The three fundamental questions of economics are maybe the weirdest thing
you'll hear about in your first Econ class.
So we'll take a slightly unconventional approach to explaining them
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The 3 fundamental questions of economics
Close your eyes.
Imagine you are sitting in a college lecture hall
and your first class of your first economics course is about to start.
Wait! Don't fall asleep!!!
All of your classmates are new to economic theory ... just like you!
Your professor starts by giving you the definition of economics
... something about scarcity and resources ...
then tells you that people behave rationally
although you're not really sure what that has to do with the subject.
Then finally something interesting: the 3 fundamental questions of economics
He tells you economists are concerned with the following questions:
What should be produced? How should it be produced?
Who should get the things that are produced?
The questions reverberate in your mind as you imagine economists
painstakingly collecting data to calculate their answers.
And you drown out your professors voice.
You have arrived in Soviet Russia.
Five-year plans are being crafted.
Charts of toilet paper consumption and cheese production decorate the walls.
Production steps and raw material requirements are being charted.
Wait that's economics? Really???
Ugh ... no ...
But that is the standard approach to teaching it ...
Maybe I was a bit of an edge case.
I switched from studying design to economics and had zero previous knowledge of it
when I sat in my first class. I didn't think I needed it.
Well I don't know how this became the standard approach but I can guess where they're coming from.
So let me explain that to you!
Think of it like we are setting up a game environment.
Those three things your professor throws at you in your first class seem pretty random.
The definition, the rationality assumption and the 3 questions.
But if we input them into our game they start making a little more sense
Let's start with definition: Our world has resources that the creatures in it can use to produce things.
There's a finite amount of each resource, but there are different uses for each
and the creatures in our world want to use the resources for lots of different things.
All right. Now the rationality assumption:
The creatures in our game behave teaspoon ... I mean rationally,
which means they choose actions that are likely to achieve their goals.
There we go! Our game is ready to roll!
... but we're not playing ... we're observing!
We want to see what our creatures will do in this world!
We want to see WHAT THEY WILL PRODUCE with those resources that they have,
WHAT KINDS OF PRODUCTION METHODS and inputs they will choose to produce those things,
and WHO will end up getting the stuff that they produced!
Oh WAIT! Weren't those our 3 fundamental questions?
Uh-huh! So the definition and rationality assumption helped us define the environment we're looking at.
And the three fundamental questions are sort of the behaviors of our creatures that we care about.
We are like ornithologists. We observe where our birds decide to build their nests and hunt for flies,
but we don't try to calculate that for them and tell them what to do.
So economists care about those 3 questions not because they want to calculate the answers,
but because they want to observe how their creatures will find the answers to them.
And they don't actually even want to know the answers that they will come up with
... eleven million one hundred eighty nine thousand nine hundred and eighty five cars,
... three hundred and two million six hundred ninety eight thousand eight hundred and forty-seven loaves of bread.
Ehh ... no they try to think up tools to analyze which conditions
allow the creatures to answer those 3 questions the best
... or in Econ speak, the most efficiently.
Under what conditions do people decide best what to produce?
Under what conditions do people decide best how to produce it?
Under what conditions do people decide best who will get the things that were produced?
To be honest, economics would be a much easier science if we could just compute the answers
to those 3 questions. Then we could optimize, tell everyone what to do, and go home.
But instead economists have discovered that markets, even crappy not very well functioning markets,
are SO MUCH better at answering those 3 questions than any committee of people
that we had to give up on that idea
... except for some die-hard Stalinists and our beloved Venus-projecters.
So now what are those mysterious CONDITIONS that economists care about?
We could call them the "institutions", the "rules of the game", the "law and order" of a society.
You see, markets don't just happen.
Yes, we have a "propensity to truck, barter, and exchange" as good old Adam put it.
But we also have a propensity to steal scam and murder.
So we need conditions that restrict the latter as much as possible.
That's a tricky business, because by giving someone power to punish others for behaving badly,
we might also be giving them a monopoly on stealing, scamming, and murdering.
But our creatures have come a long way already at figuring out how to solve that!
Separation of powers, equality in front of the law, and a well-crafted constitution
were for example pretty important innovations. So today we have pretty good examples of
pretty well functioning markets, and economics is sort of fiddling with the dials to figure out how to
streamline the whole thing even more and make it more efficient.
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