Warning! When we say economics is a science, we do not mean that we conduct experiments to test economic laws, the way a nuclear physicist studies the results of smashing atoms in a particle accelerator. There are important differences between a social science such as economics, versus a natural science such as physics. We will explain this in more detail in Lesson 2, but for now we simply want to caution you that basic economic principles can be discovered through mental reasoning. It wouldn’t make sense to go out and “test” the laws of economics, just as it doesn’t make sense to use a ruler to go out and “test” the various proofs that you might learn in a geometry class. The upshot of all this is that the lessons in this book will stand the test of time—there is no danger that a new experimental finding will overturn them tomorrow. In practice, professional economists make all sorts of conjectures, many of which turn out to be wrong. But the core body of economic theory—the types of laws and concepts contained in this book—is not testable; it’s simply a way of viewing the world.
Despite the possible confusion of economic science with a natural science, nonetheless we use the term science because it’s important to stress that there really are objective laws of economics. When politicians ignore the teachings of economics, their programs run into disaster—imagine the chaos if NASA ignored the laws of physics!
The Scope and Boundaries of Economic Science
It’s a common misconception for people to think, “Economics is the study of money.” Yes, economics obviously has a lot to say about money, and in fact one of the basic purposes of economics is to explain the different prices—which are quoted in units of money—of various goods and services being sold in the market place.
Contrary to this popular misconception, economics is broader than the mere study of money. In its widest scope, economics can be defined as the study of exchanges. This would include all of the exchanges in a normal market setting, where the seller hands over a physical object or provides a service, and in return the buyer hands over the appropriate amount of money. But economics also studies cases of barter, where the traders exchange goods or services directly with each other, without using money at all.
Pushing it to the extreme, economics even has a lot to say about cases where a single, isolated person takes actions to improve his or her situation. This is often called “Crusoe economics,” after the fictional character Robinson Crusoe who was shipwrecked on an (apparently) deserted island. We will study Crusoe economics in Lesson 4. It will be clear that even an isolated person behaves “economically” because he takes what nature has given him and exchanges the status quo for an environment that he hopes will be more pleasant.
The common theme running throughout all of the examples of exchanges is the concept of scarcity. Scarcity can be succinctly explained by the observation that there are limited resources and unlimited desires. Even Bill Gates faces tradeoffs; he cannot literally do whatever he wants. If he takes his wife out to a fancy restaurant, he has reduced his options (ever so slightly) and has diminished his ability to buy other things in the future. We can describe the situation by saying, “Bill Gates needs to economize on his resources, because they are finite.”
It is the universal fact of scarcity that gives rise to what people have termed the “economic problem”: As a society, how should we decide which goods and services to produce, with the limited resources at our disposal? In Lesson 5, we will see how the institution of private property solves this problem. But it is scarcity that causes the problem in the first place.
Warning! Economics does not study a hypothetical “economic man,” who cares only about acquiring material possessions or earning money. This is another common misunderstanding of what economics is all about. Unfortunately, there is some truth to this stereotype because many economists actually do build models of the economy that are filled with fictitious people who are very selfish and will only act altruistically if they are forced to do so. But in this book, you will not be learning any theories of that flavor. Instead, the lessons in this book do not depend on people being penny-pinchers; the laws we will develop in these pages apply to Mother Teresa as much as they apply to Donald Trump.
Economic science, as taught in this book, does not tell workers that they should take whatever job pays the most money, nor does it tell business owners that they must consider only financial issues when running their operations. These points will be made clearer during the subsequent lessons themselves, but we must stress up front that there is no “economic man” in the following pages; we are always discussing the principles that explain the choices of real people in the face of scarcity. The principles involve the fact that people have desires in the face of limited resources, but the principles are broad enough to cover people with any desires.
Economics deals with the real actions of real men. Its [laws] refer neither to ideal nor to perfect men, neither to the phantom of a fabulous economic man (homo oeconomicus) nor to the statistical notion of an average man Man with all his weaknesses and limitations, every man as he lives and acts, is the subject matter of [economics].
—Ludwig von Mises, Human Action (Auburn, Ala.: Ludwig von Mises Institute, 1998), pp. 646–47
Economics studies and tries to explain how people make exchanges. A shipwrecked sailor wants to “exchange” some sticks and two rocks for a crackling fire, while a missionary wants to “exchange” his leisure time for a grueling trip to a remote jungle where the residents have never seen a Bible. A complete theory of exchanges must cover these types of cases too, not just the more familiar example of a broker exchanging 100 stock shares for $2,000.