First, letme introduce some working definitions.
the study of how individuals act and choose among various alternatives of meansand ends in order to reasonably satisfy their needs and wants in the face of scarcity
.This isslightly different from the textbook definition of economics as
the study of how society properlyallocates scarce resources.
While both definitions agree that economics is about the proper allocation of resources, my definition shifts the focus from society (or God forbid a centraleconomic planner) to individuals. This is in line with the principle of
, i.e. only individuals act; and any observed collective behavior and effect can betraced to the actions and decisions of an individual. And this principleis key to the great insightof economist Ludwig von Mises: Economics is about real people. (see his great book
is possession of competent knowledge of fundamental economic conceptsand the ability to properly apply them in daily living. Consider the concept of
or the trade-off between one choice and another. A person who desires to enjoy life wants to doeverything he pleases, but scarcity of time is a reality. Suppose Mark has ten activities that hetruly enjoys engaging in, but he can only do up to three on any given day. He is forced toconstruct a scale of values, which changes on any given day. If for a particular day an activity ishigh in his hierarchy of values, he will prioritize it over that which is on the low end of his valuescale. If Mark loves hiking, fishing, and camping on Tuesday, the 11
of January, he’ll choose todo them over other enjoyable activities such as reading, reflecting, and writing. While Mark mayenjoy doing the latter three, he’ll not engage in them during those days when they are not on topof his scale of values. In light of scarcity of time, we say that Mark chooses to engage in hiking,fishing, and camping and at the same time chooses
to spend time reading, reflecting,andwriting. This is opportunity cost at work. To recognize that there’s opportunity cost in everychoice we make is just being realistic. It is a conscious use of our faculty of reason. When youchoose to apply the wisdom of applying economic principles in life, you are beginning todevelop economic literacy. Ignore this at your own peril.The same insights about opportunity cost can also be applied in financial matters. If there arecompeting goods, choosing to buy item A is also a choice not to buy itemB. In the same manner,choosing to buy A because it is cheaper and also of the same quality as B is also a choice not to buy B notwithstanding that B may have better packaging.At this point, it should be noted that economics is a descriptive science. It does not tell us whichchoices to make. It merely recognizes that individuals make choices based on their subjectivevaluations. It also guides us in analyzing the consequences of any given choice, but the finaldecision is left to the individual.There’s also a related concept called
. It is the tendency to value goods now thanin the future. As the saying goes, a peso today is worth more than a peso tomorrow. To put theconcepts of time preference and opportunity cost together, suppose the person above has chosento buy A, but he’s not decided yet when to buy. A decision to buy A now is a decision not to buyA later and vice versa. If he desires and chooses to buy A now, we say he has high time preference; if, on the other hand, he chooses to buy A later, we say he has low time preference.