What economics studies, and its three questions

"Where does the word 'economics' come from?" From the Greek oikonomia: oikos means household, and nemein means management. So economics began as managing a household. A family with a limited income has to plan; so does a whole country, with limited resources and unlimited wants.

Economics studies how choices are made to make the best use of limited resources to meet needs and wants. It also studies how the players in an economy (consumers, producers, governments and financial institutions such as banks) deal with one another: how people earn wages, how wealth is shared, how prices are set, how education and technology drive investment, and how policies and trade affect prices and jobs.

Good decisions need data, not guesswork. Think of a family's money diary:

• essentials: food, medicines, school supplies;
• non-essentials: jewellery, entertainment, eating out;
• savings.

The government plans spending on roads and welfare from tax money. Companies study market trends to serve customers and earn profits. Economists study the options, their opportunity costs and likely results, using government reports, surveys and company accounts.

Economists work in (Fig. 8.4):

• policy-making: advising governments on taxes or welfare spending;
• business consulting: helping firms grow or work better;
• research and education: studying trends and teaching;
• finance: advising investors where to invest.

The Economic Survey of India is a yearly report by the Ministry of Finance, presented in Parliament before the Union Budget. It reviews how the economy did last year (agriculture, industry, services, jobs, inflation, education, health) and the challenges ahead. It works as a blueprint for the coming Budget.

Now the heart of the chapter. Because of scarcity, every economy must answer three key questions (Fig. 8.5):

• What to produce (and how much)?
• For whom to produce?
• How to produce?

1. What to produce? The book's example: should farmers grow water-hungry crops like sugarcane and paddy, or drought-resistant crops like millets and pulses?

• Sugarcane brings high profits and supports the sugar industry.
• Millets and pulses save water, improve soil health and support sustainable farming.

So the opportunity cost of choosing sugarcane is the water saved and the soil health given up. It is a trade-off between short-term gain and long-term sustainability.

2. For whom to produce? People differ in needs, incomes, tastes and lifestyles, so producers choose which group to serve. Take shoes:

3. How to produce? Choose the mix of land, labour, capital and technology:

• Labour-intensive: more workers, fewer machines. Typical of farming and handicrafts.
• Capital-intensive: more machines and technology, fewer workers. Typical of steel and car-making.

"How does a firm decide?" One picture for each reason:

• Cost: if machines are expensive and workers cheap, use workers; if machines become cheap or workers scarce, use machines.
• Technology: with advanced technology nearby, machines make sense; with little, work is done by hand.
• Nature of the product: a custom-made designer dress needs skilled hands; thousands of identical T-shirts suit machines.
• Laws and rules: labour laws, or government incentives for machinery, also shape the choice.