
satisfaction to the producer as a consumer. Moreover, at times
comparative advantage will not be successful if there is not an
adequate terms of trade (Demmert, 1991). Nevertheless, comparative
advantage can be a useful tool in bringing efficacy.

The concept of labour division and comparative advantage are
established, but how do they relate to each other? Interestingly both
these principles can be said to have a cause and effect relationship,
meaning, one possibly occurred because of the other. Smith (Smith,
1999a p.117) elucidated this theory, saying “the division of
labour…is not originally the effect of any human wisdom…It is a
necessary, though very slow and gradual consequence of a certain
propensity…the propensity to truck, barter, and exchange one thing for
another.” For example, the need to exchange (or use comparative
advantage) instigated hunters to specialise, as with the case of
labour division, and make bows and arrows to exchange for something
they did not have. Moreover, Griffiths and Wall (2001) mention how
Ricardo developed on Smith’s theory of division labour to bring about
an increase in specialisation on a worldwide magnitude. Whether
comparative advantage incited the need for labour division or not,
most developed global economies use the two to increase production
levels of the economies. For example, ever since China launched its
“open door” policy in 1979, its exports, due to trade, have since been
growing. Moreover, U.S and Japan, two economic powers, in the areas
of automobiles and agriculture trade with each other on the basis of
comparative advantage. On the contrary, countries such as Burma and
North Korea, which are isolated from the world, have such low
developed economies that electricity is unavailable and production
levels are very low. It is said that “without comparative advantage,
there is no reallocation of resources within each country that will
increase the production of commodities” (Lipsey, 1983 p.425).
Moreover, “to pursue economic growth, you pursue a policy of free
trade to maximise the gains from exchange. A country can specialise
in the industries where it has comparative advantage and import
cheaper product from countries…” (Bronk, 1998 p.91). The combination
of division of labour and comparative advantage spur an economy into
being exceedingly effective.

Altogether, an economy’s main problem is that resources are scarce and
ways to efficiently use those resources are needed. Allocative
efficiency, productive efficiency, and equity help spawn productivity
alongside labour division and comparative advantage. Labour division
helps organise and better employ the resource of labour. Comparative
advantage helps saves time and resources, which a producer might waste
if making something that he is not good at, by making something with a
lower opportunity cost. A producer who can come to grips with the
problem of scarcity knows efficiency can prevail. In theory,
efficiency maybe simple to achieve, but even the strongest of
economies can sometimes fail.
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